Corporate "Inversions" Shift the Tax Burden to Us

Corporate "inversions" are back in the news again, as multinational corporations try every "creative" way they can to get out of paying their fair share of taxes for being located in the United States. With inversions, the idea is to pretend to be a foreign company even though it is physically located and the majority of its shareholders are in the U.S.

"What's that?" you say. At its base, what happens with an inversion is that a U.S. corporation claims that its head office is really in Ireland, the Cayman Islands, Jersey, etc. Originally, all you had to do was say that your headquarters was abroad. Literally.

Now, the rules require you to have at least 20% foreign ownership to make this claim, but companies as diverse as Pfizer, AbbVie, and Walgreen's are set to run rings around this low hurdle. The basic idea is that you take over a smaller foreign company and pay for it partly with your own company's stock to give the shareholders of the foreign takeover target at least a 20% ownership stake in your company.

Thus, with pharmaceutical company AbbVie's takeover of the Irish company Shire (legally incorporated in the even worse tax haven Jersey), Shire's shareholders will own about 25% of the new company, thereby qualifying to take advantage of the inversion rules. It expects that its effective tax rate will decline from 22.6% in 2013 to 13% in 2016. Yet nothing will actually change in the new company: it will still be headquartered in Chicago, and the overwhelming majority of shareholders will be American.

As David Cay Johnston points out, even some staunch business advocates like Fortune magazine are calling this tax dodge "positively un-American." Further, as he notes, Walgreen's wants to still benefit from filling Medicare and Medicaid prescriptions even if it ceases to pay much in U.S. corporate income tax. In other words, it will get all the benefits of being in the U.S., including lucrative government contracts, without paying for the costs of government.

As I told The Fiscal Times, if companies like these get their tax burden reduced, there are only three possible reactions that can occur: someone else (i.e., you and me) will pay more taxes; the government must run a higher deficit; or government programs must be cut. Of course, there is a limitless number of combinations of these three changes that can result, but one or more of them has to happen.

What can we do about this? One obvious answer to to raise the bar for foreign ownership to at least 50%+ to call a company foreign. Even more comprehensive, as reported by Citizens for Tax Justice, would be to continue to consider a company "American" for tax purposes as long as it had "substantial operations" in the United States and was managed from the United States. Furthermore, the Obama Administration has proposed limiting the amount of deductions American companies can take for interest paid on loans "from" their foreign subsidiaries, thereby preventing what is often called "profit stripping." Another idea, from Senator Bernie Sanders, would be to bar such companies from government contracts.

The whole concept of "inversions" no doubt sounds very arcane to the average person. But one of the bills to rein them in is estimated to raise $20 billion in tax revenue over the next 10 years. The stakes are substantial, so we need to take a minute to wrap our head around it if we want to head off yet another way in which the tax burden is shifted to the middle class.

Cross-posted at Angry Bear.

Piketty on the minimum wage

A lot going on with the minimum wage lately, but I will contextualize it first with Thomas Piketty's analysis in Capital in the Twenty-First Century, pp. 308-313. I'll have more to say about other parts of the book later, but for now it's important to remember that one of the keys to the book's success is that it is built on a gigantic trove of long-term data. His French wealth data, for example, goes all the way back to the immediate aftermath of the French Revolution! (Speaking of which, it's Bastille Day as I write this.)

Piketty writes in this section about increasing labor income inequality in the United States and the importance of labor market institutions in affecting wages in the medium term even as education (though see Jeff Faux's dissent in The Servant Economy) and technology are the keys to the long-run wage possibilities. He counterposes the steady increase in the real (i.e., inflation-adjusted) value of the French minimum wage since 1950 to the decline of the real U.S. minimum wage since it peaked in 1969 at $10.10 in 2013 dollars. At $7.25 today, it is a full 28% below its peak, and 1/3 less than the current French minimum wage at purchasing power parity in 2013 (see stats.oecd.org, search "data by theme" and select "labour," then "earnings," then "real minimum wages," and set the series to "US$PPP" and the pay period to "hourly.")

This decline of the real value of the minimum wage is why Piketty argues that an increase in the U.S. would make sense, much more so than in France. At this low level, there is much less danger of a negative impact on the number of jobs. His key insight is that if wages are too low, that itself causes economic inefficiencies and can even create inefficiencies for the firm. In particular, if wages are too low, it can cause workers to acquire fewer firm-specific skills than would be optimal for the employer. This would seem to hold economy-wide as well: if the general wage level is too low, workers have less incentive to acquire skills that would make them and the economy as a whole more productive. Additionally, Piketty argues that employers' superior bargaining position and the absence of "pure and perfect" competition in labor markets justifies the limits on companies' power embodied in the minimum wage.

The minimum wage has also been in the news this month. The biggest story is that for the first time Germany has adopted a minimum wage effective in 2015, set at €8.50 ($11.60) an hour. This was the price Angela Merkel had to pay to bring the Social Democratic Party into her governing coalition. In addition, the minimum wage in the future will be set by a national commission made up of labor and business representatives.

Finally, a new study by the Center for Economic Policy Research finds that the 13 states that raised their minimum wage on January 1 had higher rates of job growth (0.99% vs. 0.68%) through May 31 than the 37 states that did not raise their minimum wage. While the study does not claim to be definitive, it is one further piece of evidence that the minimum wage is not a job killer at the levels seen currently in the United States.

Cross-posted with Angry Bear.

Three Year Anniversary!

Today marks the three-year anniversary of Middle Class Political Economist. It's hard to believe I've been at this for three years!

According to Blogger, I've had over 480,000 page views in that time. I want to thank everyone for reading, commenting, and emailing me. I owe a debt of gratitude to all those who have helped promote my blog, including Marty Pflugrath at BartCop Entertainment, Mark Thoma, Brad DeLong, Laffy at The Political Carnival, the folks behind Mike's Blog Roundup at Crooks & Liars, Mike the Mad Biologist, Lynn Parramore at AlterNet, and Dan Crawford at Angry Bear. Many of my posts appear at Angry Bear and Daily Kos as well as here. My wife, Mary Hildebrand, comes up with some of the ideas for my articles and is a wonderful sounding board who is always there for me. None of them, of course, are responsible for my errors. My apologies to anyone I have left out.

My goal for the next year is to post on a more regular schedule. Look for Monday and Friday as my regular posting days. Naturally, posts in between are possible whenever warranted.

Thanks once again, everyone! I look forward to your suggestions and criticisms in the Comments section or via email to kpthomas55@hotmail.com.

Stopping Job Piracy in Dayton, Denver,... and maybe even Kansas City

As I have reported before, job piracy is a big problem in metropolitan areas like New York City and Kansas City. Giving subsidies to relocate existing facilities is a net loss for the country and for the region as well. The flip side is that the existence of job piracy makes it possible for companies to threaten to leave their current location unless they get a subsidy, as Sears has done twice in Illinois. I showed in my book Competing for Capital that several multi-state agreements to end job piracy have been total failures.

A new study by Good Jobs First, "Ending Job Piracy, Building Regional Prosperity," reports on a couple of success stories. Notably, these have not involved state governments, but take place in two metropolitan areas, in Dayton, Ohio, and in Denver. The study also reports on failed regional efforts in Minneapolis/St. Paul and Kansas City (but see more below).

The oldest of these successes is the Metro Denver Economic Development Corporation, created in the late 1980s. Its aim is to promote the entire metropolitan area as a single region, using transparency and information exchange among municipalities to prevent site selection consultants from playing different cities off against one another. All members sign a Code of Ethics committing themselves to these goals.

The Code is not a law, but it does provide for a dispute resolution process in the case of an alleged violation. A complaint triggers this process:

the Chair of the organization will call together three to five members into a meeting with the offender. If the member’s behavior is determined to be inappropriate, the offending individual is asked to issue a public apology or issue a statement to staff correcting their action and guiding future actions.

As the Good Jobs First report points out, dispute resolution has only been invoked three times in the 26 years the agreement has been in effect, and no Economic Development Corporation member has had to be expelled, the strongest sanction available for violating the Code of Ethics.

In Dayton/Montgomery County, Ohio, there are two programs that promote regional cooperation. Economic Development/Government Equity (ED/GE) began in 1991, and provides a $5 million annual pool for "regionally significant projects in the county." It also shares increased tax revenues with slower-growing municipalities in the county. Applications for the $5 million fund are judged competitively and the process will only consider funding for relocations under very narrow circumstances and only then with a letter of support from the city losing the company.

In addition, all the Montgomery county municipalities, as well as some in neighboring counties, participate in a program called Business First! that promotes the region as a whole and, like Denver's Code of Ethics, requires information sharing when a company is seeking to move within the region. Business First! also provides for a transitional tax-sharing agreement when there is an intra-regional move.

The new report emphasizes the need for engagement with economic development officials, because they actually do the work and they represent the institutional memory necessary for these agreements to remain viable in the long term. As always, transparency is a key element that is a precondition for accountable governance.

In addition to these success stories, potential good news on the job piracy front came out of Missouri last week. On July 1, Democratic Governor Jay Nixon signed a bill passed by the Republican-majority legislature that would disallow the use of state incentives to firms relocating from four Kansas counties to the four counties that make up the core of Kansas City, Missouri. This represents a dramatic turnaround from 18 months ago, when both Nixon and Kansas Republican Governor Sam Brownback told New York Times reporter Louise Story, on camera, that they would continue poaching from the other state.

Missouri's law takes effect only if Kansas passes a parallel law. As Kansas City business leaders have pointed out, the two states have given more than $200 million in tax breaks for relocations, only to see a net 400 jobs move to Kansas. Unfortunately, so far Kansas leaders have given no indication that they will follow suit. However, the Missouri law gives Kansas until August 28, 2016 to do so. Hopefully, some sense will prevail in Kansas by then.

Cross-posted at Angry Bear.

Think Obamacare isn't working? Think again

Republicans seem obsessed with the idea that Obamacare is a failure; that it is a "train wreck" exacerbating unemployment. But is that really so?

First of all, the claim that the Affordable Care Act is a job killer flies in the face of reality, as Dan Diamond at Forbes reports:  Since the law was signed in March 2010, the economy has added 7.7 million jobs, 982,300 of which are in the healthcare field. If Obamacare is a drag on employment, its effect is being drowned by other factors. Of course, the fact that healthcare is gaining jobs at a healthy clip suggests it's not a drag on employment at all.

Diamond also highlights important differences between states that expanded Medicaid and those which did not. He cites a Colorado Hospital Association study of 465 hospitals in 15 expansion states and 15 non-expansion states, which show sharply divergent patterns in the two groups on the number of people seen at the hospital without insurance, and the volume of charity care per hospital. Here is his chart, a selection from that available in the CHA study.


Source: Colorado Hospital Association, June 2014, link above


As we can see, hospitals in both expansion and non-expansion states were seeing between 4.5% and 5% uninsured quite consistently in 2012 and 2013. (Note that the study did not include Texas or California, the biggest state in each category, both of which had high overall uninsured rates.) In the first quarter of 2014, as new insurance began to kick in, there was an immediate drop to 3.1% in the expansion states, while the figure actually edged up in the non-expansion states to 5.0% from 4.8% a year previously.

For charity care, there was already a noticeable difference between the two sets of states over 2012-2013, where hospitals in expansion states provided an average of $3 million in charity care per quarter vs. about $4 million in non-expansion states. Again, we see an immediate improvement in the expansion states in the first quarter of 2014, falling by about 1/3 to $1.9 million, compared to a slight increase in the non-expansion states relative to the first quarter of 2013.

Meanwhile, rural hospitals are closing in non-expansion states, prompting the Republican mayor of Belhaven, North Carolina, where Vidant Pungo Hospital is closing, to call on the state to accept the Medicaid expansion made optional by the U.S. Supreme Court's ruling that upheld the ACA's individual mandate.

In another post, Diamond underlines other dimensions of Obamacare that usually go under the radar. Perhaps the most powerful, but rarely discussed, effect is that on healthcare quality. Diamond catches a December 2013 study from the Centers for Medicare and Medicaid Services (CMS). As Diamond explains, one early ACA initiative allowed CMS to reduce Medicare payments to hospitals that had high re-admission rates, which is generally an indicator of poor care. Specifically, as the study says, re-admissions within 30 days "often means there have been unclear instructions to patients or lack of follow-up care." Here is the 30-day re-admission rate for Medicare from 2007 through August 2013.

Source: Office of Information Products and Data Analytics, CMS (link above)


As we can see, there was virtually no change from 2007 through 2011. But in 2012, the rate fell by a full half-point, and by even more than that in the first eight months of 2013. As Diamond points out, this is pretty hard to spin as anything but a success for Obamacare. He also provides a map from the study which shows that virtually the entire country had an improvement (see link to the study or his article). In only six states were there any areas seeing worse performance, defined as an increase of over 0.25 percentage points. Numerous states saw increases in all of their CMS regions, and plenty of regions saw improvements greater than 1.5 percentage points, including Las Vegas, Memphis, and almost all of Kansas.

Finally, let's look at the issue that has dominated the discussion: Are more people actually insured? Paul Krugman sends us to the Gallup poll on the percentage of uninsured Americans. The poll, based on more than 30,000 interviews in April and May, showed that the uninsured rate dropped 3.7 percentage points for all adults from the 4th quarter of 2013 to April-May 2014 (see graph below). It dropped 6.2 percentage points for African-Americans and 6.0 points for those with an income below $36,000.


The best estimate of total ACA enrollments continues to come from Charles Gaba at ACAsignups.net, who estimates a range from 23.6 to 28.2 million gross enrollments.

Finally, don't forget the PP in PPACA, patient protection. Everyone can now get insurance regardless of pre-existing conditions, no one can have their insurance canceled because they get sick, and no one has annual or lifetime insurance caps anymore. Indeed, these factors may well lead us to see a decrease in the country's bankruptcy rate, as medical bankruptcies become less frequent.

Obamacare not working? Don't believe the hype.

Cross-posted at Angry Bear.

Apple, Starbucks, Others Under EU Tax Investigation

No sooner do I comment on the difference between tax planning and tax avoidance than Richard Murphy points out that several multinational corporations are having their tax deals looked at for potential violations of the European Union's state aid rules. As The Guardian and The Wall Street Journal report, there are three cases currently under investigation by the European Commission, but more investigations may be opened in the near future.

First is Apple in Ireland. What a surprise! It has a subsidiary it claims is taxable nowhere, incorporated in Ireland but managed from California, which under Irish law makes the subsidiary not subject to Irish tax. Of course, since it is incorporated in Ireland, Apple can defer its U.S. taxation on the unit's profits until it repatriates them, if it ever does so. Two issues are relevant here: Did Ireland's creation of this class of entity provide firms with state fiscal aid? Second, did Ireland negotiate a special deal with Apple giving the company a tax rate far below Ireland's already low 12.5% corporate income tax rate, as Apple CEO Tim Cook testified last year before the U.S. Senate, under oath. In fact, according to the New York Times, the company paid " as little as one-twentieth of 1 percent in taxes on billions of dollars in income." One source quoted by the Times said the company saved $7.7 billion in taxes in 2011.

If the tax saving in Ireland is deemed to be state aid, the Commission would have to determine two things: Was it notified to the Commission, as required by the state aid rules? (No, or we wouldn't be having this investigation in the first place.) Is the aid compatible with the common market, and thus allowable? My guess is that the Commission expects to find that fiscal aid to Apple and others (see below) distorts competition, and hence is not compatible with the common market.

It is worth remembering that Ireland has a 12.5% corporate income tax rate, rather than the 10% rate it had for decades, precisely because in 1998 the Commission found that the 10% rate was state aid and was not compatible with the common market (Competing for Capital, p. 95). So the use of the state aid rules to attack arcane tax provisions is nothing new for the Commission.

The second case is Starbucks and possible fiscal aid from the Netherlands. I have already reported on how the company happily tells investors how profitable its British subsidiary is, but books a loss in the United Kingdom and had no tax liability for 14 years. As discussed then, the issue ultimately revolves around transfer pricing between the "loss-making" U.K. affiliate and the Dutch subsidiary which holds Starbucks' intellectual property and collects 6% of revenue as royalties, plus transfer pricing into Switzerland. Theoretically, the case could also expand to the Swiss transfer pricing as Switzerland is also subject to state aid rules as part of its free trade agreement with the European Union.

Finally, the Commission is investigating whether Fiat receive state aid from Luxembourg, again as part of its tax treatment there.

All three of these cases demonstrate what I emphasized in my last post, namely that tax avoidance increases tax risk, whereas tax planning does not. It also underscores a point I made in Competing for Capital that the Commission can be quite creative in finding ways to attack fiscal provisions under the state aid rules. It's good to see that the Commission is actively attacking corporate tax avoidance; it would be great to see equal creativity and perseverance on this side of the Atlantic.

Cross-posted at Angry Bear.

The difference between tax planning and tax avoidance: one simple test

Over at Tax Research UK, Richard Murphy offers a simple test to distinguish between tax planning and tax avoidance. As he told a journalist, "That is easy. It's getting legal opinion."

With tax planning, Murphy says, you decrease your tax risk. "There are obvious examples: paying money into a pension, for example, does not create tax risk, and nor does putting money into an ISA [a UK individual savings account, which is similar to an IRA but more flexible] within allowed limits."

By contrast, "Tax avoidance, on the other hand always, and without exception, increases your tax risk." He gives examples of questionable allowances or use of tax haven structures. "In all such cases, the taxpayer's risk is increased by undertaking the transaction. That is what tax avoidance involves."

Murphy sends us further to David Quentin's tax blog. Here Quentin points out that there can be effective or ineffective tax avoidance, but that there is no such thing as ineffective tax planning. This, he argues, is an embarrassment for tax avoidance defenders, inasmuch as effective tax avoidance and ineffective tax avoidance are the same activity. With tax planning, there is no question that what you're doing is legal. With tax avoidance, there is precisely such a question. So, as Murphy said, tax avoidance involves risk. Therefore, your tax adviser will suggest you get a legal opinion to "validate" the legality of what you are doing. While a putative tax avoider will use this opinion in arguing with tax authorities, it is ultimately the latter (and the courts) that will decide on the legality of the action taken.

What do you think? Is the distinction between tax planning and tax avoidance as easy to make as Murphy claims?

Cross-posted at Angry Bear.