As I argued in a recent post, tax havens cost the middle class worldwide hundreds of billions of dollars a year, which has to be made up via higher taxes on the middle class, higher budget deficits, or program cuts. In this post, I will discuss several ways to cut the tax havens down to size. Broadly speaking, we need to expose tax haven activities, neutralize them, and ultimately roll back banking secrecy, the key element of havens' existence.
Just as with subsidies, tax havens can only emerge as a political issue if their activities are widely known. One element of this is simply to report on them and keep them in the spotlight. Stories like "Tax Me If You Can" on Frontline exposed tax scams run out of the Caymans that were promoted by one of the world's major accounting firms, KPMG. But the reform that would illuminate the largest dollar volume of tax haven activity would be to force companies to report their accounts on a country-by-country basis rather than the consolidated accounts they now publish. As Palan, Murphy, and Chavagneux point out, consolidated accounts let companies hide their transfer pricing abuses because they do not report inter-affiliate transactions. Being forced to report sales, profits, size of workforce, taxes paid, etc., by location would immediately expose cases where tiny workforces, or none at all, generated big profits in tax havens. Moreover, Palan et al. note, because this regulation is enforced via the companies, it would not require the cooperation of the tax havens, most of which have been uncooperative in providing information despite agreements they may have signed.
Once exposure generates enough political pressure to get something done, specific reforms can be enacted. One way to neutralize corporate use of tax havens is to prevent transfer pricing. This can be done through what is variously called "combined reporting" or worldwide unitary taxation. This approach ignores the legally separate existence of each of a multinational corporation's subsidiaries and treats them as a single entity, using a formula to determine what percentage of the company's profits to tax. For example, if BP makes $25 billion in 2012 and 20% of its operations are in the U.S., under combined reporting the U.S. would tax BP on $5 billion. If 5% of BP's operations are in Louisiana, the state could tax BP on $1.25 billion of income. Determining the proper percentage is done by formula, using factors such as sales, employment, and assets. With combined reporting, it doesn't matter where a company claims it made its income, because the formula overrides such shenanigans.
It should be noted that the Organization for Economic Cooperation and Development, which began targeting tax havens in 1998, opposes combined reporting, despite its efficacy, because multinational corporations oppose it, and the OECD's model tax rules strongly reflect the preferences of the multinationals. Hence, there is something of a contradiction in the OECD position, as I argued in 2002.
However, these reforms still would not get at individual tax evasion, which by itself is estimated to cost governments worldwide $255 billion a year. This requires tackling secrecy directly. One model is the European Union's Savings Tax Directive, which requires that Member States either withhold 35% of interest income earned or provide complete information on all interest income earned in their territories. As Palan et al. recommend, this can be expanded beyond individuals to corporations and trusts (currently a loophole in the directive); it could obviously be expanded to other forms of income. Other measures have been used over the years that can also be effective. One, used by the U.S. Internal Revenue Service in relation to Caribbean tax havens like the Netherlands Antilles, is simply to step up auditing on transactions involving tax havens.
There is still a long way to go in stamping out tax havens. Nevertheless, progress is being made in the EU, and the political climate in the U.S. is far more favorable now than under President Bush. Palan et al. are optimistic that tax havens will be subject to continuing pressure as a result.
Friday, November 18, 2011
Thursday, November 10, 2011
Mississippi's Eminent Domain Reform Initiative Passes with 73%
While national attention focused on the defeat of the "personhood" initiative in Mississippi on Tuesday, voters there approved Initiative 31, an amendment to the state constitution that bans the use of eminent domain to transfer property from one private owner to another (h/t Jim Roos, Missouri Eminent Domain Abuse Coalition) with 73% of the vote.
Eminent domain, where government takes private property for public use, is regulated by the Fifth Amendment to the Constitution, which says, "...nor shall private property be taken for public use, without just compensation." The issue of what constitutes a "public use" has been expanded by court decisions over several decades, with the U.S. Supreme Court's 5-4 ruling in Kelo v. City of New London that economic development qualifies as a public use, even when the property is being transferred to a different private owner.
Eminent domain is heavily entwined with economic development subsidies, in particular tax increment financing. Removing "blight" is often a reason a government can resort to eminent domain, and some variant of blight must be shown in most states to allow the use of tax increment financing. I argued in Competing for Capital that fighting subsidies often attracts "strange bedfellows" coalitions, because they can be criticized on efficiency, equity, and environmental grounds, potentially pulling opponents to subsidies from across the ideological spectrum.
For similar reasons, we see unusual political coalitions fighting private-to-private eminent domain. For one thing, these cases usually involve subsidies, as did Kelo. People understandably don't want to lose their homes, but they are especially incensed if they are losing their homes to enrich a company or private developer. Moreover, such cases can heavily impact minority communities (if property values are lower there) and small businesses (especially if compensation only takes property value into account, but not the value of the ongoing business). In Mississippi, the Southern Christian Leadership Conference and the National Federation of Independent Businesses filed a joint amicus brief with the state supreme court to keep Initiative 31 on the ballot, represented by the libertarian Institute for Justice. Talk about strange bedfellows!
This coalition can break down, however. As Ilya Somin at the Volokh Conspiracy points out, when eminent domain reform is paired with other measures, it often fails. He gives the examples of Proposition 98 in California, which included rent control restrictions, and Proposition 90, which included "regulatory takings" provisions (these limit government ability to adopt new regulations). Understandably, those additions saw off the liberal wing of the eminent domain reform coalition. "By contrast," he says, "all twelve 'clean' anti-Kelo measures have passed, usually by lopsided margins..." The Institute for Justice, however, does push "regulatory takings" provisions. To its credit, it did not demand them as a price for defending Initiative 31 in court.
With the passing of Initiative 31, Mississippi has given subsidy opponents leverage as well as protecting property owners from having to transfer their property to private developers, which often translates into an additional subsidy.
Eminent domain, where government takes private property for public use, is regulated by the Fifth Amendment to the Constitution, which says, "...nor shall private property be taken for public use, without just compensation." The issue of what constitutes a "public use" has been expanded by court decisions over several decades, with the U.S. Supreme Court's 5-4 ruling in Kelo v. City of New London that economic development qualifies as a public use, even when the property is being transferred to a different private owner.
Eminent domain is heavily entwined with economic development subsidies, in particular tax increment financing. Removing "blight" is often a reason a government can resort to eminent domain, and some variant of blight must be shown in most states to allow the use of tax increment financing. I argued in Competing for Capital that fighting subsidies often attracts "strange bedfellows" coalitions, because they can be criticized on efficiency, equity, and environmental grounds, potentially pulling opponents to subsidies from across the ideological spectrum.
For similar reasons, we see unusual political coalitions fighting private-to-private eminent domain. For one thing, these cases usually involve subsidies, as did Kelo. People understandably don't want to lose their homes, but they are especially incensed if they are losing their homes to enrich a company or private developer. Moreover, such cases can heavily impact minority communities (if property values are lower there) and small businesses (especially if compensation only takes property value into account, but not the value of the ongoing business). In Mississippi, the Southern Christian Leadership Conference and the National Federation of Independent Businesses filed a joint amicus brief with the state supreme court to keep Initiative 31 on the ballot, represented by the libertarian Institute for Justice. Talk about strange bedfellows!
This coalition can break down, however. As Ilya Somin at the Volokh Conspiracy points out, when eminent domain reform is paired with other measures, it often fails. He gives the examples of Proposition 98 in California, which included rent control restrictions, and Proposition 90, which included "regulatory takings" provisions (these limit government ability to adopt new regulations). Understandably, those additions saw off the liberal wing of the eminent domain reform coalition. "By contrast," he says, "all twelve 'clean' anti-Kelo measures have passed, usually by lopsided margins..." The Institute for Justice, however, does push "regulatory takings" provisions. To its credit, it did not demand them as a price for defending Initiative 31 in court.
With the passing of Initiative 31, Mississippi has given subsidy opponents leverage as well as protecting property owners from having to transfer their property to private developers, which often translates into an additional subsidy.
Tuesday, November 8, 2011
Republicans Prepare Ground to Renege on Debt Reduction Agreement
Looks like Markos Moulitsas was right, as I suspected. Ali Gharib is reporting at Think Progress Security that Congressional Republicans, including Senators John McCain and Pat Toomey, are laying the groundwork for weaseling out of the August debt ceiling accord provisions that if the Super Committee reaches no agreement, it triggers $600 billion in defense cuts over 10 years. Gharib quotes McCain yesterday (emphasis Gharib's):
We are looking at a stand-alone bill to negate what Republicans supposedly gave up in the debt ceiling negotiations, canceling the $600 billion in defense cuts. If it passes, Democrats will have given up $600 billion in cuts to domestic programs -- for exactly nothing in return. Yet another Lucy pulls away the football moment. Gharib recommends that President Obama issue a veto threat against such a bill now, but it's not like $1.5 trillion in cuts is good policy in a jobs recession. But Gharib may be right, on the grounds that the President needs to hold Republicans to their deals. Will the President hold his ground? Get ready for the cries of "You don't support the troops."
The sequestration is not engraved on golden tablets. It is a notional aspiration. And those of us — and I think we’d have sufficient support to prevent those kind of cuts from being enacted because of the impact it would have on national security.
We are looking at a stand-alone bill to negate what Republicans supposedly gave up in the debt ceiling negotiations, canceling the $600 billion in defense cuts. If it passes, Democrats will have given up $600 billion in cuts to domestic programs -- for exactly nothing in return. Yet another Lucy pulls away the football moment. Gharib recommends that President Obama issue a veto threat against such a bill now, but it's not like $1.5 trillion in cuts is good policy in a jobs recession. But Gharib may be right, on the grounds that the President needs to hold Republicans to their deals. Will the President hold his ground? Get ready for the cries of "You don't support the troops."
How Transfer Pricing Hurts the Middle Class
One of the basic building blocs for understanding the effect of tax havens is the mechanism by which profits show up in the havens rather than the countries where they are really earned. This tool is known as “transfer pricing,” which at its most basic is simply the centralized setting of prices for transactions between two subsidiaries of the same company. The fact that intra-corporate sales make up much of world trade (estimates range between 33% and 60%) means that how the prices are set can have a huge economic impact.
When one subsidiary of a multinational company sells something to another one, the price for the good or service is not set in a market. A Ford transmission will not work in a Chevrolet, so there is no independent buyer for products like that. But for Ford Motor Company to know how well its various entities are doing, it has to have prices attached to intra-corporate sales. The pricing system is centralized, and can be used for multiple purposes; the most interesting for our purposes is shifting profits into lower tax jurisdictions. The charts below show how this works. In the example, it is the price of the transmission that is set via transfer pricing for the sale of French-made transmissions for use in final assembly in the U.K. All numbers are arbitrary.
| | Ford France | | Ford UK |
| | | Price of car | 15000 |
| Price of transmission | 1000 | Price of transmission | 1000 |
| Cost of production | 500 | All other costs | 12000 |
| Pre-tax profit | 500 | Pre-tax profit | 2000 |
| Tax at 40% | 200 | Tax at 20% | 400 |
| Post-tax profit | 300 | Post-tax profit | 1600 |
Total post-tax profit: $1900
| | Ford France | | Ford UK |
| | | Price of car | 15000 |
| Price of transmission | 600 | Price of transmission | 600 |
| Cost of production | 500 | All other costs | 12000 |
| Pre-tax profit | 100 | Pre-tax profit | 2400 |
| Tax at 40% | 40 | Tax at 20% | 480 |
| Post-tax profit | 60 | Post-tax profit | 1920 |
Total post-tax profit: $1980
We have the same car, the same final selling price, the same cost of production, the same pre-tax profit. But by reducing how much Ford France charged Ford UK for the transmission, profit was shifted into the lower tax country (in this example, the UK). Post-tax profit increased by the change in sales price ($400) times the difference in the tax rate (20%).
Of course, it is not like tax authorities don't know that shenanigans like this can arise. But it can be hard to detect it even if you're looking for it. Richard Caves' Multinational Enterprise and Economic Analysis provides a good overview of many research studies, which have found that it easier to get away with abusive transfer pricing when there is no real arm's length market for the good. For example, there is obviously a large market for spark plugs, so it's relatively easy to see if the price a company assigns for their sale between subsidiaries makes sense. On the other hand, there is frequently no market for a company's patents, because it often does not want to license them to other firms because they are a source of competitive advantage. That explains why Microsoft put patents in an Irish subsidiary where the royalties are untaxed: there is no good way to determine if the prices charged to other subsidiaries for their use is a reasonable one or not.
We see, then, that by a relatively simple mechanism a company can make its profits show up in lower tax jurisdictions. As previous columns discussed, most multinationals have a substantial network of subsidiaries in tax havens to reduce the taxes they pay in the U.S. and other developed countries. Their reduction, of course, means higher taxes for us, higher deficits, program cuts, or some combination of the three.
My next post will deal with how to combat tax havens.
Monday, November 7, 2011
How Profitable Fortune 500 Companies Save $70 Billion a Year in Taxes
A new report by Citizens for Tax Justice and its sister organization, the Institute for Taxation and Economic Policy (h/t Dirt Diggers Digest), documents the extent to which the Fortune 500 is able to skate around the tax system and pay far less than its fair share. The study covers 280 firms in the F500 that had pre-tax profits in the U.S. every year from 2008 to 2010, excluding companies that reported "ridiculous" geographic allocations of their pre-tax profits
Between subsidies, stock options, indefinite deferral of taxes on income earned abroad, apparently abusive transfer pricing, skillful use of tax havens, and aggressive tax shelters (which can only be identified after the fact), these companies reduced the amount of their global income that was taxable in the United States, and slashed the amount paid on their U.S. taxable income by over $70 billion per year. That is, the difference between what these companies would have paid at the 35% corporate income tax on their $1.4 trillion in U.S. profits over those three years, and what they actually paid, came to $222.7 billion.
This only scratches the surface. Note that this is only the companies' U.S. income--which has already been reduced by transfer pricing, making profits show up in low-tax foreign jurisdictions. The report singles out Google and Microsoft because "almost all or even more than all of their pretax profits were reported as foreign, even though most of their revenues and assets were in the United States." In Microsoft's case, as I report in my latest book, one of its subsidiaries in Ireland had $16 billion in patent assets but almost no employees, draining royalties from the U.S. to Ireland for booking purposes. U.S. companies do not pay taxes on their foreign earnings until they are brought back to the United States. As the CTJ/ITEP report points out, if the U.S. stopped taxing foreign earnings, as for example, Herman Cain and Rick Perry advocate, this would create even bigger incentives to declare profits overseas rather than in this country.
Considering U.S. taxes only, the report shows that 30 companies paid negative tax rates on their 2008-10 domestic income, with General Electric having negative taxes in all three years, receiving $4.7 billion in tax refunds despite $10.5 billion in U.S. pre-tax income.
As I have emphasized repeatedly, what one group does not pay in taxes means higher taxes on others, greater deficits, or budget cuts. One way or the other, those of us who do pay our taxes are harmed by those who do not. This report does a great job spotlighting the worst offenders. In posts in the near future, I will discuss how transfer pricing works, and ways to tackle tax havens.
Between subsidies, stock options, indefinite deferral of taxes on income earned abroad, apparently abusive transfer pricing, skillful use of tax havens, and aggressive tax shelters (which can only be identified after the fact), these companies reduced the amount of their global income that was taxable in the United States, and slashed the amount paid on their U.S. taxable income by over $70 billion per year. That is, the difference between what these companies would have paid at the 35% corporate income tax on their $1.4 trillion in U.S. profits over those three years, and what they actually paid, came to $222.7 billion.
This only scratches the surface. Note that this is only the companies' U.S. income--which has already been reduced by transfer pricing, making profits show up in low-tax foreign jurisdictions. The report singles out Google and Microsoft because "almost all or even more than all of their pretax profits were reported as foreign, even though most of their revenues and assets were in the United States." In Microsoft's case, as I report in my latest book, one of its subsidiaries in Ireland had $16 billion in patent assets but almost no employees, draining royalties from the U.S. to Ireland for booking purposes. U.S. companies do not pay taxes on their foreign earnings until they are brought back to the United States. As the CTJ/ITEP report points out, if the U.S. stopped taxing foreign earnings, as for example, Herman Cain and Rick Perry advocate, this would create even bigger incentives to declare profits overseas rather than in this country.
Considering U.S. taxes only, the report shows that 30 companies paid negative tax rates on their 2008-10 domestic income, with General Electric having negative taxes in all three years, receiving $4.7 billion in tax refunds despite $10.5 billion in U.S. pre-tax income.
As I have emphasized repeatedly, what one group does not pay in taxes means higher taxes on others, greater deficits, or budget cuts. One way or the other, those of us who do pay our taxes are harmed by those who do not. This report does a great job spotlighting the worst offenders. In posts in the near future, I will discuss how transfer pricing works, and ways to tackle tax havens.
Tuesday, November 1, 2011
Poll Results: Anti Counterfeiting Trade Agreement
The poll is now closed.
Had you heard of the Anti Counterfeiting Trade Agreement (ACTA) before today?
Yes: 1
No: 9
No surprise here; the agreement is not well known. But as I argued in the related post, this treaty, if it withstands constitutional challenge, will increase the cost of medications in many countries by taking away the ability of government health agencies to negotiate with drug companies for lower prices.
Had you heard of the Anti Counterfeiting Trade Agreement (ACTA) before today?
Yes: 1
No: 9
No surprise here; the agreement is not well known. But as I argued in the related post, this treaty, if it withstands constitutional challenge, will increase the cost of medications in many countries by taking away the ability of government health agencies to negotiate with drug companies for lower prices.
Tax Havens Cost the Middle Class Untold Billions
As I argued yesterday, when taxes are reduced for one group, government must raise taxes on someone else, run bigger deficits, or cut programs. Tax havens, jurisdictions with strong secrecy provisions and low or zero tax rates, are one way that rich individuals and corporations reduce their tax payments, both legally and illegally. A recent book by Ronen Palan, Richard Murphy, and Christian Chavagneux summarizes the latest work on tax havens and contends that they form a central part of the global economy. Tax Havens: How Globalization Really Works presents data that 30% of multinational corporations' foreign direct investment passes through tax havens like Bermuda, Ireland, or Luxembourg, overwhelmingly for tax purposes. Tax havens, then, are far more central to the global economy than we generally suppose.
How much does this cost average taxpayers? In a separate report, Murphy calculated that wealthy individuals have roughly $11.5 trillion in tax havens, which at a 7.5% rate of return would generate $860 billion in income each year. If, on average, these people faced a 30% marginal tax, that would come to $255 billion annually that the rich avoid in taxes. Needless to say, this is a best guess, since the value of these assets is not disclosed publicly. See his report for more details on how he generated those figures.
That's just individuals. The situation with corporations is murkier still. While corporations set up subsidiaries in tax havens for the obvious purpose of reducing their tax, Palan et al. say there is no solid estimate of the overall cost of these activities. The Government Accountability Office reported in 2008 that of the largest 100 U.S. companies, 86 had subsidiaries abroad, and 83 of these had subsidiaries in tax havens. Bank of America had 115 subsidiaries in tax havens, including 59 in the Cayman Islands. Citigroup had a whopping 427 tax haven subsidiaries, including 91 in Luxembourg and 90 in the Cayman Islands. Goldman Sachs only had 29, 15 in the Cayman Islands.
I mention the Cayman Islands because President Obama has long been a critic of tax havens, saying during the 2008 campaign of Ugland House in the Cayman Islands, "Either this is the largest building in the world or the largest tax scam in the world. And I think the American people know which it is." Palan et al. report that the Caymans are the sixth largest financial center in the world, with $1.9 trillion in assets in December 2007. However, since taking office, the President has not succeeded in passing a version of the Stop Tax Haven Abuse Act, which in its original form he co-sponsored with Carl Levin, Norm Coleman, Ken Salazar and Sheldon Whitehouse.
Tax havens could not exist without the financial services industry, which provides the tax lawyers, accountants, and other professionals who make it possible for the rich and corporations to reduce their taxes. Collectively, they and their clients are the 1%. Occupy Wall Street has highlighted the abuses benefiting them, and tax havens are most definitely part of their pattern of abuse. Tax havens have proved amazingly resilient, however, and it will take sustained political pressure to shut them down.
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