Both the WaPo and the NYT have articles today on a topic of great importance for the tax debate in advanced economies.  The pieces discuss how officials from the UK and European economies are being pushed by their citizens to go after the type of tax avoidance engaged in by Apple, Google, GE, and countless other multinationals. 

There are at least two reasons this development is important.  First, technology and tax law have led the emergence of what international tax analyst Ed Kleinbard calls “stateless income,” a phenomenon that was on full display at the Apple hearing yesterday, where the company’s spokesperson said in so many words, “you can’t tax this income because it only exists where tax liabilities do not exist.”

It’s like some newly discovered physical particle that can only exist in a state of non-taxation.

Second, and this is very important to forthcoming policy, which is what this post is really about, a strong American argument in favor of territoriality, a regime favored by the multinationals but opposed by those who would shut down the types of tax sheltering on display yesterday, is that we have to go there because Europe is solidly there.  In fact, as these articles show, Europeans are closely questioning the costs and benefits of the current system.

There are no global estimates of how much revenue governments lose through tax avoidance or evasion schemes.

But recent research by the Organization for Economic Cooperation and Development (OECD) indicates that the problem is massive. Foreign direct investment, for example, in theory represents a long-term commitment by a firm in one country to owning productive capacity — a plant or building, for example — in another. But data show billions of dollars in foreign direct investment moving through small nations such as Bermuda and the Bahamas, suggesting that the money is not invested there but simply used to set up a corporate presence, for tax purposes, before moving to a final destination elsewhere.

So, what’s needed in this debate is a robust discussion of alternatives to territorial regimes for taxing international income.  I can’t do this justice right now (getting ready to go on MSNBC’s NOW at noon), but I encourage enterprising tax scholars and journalists to teach us about the relative pluses and minuses of these and other options.

–“Tough territorial” As shown in the link above, territorial systems apply no home country taxes to foreign earnings by MNC’s.  “Tough” territorial un-exempts some portion of foreign earnings from home country taxes.  The larger the share that’s not exempted, the “tougher” the system.  Works a bit like minimum or alternative tax rules.

–End deferral, lower the rate.  If US multinationals could not defer their foreign earnings (hold them abroad to avoid US taxes), they wouldn’t benefit from the machinations to make them stateless.  The extra revenue that this would generate could be used to lower the corporate rate.  The Apple guy said he’d support closing loopholes if it would buy his firm a lower rate, even if it meant they’d have to pay higher taxes.  Let’s see what he says to this.  (I’d be amazed if he would accept it, which is always the hitch with these “broader base, lower rate” appeals.)

–Sales apportionment.  I mentioned this yesterday (see Apple link above)—here’s a piece by Bill Parks explaining the idea.  I also heard tax scholar Alan Auerbach support this alternative yesterday on the radio.  Firms pay taxes on their worldwide profits to country X based on the share of their sales in X.  No sales in the Caymans, no application of Cayman “tax law” to the earnings you book there.

It’s a solid, simple idea, but a knowledgeable friend views it as a version of a territorial system, because it’s conceivable that under this system an American firm, for example, would pay little or no taxes here if all their sales are made abroad (e.g., I believe that 2/3 of Apple’s sales come from  outside of the US).

Gotta run, but you get the idea.  There’s maybe some momentum for reform of this international tax avoidance problem, but you can’t beat something with nothing.  I’d love to see the echo chamber of this part of the debate filled with alternatives like these versus territoriality.

“…we are deeply committed to our country’s welfare.”  Apple CEO Tim Cook at a hearing yesterday focused on the company’s extensive tax avoidance.

OK…I’ve got no reason to question that assertion.  I suspect Mr. Cook and other execs over there are thoroughly patriotic.  But they are also unquestionably “deeply committed” to their bottom line and their shareholders, as they should be.  And herein lies the problem: it’s at the intersection of our broken business tax code and the competing interests of our nation’s welfare and corporate profitability.

There are lots of reasons why we want innovative businesses like Apple—the Senators fell over each other to tell Cook how much they love their iPads—to be profitable.  It invokes the virtuous cycle of innovation, consumer satisfaction and demand, growth, innovation, etc.   But part of that cycle should also spin off revenue to support the nation’s welfare, not least of which are its public goods that educate the future workforce and support the public infrastructure that’s complementary to corporate success.  Even global companies like Apple, with 2/3’s of their revenues from abroad, need quality roads and ports and airports and water and (especially) communications systems.

The current tax code—specifically the treatment of overseas earnings—breaks that last part of the cycle.  Innovative, global firms are perfectly able to achieve great success re sales, profits, and share prices.  That’s why it’s always so discordant to me to hear them complaining all the time about taxes and regulations.  But because they can indefinitely shield their foreign profits from US taxes, meanwhile engaging in endless (legal) schemes to avoid taxes in countries where they book those earnings, the link between the profitability of American companies and the well-being of America is broken.

Moreover, the fact that multinationals have such a pronounced tax advantage over solely domestic firms creates a deeply perverse incentive to produce abroad versus here.

I grew up in an era where you could make a case that what was good for GM was good for America.  As they did better, their products made us better off, and they in turn helped to pay for the public goods that are essential to improving living standards in an advanced economy.  But can you make that case today?  Yes, many enjoy Apple products—I’m a PC guy, so perhaps I should recuse myself from this whole debate—but the feedback loop just described is broken.

In that regard, when Cook says “we don’t depend on tax gimmicks” he’s being far less credible than in the opening quote above.  In between gushing over cool apps:

…lawmakers accused Apple of setting up an elaborate system overseas to stash cash and avoid tax payments on at least $74 billion in profits between 2009 and 2012, facts that were uncovered in a Senate investigation on Monday.

The problem isn’t Cook or Apple.  They’re following the incentives we’ve set up for them and they alone cannot resolve the split those incentives engender between country, profits, and shareholders.  Therefore, instead of wasting time with these types of ambiguous investigations, what Congress should be asking is how can we shut down the vicious cycle and restart the virtuous one?

As economist Eileen Appelbaum points out here, moving to a territorial system, where foreign profits go largely untaxed at home, would only deepen the already too-strong incentives to produce abroad.  A better idea is to close the deferral loophole and use some of the extra revenue to lower the rate.  Eileen links to another interesting idea that’s getting more attention: moving international firms to an apportionment model.  Under that framework, a firm’s liability in a given country would be determined by their share of sales, employees, or property (or some combination of those shares) in that country.  This immediately shuts down offshore Cayman accounts since none of those factors exist on those lovely beaches.

Those are the directions to go with corporate tax reform.  The guiding principle here should not be to haul executives in front of the Senate so that they can profess their love of country.  It’s to craft a code that puts their money where their mouth is.