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Archive for the ‘Deferral’ Category

I’m in favor of free markets.

That means I’m sometimes on the same side as big business, but it also means that I’m often very critical of big business.

That’s because large companies are largely amoral.

Depending on the issue, they may be on the side of the angels, such as when they resist bad government policies such as higher tax rates and increased red tape.

But many of those same companies will then turn around and try to manipulate the system for subsidies, protectionism, and corrupt tax loopholes.

Today, I’m going to defend big business. That’s because we have a controversy about whether a company has the legal and moral right to protect itself from bad tax policy.

We’re dealing specifically with a drugstore chain that has merged with a similar company based in Switzerland, which raises the question of whether the expanded company should be domiciled in the United States or overseas.

Here’s some of what I wrote on this issue for yesterday’s Chicago Tribune.

Should Walgreen move? …Many shareholders want a “corporate inversion” with the company based in Europe, possibly Switzerland. …if the combined company were based in Switzerland and got out from under America’s misguided tax system, the firm’s tax burden would drop, and UBS analysts predict that earnings per share would jump by 75 percent. That’s a plus for shareholders, of course, but also good for employees and consumers.

Folks on the left, though, are fanning the flames of resentment, implying that this would be an example of corporate tax cheating.

But they either don’t know what they’re talking about (a distinct possibility given their unfamiliarity with the private sector) or they’re prevaricating.

Some think this would allow Walgreen to avoid paying tax on American profits to Uncle Sam. This is not true. All companies, whether domiciled in America or elsewhere, pay tax to the IRS on income earned in the U.S. 

The benefit of “inverting” basically revolves around the taxation of income earned in other nations.

But there is a big tax advantage if Walgreen becomes a Swiss company. The U.S. imposes “worldwide taxation,” which means American-based companies not only pay tax on income earned at home but also are subject to tax on income earned overseas. Most other nations, including Switzerland, use “territorial taxation,” which is the common-sense approach of only taxing income earned inside national borders. The bottom line is that Walgreen, if it becomes a Swiss company, no longer would have to pay tax to the IRS on income that is earned in other nations. 

It’s worth noting, by the way, that all major pro-growth tax reforms (such as the flat tax) would replace worldwide taxation with territorial taxation. So Walgreen wouldn’t have any incentive to redomicile in Switzerland if America had the right policy.

And this is why I’ve defended Google and Apple when they’ve been attacked for not coughing up more money to the IRS on their foreign-source income.

But I don’t think this fight is really about the details of corporate tax policy.

Some people think that taxpayers in the economy’s productive sector should be treated as milk cows that exist solely to feed the Washington spending machine.

…ideologues on the left, even the ones who understand that the company would comply with tax laws, are upset that Walgreen is considering this shift. They think companies have a moral obligation to pay more tax than required. This is a bizarre mentality. It assumes not only that we should voluntarily pay extra tax but also that society will be better off if more money is transferred from the productive sector of the economy to politicians.

Needless to say, I have a solution to this controversy.

…the real lesson is that politicians in Washington should lower the corporate tax rate and reform the code so that America no longer is an unfriendly home for multinational firms.

For more information, here’s the video I narrated on “deferral,” which is a policy that mitigates America’s misguided policy of worldwide taxation. And you’ll see (what a surprise) that the Obama Administration wants to make the system even more punitive.

P.S. On this topic, click here is you want to compare good research from the Tax Foundation with sloppy analysis from the New York Times.

P.P.S. Many other companies already have re-domiciled overseas because the internal revenue code is so punitive. The U.S. tax system is so bad that companies even escape to Canada and the United Kingdom!

P.P.P.S. It also would be a good idea to lower America’s anti-competitive corporate tax rate.

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Whether it’s American politicians trying to extort more taxes from Apple or international bureaucrats trying to boost the tax burden on firms with a global corporate tax return, the left is aggressively seeking to impose harsher fiscal burdens on the business community.

A good (or “bad” would a more appropriate word) example of this thinking can be found in the New York Times, where Steven Rattner just wrote a column complaining that companies are using mergers to redomicile in jurisdictions with better tax law.*

He thinks the right response is higher taxes on multinationals.

While a Senate report detailing Apple’s aggressive tax sheltering of billions of dollars of overseas income grabbed headlines this week, …the American drug maker Actavis announced that it would spend $5 billion to acquire Warner Chilcott, an Irish pharmaceuticals company less than half its size. Buried in the fifth paragraph of the release was the curious tidbit that the new company would be incorporated in Ireland, even though the far larger acquirer was based in Parsippany, N.J. The reason? By escaping American shores, Actavis expects to reduce its effective tax rate from about 28 percent to 17 percent, a potential savings of tens of millions of dollars per year for the company and a still larger hit to the United States Treasury. …Eaton Corporation, a diversified power management company based for nearly a century in Cleveland, also became an “Irish company” when it acquired Cooper Industries last year. …That’s just not fair at a time of soaring corporate profits and stagnant family incomes. …President Obama has made constructive proposals to reduce the incentive to move jobs overseas by imposing a minimum tax on foreign earnings and delaying certain tax deductions related to overseas investment.

But Mr. Rattner apparently is unaware that American firms that compete in other nations also pay taxes in other nations.

Too bad he didn’t bother with some basic research. He would have discovered some new Tax Foundation research by Kyle Pomerleau, which explains that these firms already are heavily taxed on their foreign-source income.

Tax Foundation - Overseas Corporate Tax Burden…the amount U.S. multinational firms pay in taxes on their foreign income has become a common topic for the press and among politicians. Some of the more sensational press stories and claims by politicians lead people to believe that U.S. companies pay little or nothing in taxes on their foreign earnings. Last year, even the president suggested the U.S. needs a “minimum tax” on corporate foreign earnings to prevent tax avoidance. Unfortunately, such claims are either based upon a misunderstanding of how U.S. international tax rules work or are simply careless portrayals of the way in which U.S. companies pay taxes on their foreign profits. …According to the most recent IRS data for 2009, U.S. companies paid more than $104 billion in income taxes to foreign governments on foreign taxable income of $416 billion. As Table 1 indicates, companies paid an average effective tax rate of 25 percent on that income.

Unfortunately, the New York Times either is short of fact checkers or has very sloppy editors. Here are some other egregious errors.

And none of this counts Paul Krugman’s mistakes, which are in a special category (see here, here, here, here, and here for a few examples).

*There is an important lesson to be learned when American companies redomicile overseas. Unfortunately, the New York Times wants to make a bad system even worse.

P.S. Rand Paul has a must-watch video on the issue of anti-Apple demagoguery.

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Senator Rand Paul is perhaps even better than I thought he would be.

The Founding Fathers would be proud

He already is playing a very substantive role on policy, ranging from his actions of big-picture issues, such as his proposed budget that would significantly shrink the burden of government spending, to his willingness to take on lower-profile but important issues such as repealing the Obama Administration’s wretched FATCA law.

But he also plays a very valuable role by articulating the message of liberty and refusing to allow leftist politicians to claim the moral high ground and use false morality to cloak their greed for other people’s money.

And there’s no better example than what he just did at the Senate hearing about Apple’s tax burden.

Wow. I thought I hit on the key issues in my post on the anti-Apple demagoguery, but Senator Paul hit the ball out of the park.

If you want other video examples of Senator Paul in action, click here to see him grill a TSA bureaucrat and click here to see him rip an Obama appointee on whether Americans should be free to choose the light bulb they prefer.

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The Senate is holding a Kangaroo Court designed to smear Apple for not voluntarily coughing up more tax revenue than the company actually owes.

Here are four things you need to know.

Apple is fully complying with the tax law. There is no suggestion that Apple has done anything illegal. The company is being berated by politicians for simply obeying the law that politicians have enacted. What’s really happening, of course, is that the politicians are conducting a show trial in hopes of creating an environment more conducive to tax increases on multinational companies (this is in addition to the OECD effort to impose higher tax burdens on multinational firms).

Left-wing whining

It is better for Apple to retain its profits than it is for politicians to grab the money. If Harry Reid, Barack Obama, and the rest of the crowd in Washington are able to use this fake issue as an excuse to raise taxes, the only things that changes is that the tax system becomes more onerous and politicians have more money to spend. Neither of those results are good for growth, particularly compared to the potential benefits of leaving the money in the productive sector of the economy.

Apple shouldn’t pay any tax to the IRS on any of its foreign-source income. A few years ago, Google was criticized for paying “only” 2.4 percent tax on its foreign-source income, but I explained that was 2.4 percentage points too high. Likewise, when Apple earns money overseas, that should not trigger any tax liability to the IRS since the income already is subject to all applicable foreign taxes (much as, say, Toyota pays tax to the IRS on its US-source income). Good tax policy is based on the common-sense notion of “territorial taxation,” which means governments only tax income and activity within their national borders. Unfortunately, the American tax system is partially based on the anti-competitive policy of “worldwide taxation,” which means the IRS gets to tax income that is earned – and already subject to tax – in other nations. Fortunately, we have a policy called “deferral,” which allows companies to postpone this second layer of tax.

If Apple is trying to characterize US-source income into foreign-source income, that’s because the US corporate tax system is anti-competitive. Multinational companies often are accused of “abusing” transfer-pricing rules on intra-company transactions to inappropriately turn US-source income into foreign-source income. To the extent this happens (and always with IRS approval), it is because the American corporate tax rate is now the highest in the developed world (and the second highest in the entire world), so companies naturally would prefer to reduce their tax burdens by declaring income elsewhere. So the only pro-growth solution is lowering the corporate tax rate.

It’s worth noting, by the way, that the Tax Foundation recently estimated that the revenue-maximizing corporate tax rate is 14 percent.

So if the anti-Apple lynch mob actually wants more revenue, they should learn a Laffer Curve lesson and slash the corporate tax rate.*

*I want to maximize growth, not maximize revenue.

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I’m very leery of corporate tax reform, largely because I don’t think there are enough genuine loopholes on the business side of the tax code to finance a meaningful reduction in the corporate tax rate.

That leads me to worry that politicians might try to “pay for” lower rates by forcing companies to overstate their income.

Based on a new study about so-called corporate tax expenditures from the Government Accountability Office, my concerns are quite warranted.

The vast majority of the $181 billion in annual “tax expenditures” listed by the GAO are not loopholes. Instead, they are provisions designed to mitigate mistakes in the tax code that force firms to exaggerate their income.

Here are the key findings.

In 2011, the Department of the Treasury estimated 80 tax expenditures resulted in the government forgoing corporate tax revenue totaling more than $181 billion. …approximately the same size as the amount of corporate income tax revenue the federal government collected that year. …According to Treasury’s 2011 estimates, 80 tax expenditures had corporate revenue losses. Of those, two expenditures accounted for 65 percent of all estimated corporate revenues losses in 2011 while another five tax expenditures—each with at least $5 billion or more in estimated revenue loss for 2011—accounted for an additional 21 percent of corporate revenue loss estimates.

Sounds innocuous, but take a look at this table from the report, which identifies the “seven largest corporate tax expenditures.”

GAO Tax Expenditure Table

To be blunt, there’s a huge problem in the GAO analysis. Neither depreciation nor deferral are loopholes.

I wrote a detailed post explaining depreciation earlier this month, citing three different experts on the issue. But if you want a short-and-sweet description, here’s how I described depreciation in my post on corporate jets.

If a company purchases a jet for $20 million, they should be able to deduct – or expense – that $20 million when calculating that year’s taxable income… A sensible tax system defines profit as total revenue minus total costs – including purchases of private jets. But today’s screwy tax code forces them to wait five years before fully deducting the cost of the jet (a process known as depreciation). Given that money today has more value than money in the future, this is a penalty that creates a tax bias against investment (the tax code also requires depreciation for purchases of machines, structures, and other forms of investment).

In other words, businesses should be allowed to immediately “expense” investment expenditures. What the GAO refers to as “accelerated depreciation” is simply the partial mitigation of a penalty, not a loophole.

The same is true about “deferral.” Here’s what I wrote about that issue in February 2010.

Under current law, the “foreign-source” income of multinationals is subject to tax by the IRS even though it already is subject to all applicable tax where it is earned (just as the IRS taxes foreign companies on income they earn in America). But at least companies have the ability to sometimes delay when this double taxation occurs, thanks to a policy known as deferral.

I added to those remarks later in the year.

From a tax policy perspective, the right approach is “territorial” taxation, which is the common-sense notion of only taxing activity inside national borders. It’s no coincidence that all pro-growth tax reform plans, such as the flat tax and national sales tax, use this approach. Unfortunately, America is one of the world’s few nations to utilize the opposite approach of “worldwide” taxation, which means that U.S. companies face the competitive disadvantage of having two nations tax the same income. Fortunately, the damaging impact of worldwide taxation is mitigated by a policy known as deferral, which allows multinationals to postpone the second layer of tax.

Simply stated, the U.S. government should not be trying to tax income earned in other countries. “Deferral” is the mitigation of a penalty, not a loophole.

So why would the GAO make these mistakes? Well, to be fair to the bureaucrats, they simply relied on the analysis of the Treasury Department.

But why does Treasury (and the Joint Committee on Taxation) make these mistakes? The answer is that they use the “Haig-Simons” tax base as a benchmark, and that approach assumes bad policies such as the double taxation of income that is saved and invested. If you want to get deep in the weeds of tax policy, I shared late last year some good analysis on Haig-Simons produced by my colleague Chris Edwards.

By the way, properly defining loopholes also is an issue for reform on the individual portions of the tax code. I’ve previously pointed out the flawed analysis of the Tax Policy Center, which put together a list of the 12 largest “tax expenditure” and included six items that don’t belong.

To conclude, the right tax base is what’s called “consumed income.” But that’s simply another way of saying that the system should only tax income one time, and it’s how income is defined for both the flat tax and national sales tax.

One final comment about GAO. It’s understandable that they used the Treasury Department’s methodology, but they also should have produced a list of tax expenditures based on a consumed-income tax base. That’s basic competence and fairness.

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I was a bit surprised couple of years ago to read that an American company re-located to Canada to benefit from better tax policy.

But I wasn’t totally shocked by the news because Canada has been lowering tax rates, reducing the burden of government spending, and taking other steps to make its economy more competitive.

But I am downright stunned to learn that America’s high corporate tax rate is such an outlier that companies are even moving to welfare states such as the United Kingdom.

Here are some excerpts from a story in the Wall Street Journal.

More big U.S. companies are reincorporating abroad despite a 2004 federal law that sought to curb the practice. One big reason: Taxes. Companies cite various reasons for moving, including expanding their operations and their geographic reach. But tax bills remain a primary concern. … Aon plc…relocated to the U.K. in April. Aon has told analysts it expects to reduce its tax rate, which averaged 28% over the past five years, by five percentage points over time, which could boost profits by about $100 million annually. Since 2009, at least 10 U.S. public companies have moved their incorporation address abroad or announced plans to do so, including six in the last year or so, according to a Wall Street Journal analysis of company filings and statements. …Eaton, a 101-year-old Cleveland-based maker of components and electrical equipment, announced in May that it would acquire Cooper Industries PLC, another electrical-equipment maker that had moved to Bermuda in 2002 and then to Ireland in 2009. It plans to maintain factories, offices and other operations in the U.S. while moving its place of incorporation—for now—to the office of an Irish law firm in downtown Dublin. …Eaton’s chief executive, Alexander Cutler, has been a vocal critic of the corporate tax code. “We have too high a domestic rate and we have a thoroughly uncompetitive international tax regime,” Mr. Cutler said on CNBC in January. …In moving from Dallas to the U.K. in 2009, Ensco followed rivals such as Transocean Ltd., Noble Corp. and Weatherford International Ltd. that had relocated outside the U.S. The company said the move would help it achieve “a tax rate comparable to that of some of Ensco’s global competitors.”

Wow. I can understand moving to Ireland, with its 12.5 percent corporate tax rate, but I wouldn’t have thought that the U.K.’s 24 percent rate was overly attractive.

But compared to the punitive 35 percent rate in the United States, I guess 24 percent doesn’t look that bad.

So what’s the solution? The obvious answer is to lower the corporate tax rate. But it also would help to eliminate worldwide taxation, as noted in the article.

Lawmakers of both parties have said the U.S. corporate tax code needs a rewrite and they are aiming to try next year. One shared source of concern is the top corporate tax rate of 35%—the highest among developed economies. By comparison, Ireland’s rate is 12.5%. …Critics of the tax code also say it puts U.S. companies at a disadvantage because it taxes their profits earned abroad. Most developed countries tax only domestic earnings. While executives would welcome a lower tax rate and an end to global taxation, some worry their tax bills could rise under other measures that could be included in a tax-overhaul package.

Both Obama and Romney have said that they favor a slightly lower corporate rate, but I’m skeptical about their true intentions. In any event, neither one of them is talking about a low rate, perhaps 15 percent of below.

For more information, here’s my video on corporate taxation.

And the issue of worldwide taxation may sound arcane, but this video explains why it also is important.

Let’s close by noting that there are two obstacles to pro-growth reform. First, any good reform will deprive politicians of tax revenue. And since they’ve spent the country into a fiscal ditch, that makes it very difficult to enact legislation that – at least on paper – means less money flowing to Washington.

Second, politicians are very reluctant to lower tax rates on groups that can be demagogued, such as “rich people” and “big corporations.” This is the destructive mentality that drives class-warfare tax policy.

So America faces a choice. Jobs, investment, and growth or big government, class warfare, and stagnation. The solution should be obvious…unless you’re a politicians interested in preserving power in Washington.

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Mitt Romney is being criticized for supporting “territorial taxation,” which is the common-sense notion that each nation gets to control the taxation of economic activity inside its borders.

While promoting his own class-warfare agenda, President Obama recently condemned Romney’s approach. His views, unsurprisingly, were echoed in a New York Times editorial.

President Obama raised…his proposals for tax credits for manufacturers in the United States to encourage the creation of new jobs. He said this was greatly preferable to Mitt Romney’s support for a so-called territorial tax system, in which the overseas profits of American corporations would escape United States taxation altogether. It’s not surprising that large multinational corporations strongly support a territorial tax system, which, they say, would make them more competitive with foreign rivals. What they don’t say, and what Mr. Obama stressed, is that eliminating federal taxes on foreign profits would create a powerful incentive for companies to shift even more jobs and investment overseas — the opposite of what the economy needs.

Since even left-leaning economists generally agree that tax credits for manufacturers are ineffective gimmicks proposed for political purposes, let’s set that topic aside and focus on the issue of territorial taxation.

Or, to be more specific, let’s compare the proposed system of territorial taxation to the current system of “worldwide taxation.”

Worldwide taxation means that a company is taxed not only on it’s domestic earnings, but also on its foreign earnings. Yet the “foreign-source income” of U.S. companies is “domestic-source income” in the nations where those earnings are generated, so that income already is subject to tax by those other governments.

In other words, worldwide taxation results in a version of double taxation.

The U.S. system seeks to mitigate this bad effect by allowing American-based companies a “credit” for some of the taxes they pay to foreign governments, but that system is very incomplete.

And even if it worked perfectly, America’s high corporate tax rate still puts U.S. companies in a very disadvantageous position. If an American firm, Dutch firm, and Irish firm are competing for business in Ireland, the latter two only pay the 12.5 percent Irish corporate tax on any profits they earn. The U.S. company also pays that tax, but then also pays an additional 22.5 percent to the IRS (the 35 percent U.S. tax rate minus a credit for the 12.5 percent Irish tax).

In an attempt to deal with this self-imposed disadvantage, the U.S. tax system also has something called “deferral,” which allows American companies to delay the extra tax (though the Obama Administration has proposed to eliminate that provision!).

Romney is proposing to put American companies on a level playing field by going in the other direction. Instead of immediate worldwide taxation, as Obama wants, he wants to implement territorial taxation.

But what about the accusation from the New York Times that territorial taxation “would create a powerful incentive for companies to shift even more jobs and investment overseas”?

Well, they’re somewhat right…and they’re totally wrong. Here’s what I’ve said about that issue.

If a company can save money by building widgets in Ireland and selling them to the US market, then we shouldn’t be surprised that some of them will consider that option.  So does this mean the President’s proposal might save some American jobs? Definitely not. If deferral is curtailed, that may prevent an American company from taking advantage of a profitable opportunity to build a factory in some place like Ireland. But U.S. tax law does not constrain foreign companies operating in foreign countries. So there would be nothing to prevent a Dutch company from taking advantage of that profitable Irish opportunity. And since a foreign-based company can ship goods into the U.S. market under the same rules as a U.S. company’s foreign subsidiary, worldwide taxation does not insulate America from overseas competition. It simply means that foreign companies get the business and earn the profits.

To put it bluntly, America’s tax code is driving jobs and investment to other nations. America’s high corporate tax rate is a huge self-inflected wound for American competitiveness.

Getting rid of deferral doesn’t solve any problems, as I explain in this video. Indeed, Obama’s policy would make a bad system even worse.

But, it’s also important to admit that shifting to territorial taxation isn’t a complete solution. Yes, it will help American-based companies compete for market share abroad by creating a level playing field. But if policy makers want to make the United States a more attractive location for jobs and investment, then a big cut in the corporate tax rate should be the next step.

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