For all the concerns raised by economists and others about the House tax plan, it is generally assumed that the proposal will reduce the gaming of the tax system by multinational corporations. Among the more active debates: Will the currency adjust perfectly or will retail prices rise? Is the plan legal under our trade agreements? Do foreign investments take a dive?
While all those questions are hotly debated, consensus is that the current gaming will end. “Not to worry,” we are told, “that’s covered.” In a recent article, Marty Sullivan, chief economist at the nonpartisan Tax Analysts, was quoted saying that “the basic, fundamental structure of it seems much more resilient to gaming — by far.”
So, it is curious that earlier this year, General Electric, Pfizer, and others that have been called out for aggressive tax avoidance publicly aligned with a coalition of companies to push the House tax plan. Between 2001 and 2015, Verizon paid an average of 12.4 percent in federal income taxes, as opposed to the 35 percent statutory rate, on steadily increasing profits. In five of those years — all profitable — the company paid no federal income tax. General Electric, for more than a decade, paid negative 1.6 percent on $58 billion in profits. Yet, the senior management of these companies clearly believe they will do better under the proposal.
How do you reconcile these competing assumptions? I didn’t understand, so I asked. After several conversations with economists, the answer is in the definition of “gaming.” The House plan, if implemented, would end the incentive to invert or book profits offshore. That is true. Instead, it would shift the gaming from location of profits to location of sales.
The few economists looking closer at this problem have written about how Microsoft or Apple could potentially locate servers in tax havens. Any downloads of software, music, or movies could count as foreign sales and therefore generate no tax liability. That would increase the impact of tax avoidance as those companies currently do owe taxes on profits they book offshore — to be paid when they repatriate those profits to the U.S. parent. By switching from a system in which companies pay on all their profits to a so-called “territorial” system, the House plan would permanently exempt future taxes on all revenues booked offshore, opening the door to rampant abuse.
When asked about this, one economist was not terribly worried. Presumably, only a small number of companies are in a position to use that method of avoidance. But just 50 companies account for two-thirds of the roughly $2.5 trillion in U.S. profits that are currently recorded offshore. Apple alone owes more than $60 billion on its profits booked offshore. These practices are not widespread throughout the corporate world. Technology companies, pharmaceuticals, and finance are the major players in offshore gaming. Just “a few” very large companies are the problem.
There is also the potential for exporters to merge with importers to share excess tax credits. This would reduce or eliminate tax liability for the importer on whom the plan relies to pay the lion’s share of the taxes. When asked about this, one economist responded, “that is not gaming.” True, mergers are a legitimate business practice but, in this instance, it is still a practice driven not by product or service quality, not by delivery or manufacturing efficiency, but by the tax code.
While there are numerous incentives in the tax code to affect corporate behavior, this one has no other purpose than tax avoidance. One entrepreneur who started an outdoor recreation company (an importer of materials and equipment) said he would consider buying a wheat exporting company to offset his tax liability. Not much synergy between rafting supplies and wheat, but the tax credits would be attractive.
It seems a misplaced goal to stop the booking of profits offshore as an end unto itself. It is not as though the majority of profits are actually held offshore — waiting to be brought back to this country. A Senate investigation found that half of the funds booked offshore are held in Treasuries or other U.S. investments. Rather, the issue is the lost tax revenue or, as most in the public would see it, tax dodging. Since tax dodging via tax havens and other methods would continue among the largest players, it seems misleading to say to the public that the House plan would end the gaming.
Our goal in tax reform should be to agree upon a corporate tax rate that helps the country cover our costs, and then minimize the unintended ways to avoid paying it.
The most straightforward and hardest to game among reform proposals is to leave the basic structure in place but end the ability for multinationals to defer paying the taxes they owe. Individuals pay taxes on money they earn, whether they earn it in Des Moines or Dublin. Small and wholly domestic businesses pay taxes, timely, on their earnings.
There is no economic justification behind the special treatment of multinationals. We should also tighten rules to prohibit inversions and ensure companies are playing by the rules by publicly reporting — country-by-country — their profits, taxes paid, and certain operations. This is a pragmatic, comprehensive, and comparatively simple tax reform that solves the specific problem of lost revenue due to offshoring profits in tax havens.
Gary Kalman is executive director of the FACT Coalition, a nonpartisan alliance of more than 100 organizations working toward a fair tax system that addresses the challenges of a global economy. This article previously appeared in The Hill.