Current attempts by the Obama Administration to close loopholes that allow US corporations to escape taxation on profits earned overseas, the so called "corporate inversions" whereby the foreign subsidiary of a US parent corporation suddenly comes under the control of a foreign national entity (usually through a merger with a third corporation that ends up having less than 80% US investor control for tax purposes based on a 2004 tax reform) putting its foreign earnings beyond the reach of the US federal tax system, has recently gained much attention. The President wants to make such things as "hopscotch loans" which are a shifty way of bringing foreign earnings back to the US tax free, taxed as dividend payments.
The US Treasury Department considers hopscotch loans to be those made by inverted companies get around federal taxes on foreign earnings by having the foreign subsidiary under its control make loans to the new foreign parent, instead of its U.S. parent. Hopscotch loans are currently considered the property of a foreign entity rather than a US based corporation and are therefore not taxed as dividends. The Obama Administration further hopes that new proposed legislation will prevent multinational firms from effectively "laundering" their earnings through newly created foreign "parent companies" by selling stock through them to US registered firms or by otherwise placing US earnings on the books of a foreign registered entity (which is usually still majority owned by the former parent company of the foreign US subsidiary) for the purposes of shifting earnings back to the US tax free. In essence, the new tax rules, "Prevent inverted companies from restructuring a foreign subsidiary in order to access the subsidiary’s earnings tax-free."
The problem is that the US Treasury loses billions in potential tax revenues through these and other tax dodging schemes. This is bad news in times of deficits. It is also argued that current US tax laws have "locked up" anywhere from one to two trillion in foreign earnings overseas because of high US statutory tax rates on corporations. This is nonsense as US corporations pay some of the lowest effective federal income tax rates in the world! According to some Federal Reserve data, corporate taxes as a share of pre-tax corporate profits have averaged only 15% a year since 2010 when the recovery began in earnest. High statutory rates are beside the point. One analyst from the Tax Policy Center puts it this way;
"...both the high US tax rate and the worldwide system of taxation have more bark than bite. In particular, agile US based multinational firms with substantial global operations often pay effective tax rates that are much lower than 35 percent. Effective tax rates in the teens are common, and some global corporations even pay rates in the single digits.4 Also, our worldwide system of taxation does not tax foreign income until it is repatriated to the US parent corporation."
The purpose of this essay is to demonstrate that corporate tax policy is neither an obstacle to further US domestic investment nor is it even the case that hundreds of billions are trapped overseas for the long term; much of the money is making its way back though it is escaping taxation by the US federal government. Allegedly high statutory federal tax rates on US corporate income is merely another conservative red herring. If high US corporate tax rates were an issue, the US would not currently be home to over $4.9 trillion worth of capital stock by foreign direct investors! According to analysts from the UN Commission on Trade and Development this amounts to nearly a fifth of the total global stock of inward direct foreign investment.
According to US Congressman Sander Levin of the House Ways and Means Committee, corporate inversions are mostly a new phenomenon; over the past twenty years about 75 inversions have occurred with 47 of them within the past ten alone. Until 1994, only one inversion occurred in 1983. Thus, not only have about two thirds of all 76 inversions occurred in the past ten years but a dozen or more are planned in the near future according to Representative Levin. These corporations are only a small share of the total US corporations doing business abroad but they are large corporations representing hundreds of billions of lost federal tax revenue over time. New legislation currently introduced in the House would make inversions more difficult by (a) lowering the threshold of ownership of the newly combined corporation (incorporated offshore) by historic shareholders of the U.S. parent corporation from the current 80% to 50%; (b) frustrate "decontrolling" strategies of US multinationals through stock purchases of the new foreign parent from the foreign US owned subsidiary (controlled foreign company or CFC) by taxing the new foreign parent on the transferred stock as if it was sold by the former U.S. parent, rather than the CFC; (c) eliminating the use of "hopscotch loans" by taxing the transference of funds from the CFC to the new foreign parent as payment of a dividend from overseas earnings and; (d) preventing inverted companies from transferring cash or property from CFCs to the new foreign parent by means of "the new foreign parent selling its stock in the former U.S. parent to a CFC with deferred earnings in exchange for cash or property of the CFC, effectively resulting in a tax-free repatriation of cash or property bypassing the U.S. parent." Many of these provisions are discussed in the US Treasury Department fact sheet cited above in the introduction to this essay. Levin and other sponsors of the new legislation for FY2015 believe that it will save nearly $19.5 billion in federal tax revenues over the next ten years.
Large transnational corporations have always sought to shelter their earnings from the federal government. But in the era of globalization in which the hypermobility of capital is greatly enhanced this becomes an especially severe problem. Business journalist Rachel Keller summed up the issue in a 2009 piece on popular global tax havens in Dollars & Sense;
Over the years, trillions of dollars in both corporate profits and personal wealth have migrated “offshore” in search of rock bottom tax rates and the comfort of no questions asked...Tax Justice Network, an international non-profit advocating tax haven reform, estimates one-third of global assets are held offshore. The offshore world harbors $11.5 trillion in individual wealth alone, representing $250 billion in lost annual tax revenue. Treasury figures show tax havens sucking $100 billion a year out of U.S. coffers. And these numbers have all been growing steadily over the past decade. A Tax Notes study found that between 1999 and 2002, the amount of profits U.S. companies reported in tax havens grew from $88 billion to $149 billion.
According to a 2014 joint study by US Public Interest Research Group/Citizens for Tax Justice of the largest US transnational corporations, 362 firms maintained 7,827 tax haven subsidiaries in 2013 where it can be assumed that they booked their annual earnings in order to avoid paying billions in federal tax revenue. Trillions are collectively booked as "offshore" earnings. The problem according to the report is that perhaps half or more of the profits booked as earned "offshore" were actually earned in the US and are being held in onshore US banks or invested in US financial markets in stocks, bonds or other assets. The money isn't actually "trapped" overseas, it is just untaxed.
It is obvious that the sheer magnitude of tax loss to the US treasury is staggering; just a sizable share of the lost annual revenue every year would go a long way in reducing the current deficits. Unfortunately, the political outcome of such deficit growth is to increase pressure for budget reduction rather than tax increases on the corporate rich which is one reason that the current Obama Administration efforts on corporate inversions are so valuable; they refocus on the real problem! The well known fact that so many large corporations don't pay much in taxes (and that many pay nothing at all!) should be sufficient to dispel the myth that it is high statutory tax rates that cost the domestic US economy needed job creating investment. Well known findings by the US Government Accounting Office have found that between 1998 and 2005, about 55% of large US corporations paid no federal income tax on their earnings in one or more of those years and, according to a GAO press release dated July 1, 2013,
For tax year 2010 (the most recent information available), profitable U.S. corporations that filed a Schedule M-3 paid U.S. federal income taxes amounting to about 13 percent of the pretax worldwide income that they reported in their financial statements (for those entities included in their tax returns). When foreign and state and local income taxes are included, the ETR for profitable filers increases to around 17 percent. The inclusion of unprofitable firms, which pay little if any tax, also raises the ETRs because the losses of unprofitable corporations greatly reduce the denominator of the measures. Even with the inclusion of unprofitable filers, which increased the average worldwide ETR to 22.7 percent, all of the ETRs were well below the top statutory tax rate of 35 percent.
One study from February of 2014 by the Citizens for Tax Justice of 288 large transnational US firms showed that between 2008 and 2012, the five year average effective tax rate (ETR) on well over $2.3 trillion in gross profit for these firms was only 19.4%! Roughly one third of these firms paid an ETR of less than ten percent and 26 of the firms studied paid nothing at all! One shocking fact, but one consistent with early GAO findings was that one hundred and eleven of the 288 companies studied (39 percent of them) paid zero or less in federal income taxes in at least one year from 2008 to 2012 according to the joint USPIRG/CTJ report.
It has been known for some time that US transnational firms use various manipulations of the tax code, tactics that amount to sophisticated forms of money laundering, to escape their federal income tax obligations. It has long been known that money "trapped" overseas is actually here in the US and is booked offshore to escape taxes. We are further cynically told that lowering the statutory US corporate tax rate will bring the repatriation of this money allegedly trapped overseas. According to one report by the Center for American Progress;
"...there is in fact something trapped on the balance sheets of U.S. multinationals. But it is not corporate profits—it is federal tax revenue. Profits characterized as overseas for accounting purposes may be little different economically from any other profits, but because of a provision known as deferral, explained in the next section, these profits can accumulate for years, sometimes indefinitely, without being taxed. According to Joint Committee on Taxation estimates, this costs the federal government $50 billion per year, and this cost is growing over time as corporations find ever more creative ways to make their U.S. profits look like offshore income. The problem with these accumulated corporate profits is not that they are “offshore”—it is that they are untaxed. This problem is real and serious...There is no trillion-dollar stockpile of cash under a collective corporate mattress in Luxembourg, waiting to be put to use in the American economy if only tax policy were different. That money is already here, and the only thing “trapped offshore” is federal revenue."
The US tax system allows for generous tax credits for repatriated overseas earnings; no "double taxation" tax place. Furthermore, deferral allows federal taxes owed to be deferred until repatriation. This seems to give even further incentives for transnational firms to locate offshore. One commonly cited figure for US corporate earnings "trapped" overseas is about $2 trillion! This is likely, at least in part, the result of a practice called profit or "earnings stripping" whereby US firms set up foreign subsidiaries overseas which accounts for most of the profits earned while the US parent company shows most of the expenses on its books. According to the CAP report the U.S. parent company can strip its U.S. profits by placing them on the books of a subsidiary in a tax-haven country thus avoiding paying U.S. corporate income taxes, without effecting any change to the actual structure of its business. The report points out that, "The total pre-tax income of the multinational as a whole stays the same, all of the real activity—jobs, sales, manufacturing activities—stays the same, but the tax bill declines." Though it is hard to know the exact magnitude of such accounting shifts and income disguising activity the authors of the CAP report point to an interesting clue; "The balance sheets of U.S. multinationals show outsized profits in a handful of small tax-haven countries: Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland together contain less than one half of 1 percent of the world’s population, yet they managed to generate 43 percent of the overseas profits reported by American companies in 2008." This is doubtless only the proverbial tip of the iceberg. It is time to stop the all the cant and deceit about "high statutory US corporate tax rates!"
Allowing foreign corporations to repatriate foreign earned profits tax free for a brief time is also a policy known to not only fail but actually produce perverse incentives for transnational firms to cut the workforce and locate even more of their operations overseas. This is what happened in 2004 with Bush's tax holiday legislation. One report by the Center for Budget and Policy Priorities cited a Senate follow up investigation that concluded that; "The top 15 repatriating corporations repatriated more than $150 billion during the holiday while cutting their U.S. workforces by 21,000 between 2004 and 2007..."
Investigations of the efficacy of the 2004 repatriation holiday show that most of the repatriated earnings went to pay stockholder dividends and or went to stock repurchases rather than for job creating investment. The CBPP report cited an NBER study that found that most of the more than $300 billion repatriated from the 2004 tax holiday went to pay shareholders or buy back stock shares. More such tax holidays will only increase federal deficits. Tax breaks for big business is usually a failure; these firms are already flush with cash, it is the middle class and working poor that need more money put into their hands!
Let's Focus on Boosting Aggregate Demand
Tax breaks for the rich is the biggest fraud of our time. Countless investigations by the government and private sources find that corporate earnings booked offshore are actually invested in US capital markets and elsewhere in the domestic economy evading taxes. Tax cuts are actually unnecessary; big business is already paying very little in taxes and is even receiving tax subsidies on top of already large profits; according to CTJ some negative tax rates range from five percent to over 200%! But these facts don't stop the trickle down dogma; it is a staple of far right ideology.
Putting more money in the hands of workers makes the most sense. A Federal Reserve Bank of Chicago study in 2011 made this conclusion, "...a $1 minimum wage hike increases household income by roughly $250 and spending by approximately $700 per quarter in the year following a minimum wage hike." This is a pretty strong recommendation for a minimum wage increase as a fiscal stimulus to the overall economy. It is spending not saving that brings recovery! It is estimated that the raise in the federal minimum wage in 2009 to $7.25/hour increased spending overall and that raising the minimum wage to its inflation adjusted historic peak could result in an additional $60 billion in consumer spending over the course of a single year! The vast majority of those who would be affected by a federal minimum wage increase-over four fifths of those potentially affected-are not teenagers but adults over the age of 20 who are helping to support families. Let's focus our recovery efforts on America's working families. Big business has already been getting a free ride by comparison and, considering their generous treatment, is doing very little for the American economy in return.