Stopping International Tax Avoidance: What Are the Best Alternatives?

May 23rd, 2013 at 11:23 am

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.

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23 comments in reply to "Stopping International Tax Avoidance: What Are the Best Alternatives?"

  1. wkj says:

    Another option would be a market capitalization tax for publicly traded corporations. Among its other virtues, this proposal would bypass the complexities of income measurement.

    • Jared Bernstein says:

      What about privately held ones (and this plan would incent privitization)?

      • wkj says:

        The issues relating to non-public businesses are briefly addressed on the last page of the paper. Those entities would still be subject to a corporate income tax, unless they were partnerships, LLCs or S corporations whose owners are taxed on a pass-through basis.

        As a general matter, access to public markets is compelling for most businesses, most of the time. Going “private” is normally just a step toward going “public” once again as soon as that can be accomplished profitably.

  2. Nick Batzdorf says:

    That noise you just heard all the way from Los Angeles was the most massive “FEH!” it’s possible to muster.

    Get outta here! You know that if the Tim Cooks of the world are in favor of lowering the rates and closing loopholes, it’s not the way to go. His comment about supporting that “even if Apple paid more”…well, he would say that, wouldn’t he.

    Anyway, while I know nothing about tax policy, I do think about what’s happening in Cyprus. “Repatriating” past earnings too quickly would be a different kind of bank run, but the effect on these island nations (and even Ireland) could be pretty bad – depending on the country’s difference between GDP and GNP. Avoiding that would require some creativity, perhaps investing some of that money to provide an alternative to money laundering?

  3. Perplexed says:

    -“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.”

    Just who constitutes this proverbial “we”? Are our bribed and coerced politicians now “we”? This certainly wasn’t done by “we the people.” First “we” grant them monopoly profits through patent protections and then “we” (basically lobbyists and paid-for politicians) allow them to avoid paying taxes on those profits and now “we the people” have to negotiate lower rates in order to tax more of the profits? Just how much corporate welfare is needed to make sure that “we the people” have the high-priced i-phones that are so critical to our survival and overall well-being?

    How about a return to competitive capitalism by getting rid of the monopoly profits and then a return to democracy by public only financing of political campaigns? Democracy and capitalism have worked for us in the past, why not try it again? Constantly treating the symptoms without trying to cure the disease will just lead to endlessly treating the symptoms until the disease ultimately kills its host.

    • Jared Bernstein says:

      Ok, but “we” elect them.

      • Perplexed says:

        “We the people” don’t elect them if “we the plutocrats and their lobbyists” first determine who is eligible to be elected. “We the people” just choose between pre-approved alternatives. Its not just a subtle, meaningless distinction; its the difference between a representative democracy and some other form of government.

  4. smith says:

    What again is the rationale for lowering rates under any circumstances? Why shouldn’t we end deferral, raise the rate.
    a) Corporations are sitting on huge sums of money
    b) Taxing corporations helps address issues of increased inequality (see Table 3 )
    c) Dividends are being taxed at nearly 1/2 the top marginal rate
    d) Double taxation is a good thing because corporations enjoy special benefits and privileges which even with a double tax are insufficiently funded by the corporate tax they currently pay.
    e) Corporations no longer fund R&D as they did in the past.

    The best way to end deferral is to end it. What could be simpler? Let the Republicans argue that companies with millions of dollars can’t afford to pay part of that amount as taxes. The few Democrats not in the pocket of corporations and savvy third party progressives can win that argument.

  5. Kevin Rica says:

    I’m not going to say that I know how to fix the problem, but I’m sure that it is doable. If worse-came-to-worse, we should just burn more coal and let nature take its course on the Caymans and Cook Islands. They are not providing much real value added to the world economy anyway. Switzerland and Lichtenstein unfortunately are going to be more of a challenge unless we use another method.

    However, it will definitely be worth the effort. Corporate (and individual) tax avoidance is more important than most people believe. The equity issues are a minor distraction. In my never humble opinion, this is an important element of the global savings glut (GSG) that has done so much to destabilize the world economy in the last 15 years. The biggest element of the GSG remains the structural problems of Asia. In particular, China needs to nationalize its state-owned enterprises and then float the RMB.

    But we won’t have a durable, global macroeconomic balance until the floating wealth of the world’s uber-rich is subject to normal taxation. Those people don’t save, they accumulate.

  6. wendy beck says:

    Regarding “End deferral, lower the rate” : I believe Tim Cook, the Apple guy, said that he’d be willing to consider that if the rate was in the single digits.

    That’s been the problem with this insane lowering of the rates for the rich (and now proposed for corporation) ostensibly to encourage “compliance”. We’ve seen the result for individuals: Mitt Romney’s 13.9%, etc.

    We do need an overhaul of the tax system and maybe if the loopholes disappear we should lower rates a bit, but with every loophole that returns, I’d increase the tax rate. You know they’ll return. That’s the problem.

    • wendy beck says:

      Correction: Tim Cook gave that “single digit” number in talking about an acceptable rate for repatriation.

    • Kevin Rica says:

      The single-digit rate argument essentially comes down to “legalize what we pay now. That will solve the problem of illegality.” However, of course, it won’t solve the problem of helping the government raise revenues. And the companies will still try to avoid the single digit when they find an acceptable strategy (like creating a shell company), they might avoid some of the more extreme strategies.

      If we collected the taxes that Apple avoids paying, rather than Apple having a cash hoard that they have now use for (GSG), they will have a use for it: Pay some taxes!

      It’s the same thing as another amnesty for illegal immigrants. Now they are legalized, but the economy still doesn’t need them and they still depress wages, maybe even more.

      And if you legalize cocaine, it won’t be illegal, it will just be a very addictive, psychoactive drug. It won’t get you arrested, it will just be dangerous and more readily available.

      Legalization just changes the nature of the problem.

  7. Dave says:

    End deferral, lower the rate somewhat. Perhaps 20%.

    I think the main point that needs to be made is that we just don’t care what Cook, Apple in general, or any other CEO, board member or billionaire would accept. This won’t be fixed realistically until people get off their globalization high horse and realize that most citizens live in countries, not corporations.

    The fact that the Senate is so concerned with what Apple thinks is good reason to believe that nothing productive will happen in this misguided tax reform charade that the administration is so strongly behind.

  8. D. C. Sessions says:

    The question for all of these plans is very simple: how robust are they against tax engineering, when the engineers are motivated by hundreds of billions of tax savings? That’s some pretty asymmetrical warfare, and the governments are on the wrong end of the force disparity.

    Example: Solarian Spice and Liquors (entirely owned and operated out of Java) has no business presence in any other country. It hires ships to transport goods from China, where it has negotiated nearly profitless deals for production, and those goods are purchased somewhere in the mid-Pacific by its distributors for North America — who purchase them at highly marked-up prices that leave just enough margin that those distributors can make enough profit to stay in business. SS&L provides “marketing allowances” and collateral to their distributors to keep SS&L products in the public eye. SS&L hires contract firms all over the world to do their new product development, but does not directly employ any product developers themselves.

    How do you propose to get a slice of SS&L’s North American operations? VAT won’t work — SS&L gets the lion’s share of the value-add, with only slim margins at the source and destination. In fact, none of the proposed plans can touch them.

    I’ll be happy to hear how North American govenments can get a share of SS&L’s profits, but in a world of limited sovereignty I don’t see it happening. And I hope it’s obvious that if the alternative is paying more than token taxes, Apple could readily restructure itself to something like Solarian Spice and Liquor.

    • Perplexed says:

      AMT for corps. & no deferral. If they and their plutocrat shareholders weren’t coercing “our” representatives we wouldn’t see the tax evasion and we also wouldn’t see “our” representatives kowtowing to their real masters and seeking their approval for what is supposed to be “the peoples'” decision. “We the people” have surrendered our control for the price of campaign contributions. Really sad considering we could have raised the same money through taxes instead of selling out so cheaply.

      • D. C. Sessions says:

        AMT for corps. & no deferral.

        Nice idea. Which doesn’t answer the question: how to deal with tax engineers that arrange a series of handoffs between sock puppets such that all of the profits occur outside of US jurisdiction and the company isn’t a US corporation?

        • Perplexed says:

          -“Which doesn’t answer the question: how to deal with tax engineers…”

          Make it part of AMT. Allocate the untaxed profits back to the beneficiaries and tax them (maybe even at a penalty rate for making it such hard work to begin with and give an incentive to those without tax engineers). The political control is the problem, there are plenty of “engineering” solutions. The obstacles hardly seem insurmountable given a choice to get it done.

          • D. C. Sessions says:

            Please look above at the example of Solarian Spice and Liquors. If you can’t solve that one, your solution isn’t one.

  9. Kevin Rica says:

    I guess tax avoidance is as unavoidable as death and taxes.

  10. Kevin Rica says:

    Interesting piece in the NYTimes today about tax avoidance.

    Guess who one of the big offenders really is? Read the last word — It’s Delaware.

    What sort of sleazy policial establishment would be behind that?

  11. M. Gamble says:

    I am going to propose something that gets my interest several times over the years then I sort of back burner it. The radical idea of just quit taxing Corporations income entirely. Now this means you have to find a mechanism to make sure that Corp. now pay dividends. Also Capital Gains will necessarily have to be increased. Deferring taxes will of course have to stop. And I think the only way to rain in excessive transferring Corp. income to perks for top executives is to strengthen and make sure it is followed a “Bill of Rights” for investors. Wrest some of that control out of the hands of Boards and CEOs to the people who own the stock. Now in my mind just an idea, no complete proposals.

    • Perplexed says:

      Better yet, lets move away from this form of welfare for the wealthy and eliminate the corporation all together. Corporations were allowed only because the theory was that the public would benefit from allowing them. We know now that this was as fictitious as trickle down economics. There is no public benefit (other than the paltry amount of taxes they provide) to allowing this legal construct to exist. If the wealthy want the protection against unlimited liability from the damage they cause then let them buy insurance in the “free market” instead of getting it for free from the public. Make all of the income taxable as personal income and stop socializing the costs these enormous artificial legal entities impose on the public.