One Simple Way To Keep U.S. Corporations From Hiding Cash

A worker demonstrates outside the Labor Ministry with a sign that reads in Spanish “I don’t have an account in Panama,” in Buenos Aires, Argentina, Wednesday, April 6, 2016. CREDIT: AP PHOTO/NATACHA PISARENKO

The Panama Papers’ revelations of widespread tax avoidance by the global elite have already forced a handful of high-profile resignations, an indignant response from the Kremlin, and embarrassment for the head of the British government. The pitchforks are out for the wealthy individuals and companies who take advantage of the technically lawful shadow network of shell companies and tax havens.

So far, the only proposals for reform have focused on modest oversight or penalties for people who go too far over the line.

Separate policy initiatives in Paris and Berlin would create a “blacklist” of notorious tax haven nations and force them to clean house or lose access to the Society for Worldwide Interbank Financial Telecommunications (SWIFT), an essential tool for international banking transactions. The Financial Times reports the blacklisting idea is likely to be a hot topic later this week when the International Monetary Fund and World Bank meet in Washington.

But what if world leaders decided to go even further and simply change the whole game?

Radical reform of the global tax system doesn’t just try to make it harder to cheat. Instead, it renders cheating pointless — and might even reverse the current race to the bottom that creates tax and secrecy havens like Panama in the first place.

Corporate Fictions

The sort of individual money-stashing that defines the Panama Papers revelations would not confer any legal tax benefits to an American citizen. Money an individual American earns on offshore holdings gets taxed like the rest of their income.

But for corporations, the rules are different: So long as they don’t intend to bring that money back home, they don’t owe taxes on it.

Corporate tax avoidance through elaborate offshoring arrangements has gotten so elaborate that American companies now claim to have generated $104 billion in annual profit in Bermuda. That on-paper economic activity is roughly 18 times the size of Bermuda’s $6 billion economy.

US corporate profits in the Cayman Islands are about 15 times that nation’s GDP. In the British Virgin Islands, the ratio is seven-to-one.

“That’s a pretty clear indicator that these companies are essentially making things up,” tax expert Matt Gardner of the Institute on Taxation and Economic Policy said in an interview. “They’re creating accounting fictions.”

These corporate accounting fictions exploit the creases in intellectual property law and the corporate tax code to set up a subsidiary in a low-tax jurisdiction that can claim credit for almost all the revenue that an American corporate titan generates, regardless of where its workers and salespeople actually operate.

The entire corporate tax system is based on where profits are located. That’s becoming a big problem in a world where people with sufficient means can make it look like things that belong to them really belong to someone else far away.

“We know where a steel mill is, but we don’t really know where a patent or a trademark is,” said economist Alan Auerbach. “The location of an intangible asset isn’t so easy to ascertain.”

Auerbach, who heads the Robert D. Burch Center for Tax Policy and Public Finance at Berkeley, has been pushing for a radical change in philosophy on corporate taxes for more than six years. Under his proposal, it wouldn’t matter where companies are able to officially register their profits. They would instead be taxed based on where they sell things.

The Apple Loophole

Apple offers a simple example for the revolution Auerbach imagines. The tech giant drew scorn and scrutiny from Senate officials in 2013 over its decision to shift intellectual property rights to an Irish subsidiary and route the bulk of its international profits through Ireland and the Caribbean.

Nothing Apple had done was illegal. But it was still able to shift dozens of billions of dollars in revenue out of reach of the IRS.

Politicians take a dim view of such maneuvering, and European tax authorities have sought to force back-tax payments from Apple, Starbucks, Fiat, and a number of other firms engaged in similar accounting schemes.

But to Auerbach, the takeaway from all this is very different: If we want to collect corporate taxes from complex, modern multinational firms, we’re going about it all wrong.

The location of corporate profits is “an increasingly meaningless concept when you’ve got a multinational that has operations in 100 countries and it relies heavily on intangible assets that are generated in several countries simultaneously,” Auerbach said.

Instead of trying to figure out where profits happen and then tax them, he said, policymakers should base corporate tax assessments on the location of actual purchases.

“It’s increasingly difficult to say where money’s being earned. But it’s much easier to say where things are being purchased, because people don’t move as much as multinational profits do.”

Auerbach’s big idea, laid out in a 2010 paper published with the Hamilton Project and the Center for American Progress, would not just take away Apple’s ability to pretend that a fairly new Irish company invented the iPhone. It would eliminate the need for companies to engage in such fairy tales to begin with.

“There’s nothing pernicious about this,” Auerbach said. “The US could keep its corporate tax rate up if it did this. It’s a different kind of competition. It’s the good kind of competition rather than the bad kind of competition.”

Radical Simplicity

In the context of such radical simplicity, even the IRS’ most robust efforts to police corporate profit-shifting start to look like a squirrel chasing its tail.

“There’s a limit to how aggressively you can legally shift corporate profits out of the US and into tax havens where there’s no obvious economic activity. It’s an open question whether some of what’s happening here is fundamentally illegal,” ITEP’s Gardner said.

American tax authorities closely monitor corporate offshoring to enforce those legal limits, applying specific tax rules to evaluate the accounting fictions that US companies engineer in places like Bermuda and the Netherlands.

But the tax avoidance persists because corporate actors know how to navigate the law. Corporate lawyers and IRS officials dance around each other for a while, and then everybody goes home.

“A lot of these are complicated but legal transactions. The US government has not succeeded in getting them declared invalid,” Auerbach said.

With the Panama news pushing elite money-stashing patterns back into the spotlight, and world powers clamoring for a crackdown in response, there’s a serious risk that the revelations will merely produce a new form of the same fruitless kabuki by which accountants and governments already operate.

“It’s common in political circles to blame corporations for doing this,” Auerbach said, even when everyone agrees the profit-shifting schemes adhere to the letter of the law. “We can’t expect corporations to be charitable institutions with respect to the government and voluntarily pay more taxes than they owe. If we’ve got a bad tax system that essentially makes paying taxes voluntary, that’s the government’s problem not the corporation’s problem.”