Tuesday, March 22, 2011
A $60 Billion Dollar Shell Game
I also think that "tax the rich" is just another form of “tax the other guy.” But certainly, the well-to-do in the U.S. are getting off easy when you look at the marginal tax rates elsewhere in the world. Before the Republican tax cuts passed in 2000 and recently extended by the Democrats, the top marginal income tax rate was 39.5%. It is now 35%. I think people with incomes that high can afford the extra 4.5% as a payback to the great country where they made all those millions. Of course, some would have the rates go back to the 90% marginal rate we had under Eisenhower. I think that’s a little greedy of us who are not millionaires. I always look for a reasonable amount in the middle and don’t consider all rich people any more evil than the corporations. Taxes are not about morality, but paying for services we all enjoy.
I think it would make a lot of sense to simply go back to the marginal rates that were in place prior to Bush’s tax cuts on the highest tax bracket. I think the larger issue, when you look at our tax codes, is in the loop-holes and fine print of a law that has more pages than most library collections combined, and can only be understood by an Einstein. Let’s save the tax rate argument for another day. Instead, let’s talk about one of those loop-holes. Let’s talk about the U.S. Corporate Tax code as it is applied to multinational corporations.
Multinational Tax Laws
Now one reason I don’t worry a whole lot about corporate taxes is that I don’t believe corporations actually pay taxes; they just “pass them on.” Since I’m a customer of these big companies (for example, IBM, Apple, Google, Hewlett-Packard, Ford, Microsoft, General Motors, …), I don’t really want to pay any more for their goods and services just to fill the coffers of some government agency that I doubt is spending the money wisely. But we’re talking about multinational corporations. There are also small corporations that only do business in the U.S. These are those smaller companies that we all know provide most of the growth in jobs, and they are being taxed unfairly compared to the multinationals due to a little understood part of all nation’s tax codes called “income shifting.” That is where it becomes patently unfair that big multinationals have an advantage because they’ve got more lawyers to cut their expenses in ways the little company can’t match and their lobbyists make sure that the tax laws lean in their favor. That gives the giant companies an unfair advantage, and that I don’t agree with.
I’m talking about multinational corporations that both manufacture and sell in multiple countries, so all these different nations want their share of the tax revenue. If General Motors makes cars in China and sells them in China, who gets the corporate tax? Well, there is an international system made up of individual county’s laws that determine that. So, sit back, fasten your seat belt, and welcome to global tax law.
The tactics of these international companies depend on “transfer pricing,” paper transactions among corporate subsidiaries that allow for allocating income to tax havens while attributing expenses to higher-tax countries. Such income shifting shell games costs the U.S. government as much as $60 billion in annual revenue, according to Kimberly A. Clausing, an economics professor at Reed College in Portland, Oregon. Other economists estimate an even higher loss.
Lawyers refer to these delicious little fiscal maneuvers by cute nicknames such as the “Double Irish” and the “Dutch Sandwich.” Shall we examine how this little shell game is played?
Suppose you are the Google subsidiary in Ireland. Now Ireland is a good place to be, tax wise. They have lower corporate taxes than most of Europe and the U.S. Ireland charges 12.5 percent corporate income tax compared to the U.S. corporate income-tax rate of 35 percent and, in the U.K., it’s 28 percent.
Ireland's goal is to encourage corporations to locate there and hire there – JOBS. So you have an international company like Google, and they don’t really make anything, but they do have intellectual capital. It becomes very difficult to decide which country contributed what to the total worldwide revenue and profits. So what percentage of Google’s income do you assign to Ireland?
Guess who decides? Google. Google U.S. and Google Ireland sit down “at arm's length” (a requirement of the law) and decide what percentage of the profits were “earned” in Ireland. Then that is where it is taxed. And what motivates Google in these discussions? Lower taxes which equals lower costs which equals higher profits (and possibly lower charges for their goods and services).
Even better, Google can rent a post office box in Bermuda, and claim profits there – no corporate tax at all. The method takes advantage of Irish tax law to legally shuttle profits into and out of subsidiaries, largely escaping the country’s corporate income tax. After all, Ireland is mostly interested in the companies locating there and hiring local employees. It isn't the revenue from the corporate tax that they desire, so they are not really concerned if companies move the money elsewhere.
This legal tax dodge is called the "Dutch Sandwich" or the "Double Irish." Profits are sent to Ireland which has a low corporate tax rate. But, even better, Ireland doesn't tax some payments made to other EU states, so the money is sent to a shell in the Netherlands. The Dutch have very low tax laws, so this is a further savings. The money is then routed to an Irish-owned subsidiary in Bermuda which is why it is called Double Irish. Bermuda has a 0.0% corporate tax rate. The corporation has only paid about 0.2% of taxes in this process. Can you tell me which shell has the pea?
The earnings wind up in island havens that levy no corporate income taxes at all. Companies that use the Double Irish arrangement avoid taxes at home and abroad. Consider this at a time when the U.S. government struggles to close a projected $1.4 trillion budget gap and European Union countries face a collective projected deficit of 868 billion Euros. So what do these countries plan to do to balance their budgets? They plan to cut services.
I find this particularly egregious in the case of Google, whose slogan is “Do No Evil,” since the U.S. National Science Foundation funded the mid-1990s research at Stanford University that helped lead to Google’s creation. Taxpayers also paid for a scholarship for the company’s co-founder, Sergey Brin, while he worked on that research. Wouldn’t you think Google owes a little payback to those U.S. taxpayers and should not be sheltering their profits in foreign countries?
Google now has a stock market value of $194.2 billion. Google’s annual reports from 2007 to 2009 ascribe a cumulative $3.1 billion tax savings to the “foreign rate differential.” Such entries typically describe how much tax U.S. companies save from profits earned overseas. Ask yourself, whose pocket did that $3.1 billion come out of? A billion here. A billion there. It starts to add up. See where the $60 billion comes into play?
Again, I’m not arguing for higher taxes, but I am arguing for some degree of fairness, especially when it seems the intellectual capital that is the source of the profits of companies like Google was originally funded by the taxpayers of the U.S. who are then denied a share of the monetary benefit that Google enjoys. And it isn't just Google. Facebook is busy using the same schemes. Check out the hiring notices for international tax experts. It's a growth industry.
Technically, multinationals that shift profits overseas are deferring U.S. income taxes, not avoiding them permanently. The deferral lasts until companies decide to bring the earnings back to the U.S. In practice, they rarely repatriate significant portions, thus avoiding the taxes indefinitely.
Along comes the great recession. Congress passes a law in 2004 to encourage business investment in the U.S. They declare a tax holiday and allow corporations that transfer money back to the U.S. for a limited time with reduced tax rates. That was to encourage investment and hiring.
So what happened? Well, a lot of money got transferred back. According to the Internal Revenue Service, $362 billion came back to the U.S., of which $312 billion was eligible for the reduced tax rate. The amount repatriated was 45 percent of the total held abroad at the end of 2004. Hewlett-Packard transferred the most. Did that create jobs? No, Hewlett-Packard, even as it was pulling its $14.5 billion home from abroad, announced plans in 2005 to reduce its workforce by 14,500.
U.S. policy makers, meanwhile, have taken halting steps to address concerns about transfer pricing. In 2009, the Treasury Department proposed levying taxes on certain payments between U.S. companies’ foreign subsidiaries recovering a small amount of the money lost. Treasury officials, who estimated the policy change would raise $86.5 billion in new revenue over the next decade, dropped it after Congress and Treasury were lobbied by companies, including manufacturing and media conglomerate General Electric Co., health-product maker Johnson & Johnson, and coffee giant Starbucks Corp.
This predicted $86.5 billion in ten years averages just $8.65 billion a year. A drop in the bucket compared to the $60 billion lost each year to these tricky accounting maneuvers. But even this small amount did not come to pass because of the undue influence of the very corporations benefiting from this situation.
And look for congress to consider another tax holiday. The lack of any positive results on the last round does not prevent businesses from encouraging congress to try again. After all, "it's the economy stupid" and it's all about the JOBS. No, it's all about the MONEY!
Where's the beef ... errr ... CASH?
Then what are these large corporations doing with all these savings and the money involved? They are sitting on it. Most corporations currently have very large cash reserves. Corporations have been piling up cash and they often use it to buy out smaller competitors and this leads to further layoffs as the small, competitive company is folded into the giant corporation's assets. Currently the top 20 firms in the U.S. are sitting on a record breaking $635 billion dollars in cash reserves. They are basically sitting on the sidelines and hoarding the cash.
Corporations are also using the cash to buy back their own stock, which does benefit stockholders since the price goes up and it helps a company if they offer new stock, but it is not investment and it is not hiring. Raising stock prices by the repurchase of existing stock primarily adds to the salary of the business executives since they are often rewarded with bonuses if the stock price increases. In the long term, I think the investors would benefit more from growth of a company through investment, construction, and hiring. Not the short-term jump from reducing the total number of shares on the market.
Once again, Uncle Sucker takes it in the shorts. Oh, did I mention that one estimate of the loss of U.S. taxes from these shenanigans is $60 billion a year. That would pay off some of this debt we hear so much about.
What' cha Gonna Do?
So what are we to do about it? I suggest we simplify, simplify, simplify. All this legislation to accomplish this small goal or that small goal by changing the tax code has too many unintended consequences. How many of those loop holes were purchased with campaign donations. Where does the loyalty of the U.S. based multinationals lie? Their goal is to maximize profit – at the expense of all else? I guess so.
I just finished doing my taxes for 2010. I use a computer, TurboTax, and 30 years experience in figuring out what goes where on what form. It changes every year. I never know if I did it right. Transparency means systems that are understandable and auditable. The Gordian knot of modern tax forms is not understood by anyone, least of all those bozos in Washington that are writing this stuff. Let's cut the knot!
To tell you the truth, I don’t know what to do about it. It would take a rocket scientist or a brain surgeon to understand international tax law. I’m just a lowly engineer. What about you? Are you even aware of this issue? Do we want Congress to fix the recession? Or are we safer if congress would just keep their hands off? I think the only honest person left is the bank robber. He shows his gun and takes the money. Better than being robbed with a fountain pen. I suggest we all keep one hand on our wallets and pick up a financial newspaper with the other hand and learn a little about this and other fancy but legal dealings that are going on under the noses of the best congress that corporate money can buy.
An informed electorate that votes based on real knowledge of the performance of the politicians and who vote for enlightened self interests rather than knee-jerk slogans and corporate interests is what is needed here. Knowledge is power and ignorance is bliss. We’re a bunch of happy lemmings marching over the cliff as the federal budget bleeds red ink and taxes that should rightfully be paid to the U.S. Treasury are being mailed to a post office box in the Caiman Islands.