Obama’s Corporate Tax Plan

A joke among Russian workers in the Soviet Union under Communism: “We pretend to work and they pretend to pay us”. Something similar is afoot with President Obama proposing corporate tax reform and Congress pretending to be interested in doing something about it. There’s no chance of that, with 7/8th of Congress concerned with nothing more this year than raising money and campaigning for re-election.

Still, it’s a vital subject. The tax code — corporate or individual — hasn’t been overhauled in a quarter of a century and has become riddled with loopholes, exceptions, subsidies and other means of tax avoidance that result in corporations, even those in the same industry, paying wildly different rates. The tax code, in a word, is a mess.

The spur for reform is that the nominal 35% tax rate for large corporations is second only to Japan’s as the highest in the world, therefore hurting the competitiveness and growth of U.S. companies, so goes the argument. In fact, those loopholes and exceptions result in U.S. multinationals paying 26% on average, not 35%, only slightly above the global average of 25%.

But the averages mask the inequities in the system. Companies whose business is solely in the U.S. — food chains, retailers, railroads, truckers, for example — are exposed to the full 35% (more, counting state and local taxes), whereas companies with extensive foreign operations or transferrable intellectual property such as pharmaceutical patents and software have a wealth of devices to evade U.S. taxes. Thus we see General Electric (G.E.) pay a tax rate of 3.6 percent over the past three years, while retailer Wal-Mart was saddled with 33.6 percent.

The subject of tax disparities breached the national consciousness when an exposé of G.E. appeared in this New York Times article a year ago. It revealed that an army of 975 was deployed in G.E.’s tax department to make sure the company paid no U.S. taxes at all on worldwide profits of $14.2 billion in 2010. A year before, Exxon-Mobil paid no U.S. income tax on profits of $19.3 billion, receiving instead a $156 million credit. Foreign governments, though, took in $15.2 billion in taxes from the oil giant. Examples of companies paying very low U.S. taxes are many. How do we justify to struggling businesses in the U.S. why they should pay full rate when so many of the largest corporations pay so much less, thanks to major tax concessions bought from Congress?

Obama would cut the rate from 35% to 28% in return for eliminating the loopholes. But his requirement that the result be revenue neutral — that it bring the same amount of revenue into the Treasury’s coffers as the present tax scheme — means that all tax breaks would have to be eliminated, according to Congress’s nonpartisan Joint Committee on Taxation. It’s not just the President’s oft-cited litany of ending subsidies for oil and gas exploration and corporate jets, which don’t come anywhere close to making up the revenue lost by dropping the tax rate. It’s also jettisoning creditable tax breaks, such as accelerated write-offs of equipment purchases, intended to stimulate investment and job creation. The President’s plan is vague about what perks to kill, saying only that “consideration” would be given to a number of options. It’s hard not to view such lack of specifics as simply a token to be on the record as doing something other than campaigning in 2012, because what is needed is sweeping reform.

The U.S. taxes profits earned by corporations in other countries. The tax is deferred, however, until the companies bring the cash home (taxes paid to other countries are at that point credited against U.S. taxes due). One argument is that taxes on overseas profits should not be deferred; deferral gives companies an incentive to use accounting legerdemain to maximize profits in countries or offshore havens that have low or no corporate taxes. The opposite argument says that the U.S. is virtually alone in the world in taxing profits earned in other countries and that we should adopt a “territorial” tax scheme whereby profits earned abroad not be taxed at all.

It’s arguable that a state has no justification for taxing that portion of a business’s sales and profits that are generated entirely in another country. But apart from depriving the government of any hope of tax receipts from foreign profits, that radical move would give corporations all the more incentive to move key operations to other countries to minimize domestic taxes.

Which corporations already do. A common maneuver is for a U.S. company to sell its patents or technology, usually at a bargain price relative to the investment that created the asset, to a shell or small operating company set up for that purpose in a low tax country. The offshoot company then licenses the use of the asset back to the U.S. company at a stiff rate, banking the profits offshore ever after.

Take the example of Google, that quintessential American technology triumph that grew partly out of publically funded research by the National Science Foundation at Stanford University. It turns out that Google’s motto of “don’t be evil” is aimed at someone other than themselves, judging from their tax contrivances, as analyzed in aBloomberg BusinessWeek article. Here’s how it works:

Almost 90% of the company’s $12.5 billion overseas sales flow into the 2,000-employee company in Ireland. But Ireland has a 12.5% tax rate, so to avoid even that cost, the overseas rights to Google’s search and advertising technology are held by its Irish subsidiary in Bermuda, where there are no corporate taxes. But Ireland would tax a direct payment to Google’s Bermuda company, so Google first routes the money through the Netherlands, because Ireland does not tax payments to other European Union countries. The Dutch shell, which has no employees, imposes no tax, only a modest transfer fee, when Google sends the money to Bermuda. Result? The company’s overseas tax rate since 2007 has been 2.4%.

Thus does Google, which would not exist were it not for a miracle created by the U.S. government and taxpayer money called the Internet, keep its profits offshore safe from U.S. taxes. Another beneficiary which believes it owes as little as possible to its birth country is Facebook, which has its foreign headquarters in Ireland and reportedly has set up the same artifice. They join other multinationals — behemoths such as Pfizer pharmaceuticals and I.B.M. —, which incorporated mailbox companies in the Cayman Islands in which to park overseas profits.

There have been efforts, most recently by Senators Carl Levin of Michigan and Kent Conrad of North Dakota, to tighten the rules. What are clearly needed in reform laws are metrics that invalidate the separateness of offshore companies that have no employees, or outsized profits per employee as in the Google example, and consolidate them as part of the U.S. parent for tax purposes.

In his first two state of the union addresses, the President wanted to

"restore a sense of fairness and balance to our tax code by finally ending the tax breaks for corporations that ship our jobs overseas" (2009)
and
"slash the tax breaks for companies that ship our jobs overseas and give those tax breaks to companies that create jobs in the United States of America" (2010)

"a parade of lobbyists has rigged the tax code to benefit particular companies and industries"
and asked
"Democrats and Republicans to simplify the system. Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years — without adding to our deficit"

"Right now, companies get tax breaks for moving jobs and profits overseas. Meanwhile, companies that choose to stay in America get hit with one of the highest tax rates in the world. It makes no sense, and everyone knows it. So let’s change it."

So it is disappointing that his recently announced plan is so unspecific. We must go much further than simply lowering the tax rate and “considering” removing tax breaks. Like it or not, justifiable or not, if we are to keep companies from shipping jobs overseas, then we need to continue to go it alone as the only nation that taxes overseas profits and, what’s more, end tax deferral. Allowing corporations to hold profits abroad tax free encourages them to invest abroad rather than in the U.S. as well as game the system to reduce taxes at home by inflating overseas profits with transfer payments and accounting maneuvers.

The risk is that this could drive some American countries offshore altogether, but the added revenue of current taxation of overseas profits, combined with thorough loophole elimination, could fund a deeper cut in the tax rate beyond Obama’s 28%, and that would make the U.S. an attractive tax country, rather than the world’s most avaricious. That could entice foreign corporations to set up operations here, and that means jobs.

But it’s all just a thought exercise for as long as Republicans vow to block any such reform, even the elimination of a loophole, as being in violation of their lock-step pledge never to raise a tax. They want just the rate cut. In fact, Paul Ryan thinks the rate should be zero. That's one sure way to get rid of loopholes.

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