Johnson Controls, an industrial and auto parts supplier
headquartered in Milwaukee, announced this week that is was selling itself to
Tyco International, a maker of fire safety products based in Ireland. The deal
will let Johnson Controls pass itself off as Irish and, in the process, cut its
taxes in the United States by at least $150 million a year.
Johnson Controls is not the first American company to avoid taxes by merging
with a smaller company in a low-tax nation, and it won’t be the last. Nor is it
the biggest. That distinction goes to Pfizer, which is in the process of
becoming Irish, having merged last year with a smaller company based in Dublin.
Johnson Controls is, however, the latest and quite possibly the most brazen tax
dodger. The company would not exist as it is today but for American taxpayers,
who paid $80 billion in 2008 to bail out the auto industry. Johnson Controls’s
president personally begged Congress for the bailout, which came on top of huge
tax breaks that the company has received over the years, including at least $149
million from Michigan alone from 1992 to 2009, according to The Times.
What’s galling about this and similar maneuvers is that Congress has done
nothing to stop them. Since 2008, some three dozen American companies have used
gaps and loopholes in the law to change their tax nationalities, a process known
as “inverting.”
Inverted companies keep the benefits of being American, but have a much lower
tax bill. They remain majority-owned by shareholders of the American company.
They normally keep their headquarters and top executives in the United States.
They also keep the protections on securities and patents provided by American
laws, as well as their contracts and connections with the federal government and
its research agencies.
Legislative remedies are available. One would be to deny investors the use of
low capital gains tax rates when they sell stock in an inverted company, on the
sensible ground that the company’s reduced tax bill is enough of a break.
Corporate boards would surely think twice about approving an inversion if it
meant higher taxes for investors.
But Congress won’t lift a finger. Many lawmakers, chiefly Republicans, seize
upon the wave of inversions as proof that corporate taxes in the United States
are too high. Reform the corporate code by slashing rates, they argue, and
inversions will end. Granted, corporate tax reform is needed. But allowing
inversions to proceed in order to make a partisan point is not the way to
approach it.
As Congress dithers, consumers and taxpayer-advocacy groups can show disapproval
by identifying and publicizing the products made by inverted companies and
similarly identifying and publicizing replacement products from less offensive
competitors. In addition, advocates of ethical investing, which applies social
as well as financial criteria in selecting investments, could screen out
inverted companies. The White House should reform federal contracting rules to
make it harder for inverted companies to win contracts. It also needs to be more
vocal in criticizing Ireland, the Netherlands and other inversion destinations
for their beggar-thy-neighbor tax policies.
Congress is on the wrong side of the inversion issue. Censure has to come from
elsewhere.
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A version of this editorial appears in print on January 30, 2016, on page A20 of
the New York edition with the headline:
The Corporate Tax Dodge Continues.
JAMES MADISON never played with an iPhone, but he might have
had something to say about the news last weekend about Apple. Over the last few
years, the company has avoided paying billions of dollars in state and federal
taxes by routing profits through subsidiaries based in tax havens from Reno,
Nev., to the Caribbean.
This is a common practice among major American businesses, and back in 1787,
Madison saw it coming. Someday, he warned, companies could grow so large they
“would pass beyond the authority of a single state, and would do business in
other states.” To make sure the companies remained accountable to government, he
said the federal government should “grant charters of incorporation in cases
where the public good may require them, and the authority of a single state may
be incompetent.”
In other words, a National Companies Act.
Such an act would create a common corporate architecture for all American
companies doing business across state lines and internationally. It would
establish not only uniform tax policies but also national standards for the
structure of corporate boards, the power of chief executives, the relations of
management with workers and shareholders and the interaction of American
companies with other nations. National companies would have to abide by national
rules, and the option of shopping around for the most favorable laws or tax
policies simply wouldn’t exist.
It’s an idea that has been proposed and pursued many times, particularly during
the early 1900s, when companies like Standard Oil, which was a collection of
companies incorporated in various states and assembled into a national “trust,”
were becoming increasingly powerful. Theodore Roosevelt, William Howard Taft,
Woodrow Wilson and, later, Franklin D. Roosevelt all supported the creation of a
national companies law, but the measures were consistently opposed by the
business community and eventually defeated.
Today, however, considering how much effort and money American companies expend
on keeping a competitive advantage by figuring out which loopholes to exploit
from the bewildering array of rules now in effect, they might not entirely
oppose reform. In an era of global competition, it could help to have a clear
set of standards. It’s certainly what other nations have. In Germany, for
example, national legislation established rules for the structure of corporate
boards. Britain’s Parliament establishes how a corporation can be created and
what its rights and responsibilities are.
Legally, there is little doubt that the United States Congress could impose
similar rules under the Commerce Clause of the Constitution. Although the states
have traditionally been the main arena for corporate rules, the federal
government has long created national corporations, from the First Bank of the
United States in 1791 to the Corporation for Public Broadcasting in 1967.
Congress could use this same power to require that companies doing business
across state lines have national corporate charters, which would subject them to
federal rules. Alternatively, it could simply set rules for corporate
organization and conduct that would apply to all interstate companies of a
certain size.
Passing a National Companies Act won’t be easy. Companies would hire lobbyists
to push for favorable rules. And some states with particularly easy
incorporation terms, like Delaware, might resist. Around 60 percent of Fortune
500 companies are incorporated in Delaware, and the state earns a great deal in
fees and tax revenues as a result.
But the Apple controversy shows that the nation is ready for reform. While the
company is a symbol of private enterprise, its existence is made possible by a
charter that some government writes and grants. It should serve public as well
as private ends — and pay its rightful share in taxes — or it should not exist
at all.
RENO, Nev. — Apple, the world’s most profitable technology
company, doesn’t design iPhones here. It doesn’t run AppleCare customer service
from this city. And it doesn’t manufacture MacBooks or iPads anywhere nearby.
Yet, with a handful of employees in a small office here in Reno, Apple has done
something central to its corporate strategy: it has avoided millions of dollars
in taxes in California and 20 other states.
Apple’s headquarters are in Cupertino, Calif. By putting an office in Reno, just
200 miles away, to collect and invest the company’s profits, Apple sidesteps
state income taxes on some of those gains.
California’s corporate tax rate is 8.84 percent. Nevada’s? Zero.
Setting up an office in Reno is just one of many legal methods Apple uses to
reduce its worldwide tax bill by billions of dollars each year. As it has in
Nevada, Apple has created subsidiaries in low-tax places like Ireland, the
Netherlands, Luxembourg and the British Virgin Islands — some little more than a
letterbox or an anonymous office — that help cut the taxes it pays around the
world.
Almost every major corporation tries to minimize its taxes, of course. For
Apple, the savings are especially alluring because the company’s profits are so
high. Wall Street analysts predict Apple could earn up to $45.6 billion in its
current fiscal year — which would be a record for any American business.
Apple serves as a window on how technology giants have taken advantage of tax
codes written for an industrial age and ill suited to today’s digital economy.
Some profits at companies like Apple, Google, Amazon, Hewlett-Packard and
Microsoft derive not from physical goods but from royalties on intellectual
property, like the patents on software that makes devices work. Other times, the
products themselves are digital, like downloaded songs. It is much easier for
businesses with royalties and digital products to move profits to low-tax
countries than it is, say, for grocery stores or automakers. A downloaded
application, unlike a car, can be sold from anywhere.
The growing digital economy presents a conundrum for lawmakers overseeing
corporate taxation: although technology is now one of the nation’s largest and
most valued industries, many tech companies are among the least taxed, according
to government and corporate data. Over the last two years, the 71 technology
companies in the Standard & Poor’s 500-stock index — including Apple, Google,
Yahoo and Dell — reported paying worldwide cash taxes at a rate that, on
average, was a third less than other S.& P. companies’. (Cash taxes may include
payments for multiple years.)
Even among tech companies, Apple’s rates are low. And while the company has
remade industries, ignited economic growth and delighted customers, it has also
devised corporate strategies that take advantage of gaps in the tax code,
according to former executives who helped create those strategies.
Apple, for instance, was among the first tech companies to designate overseas
salespeople in high-tax countries in a manner that allowed them to sell on
behalf of low-tax subsidiaries on other continents, sidestepping income taxes,
according to former executives. Apple was a pioneer of an accounting technique
known as the “Double Irish With a Dutch Sandwich,” which reduces taxes by
routing profits through Irish subsidiaries and the Netherlands and then to the
Caribbean. Today, that tactic is used by hundreds of other corporations — some
of which directly imitated Apple’s methods, say accountants at those companies.
Without such tactics, Apple’s federal tax bill in the United States most likely
would have been $2.4 billion higher last year, according to a recent study by a
former Treasury Department economist, Martin A. Sullivan. As it stands, the
company paid cash taxes of $3.3 billion around the world on its reported profits
of $34.2 billion last year, a tax rate of 9.8 percent. (Apple does not disclose
what portion of those payments was in the United States, or what portion is
assigned to previous or future years.)
By comparison, Wal-Mart last year paid worldwide cash taxes of $5.9 billion on
its booked profits of $24.4 billion, a tax rate of 24 percent, which is about
average for non-tech companies.
Apple’s domestic tax bill has piqued particular curiosity among corporate tax
experts because although the company is based in the United States, its profits
— on paper, at least — are largely foreign. While Apple contracts out much of
the manufacturing and assembly of its products to other companies overseas, the
majority of Apple’s executives, product designers, marketers, employees,
research and development, and retail stores are in the United States. Tax
experts say it is therefore reasonable to expect that most of Apple’s profits
would be American as well. The nation’s tax code is based on the concept that a
company “earns” income where value is created, rather than where products are
sold.
However, Apple’s accountants have found legal ways to allocate about 70 percent
of its profits overseas, where tax rates are often much lower, according to
corporate filings.
Neither the government nor corporations make tax returns public, and a company’s
taxable income often differs from the profits disclosed in annual reports.
Companies report their cash outlays for income taxes in their annual Form 10-K,
but it is impossible from those numbers to determine precisely how much, in
total, corporations pay to governments. In Apple’s last annual disclosure, the
company listed its worldwide taxes — which includes cash taxes paid as well as
deferred taxes and other charges — at $8.3 billion, an effective tax rate of
almost a quarter of profits.
However, tax analysts and scholars said that figure most likely overstated how
much the company would hand to governments because it included sums that might
never be paid. “The information on 10-Ks is fiction for most companies,” said
Kimberly Clausing, an economist at Reed College who specializes in multinational
taxation. “But for tech companies it goes from fiction to farcical.”
Apple, in a statement, said it “has conducted all of its business with the
highest of ethical standards, complying with applicable laws and accounting
rules.” It added, “We are incredibly proud of all of Apple’s contributions.”
Apple “pays an enormous amount of taxes, which help our local, state and federal
governments,” the statement also said. “In the first half of fiscal year 2012,
our U.S. operations have generated almost $5 billion in federal and state income
taxes, including income taxes withheld on employee stock gains, making us among
the top payers of U.S. income tax.”
The statement did not specify how it arrived at $5 billion, nor did it address
the issue of deferred taxes, which the company may pay in future years or decide
to defer indefinitely. The $5 billion figure appears to include taxes ultimately
owed by Apple employees.
The sums paid by Apple and other tech corporations is a point of contention in
the company’s backyard.
A mile and a half from Apple’s Cupertino headquarters is De Anza College, a
community college that Steve Wozniak, one of Apple’s founders, attended from
1969 to 1974. Because of California’s state budget crisis, De Anza has cut more
than a thousand courses and 8 percent of its faculty since 2008.
Now, De Anza faces a budget gap so large that it is confronting a “death
spiral,” the school’s president, Brian Murphy, wrote to the faculty in January.
Apple, of course, is not responsible for the state’s financial shortfall, which
has numerous causes. But the company’s tax policies are seen by officials like
Mr. Murphy as symptomatic of why the crisis exists.
“I just don’t understand it,” he said in an interview. “I’ll bet every person at
Apple has a connection to De Anza. Their kids swim in our pool. Their cousins
take classes here. They drive past it every day, for Pete’s sake.
“But then they do everything they can to pay as few taxes as possible.”
Escaping State Taxes
In 2006, as Apple’s bank accounts and stock price were rising, company
executives came here to Reno and established a subsidiary named Braeburn Capital
to manage and invest the company’s cash. Braeburn is a variety of apple that is
simultaneously sweet and tart.
Today, Braeburn’s offices are down a narrow hallway inside a bland building that
sits across from an abandoned restaurant. Inside, there are posters of
candy-colored iPods and a large Apple insignia, as well as a handful of desks
and computer terminals.
When someone in the United States buys an iPhone, iPad or other Apple product, a
portion of the profits from that sale is often deposited into accounts
controlled by Braeburn, and then invested in stocks, bonds or other financial
instruments, say company executives. Then, when those investments turn a profit,
some of it is shielded from tax authorities in California by virtue of
Braeburn’s Nevada address.
Since founding Braeburn, Apple has earned more than $2.5 billion in interest and
dividend income on its cash reserves and investments around the globe. If
Braeburn were located in Cupertino, where Apple’s top executives work, a portion
of the domestic income would be taxed at California’s 8.84 percent corporate
income tax rate.
But in Nevada there is no state corporate income tax and no capital gains tax.
What’s more, Braeburn allows Apple to lower its taxes in other states —
including Florida, New Jersey and New Mexico — because many of those
jurisdictions use formulas that reduce what is owed when a company’s financial
management occurs elsewhere. Apple does not disclose what portion of cash taxes
is paid to states, but the company reported that it owed $762 million in state
income taxes nationwide last year. That effective state tax rate is higher than
the rate of many other tech companies, but as Ms. Clausing and other tax
analysts have noted, such figures are often not reliable guides to what is
actually paid.
Dozens of other companies, including Cisco, Harley-Davidson and Microsoft, have
also set up Nevada subsidiaries that bypass taxes in other states. Hundreds of
other corporations reap similar savings by locating offices in Delaware.
But some in California are unhappy that Apple and other California-based
companies have moved financial operations to tax-free states — particularly
since lawmakers have offered them tax breaks to keep them in the state.
In 1996, 1999 and 2000, for instance, the California Legislature increased the
state’s research and development tax credit, permitting hundreds of companies,
including Apple, to avoid billions in state taxes, according to legislative
analysts. Apple has reported tax savings of $412 million from research and
development credits of all sorts since 1996.
Then, in 2009, after an intense lobbying campaign led by Apple, Cisco, Oracle,
Intel and other companies, the California Legislature reduced taxes for
corporations based in California but operating in other states or nations.
Legislative analysts say the change will eventually cost the state government
about $1.5 billion a year.
Such lost revenue is one reason California now faces a budget crisis, with a
shortfall of more than $9.2 billion in the coming fiscal year alone. The state
has cut some health care programs, significantly raised tuition at state
universities, cut services to the disabled and proposed a $4.8 billion reduction
in spending on kindergarten and other grades.
Apple declined to comment on its Nevada operations. Privately, some executives
said it was unfair to criticize the company for reducing its tax bill when
thousands of other companies acted similarly. If Apple volunteered to pay more
in taxes, it would put itself at a competitive disadvantage, they argued, and do
a disservice to its shareholders.
Indeed, Apple’s decisions have yielded benefits. After announcing one of the
best quarters in its history last week, the company said it had net profits of
$24.7 billion on revenues of $85.5 billion in the first half of the fiscal year,
and more than $110 billion in the bank, according to company filings.
A Global Tax Strategy
Every second of every hour, millions of times each day, in living rooms and at
cash registers, consumers click the “Buy” button on iTunes or hand over payment
for an Apple product.
And with that, an international financial engine kicks into gear, moving money
across continents in the blink of an eye. While Apple’s Reno office helps the
company avoid state taxes, its international subsidiaries — particularly the
company’s assignment of sales and patent royalties to other nations — help
reduce taxes owed to the American and other governments.
For instance, one of Apple’s subsidiaries in Luxembourg, named iTunes S.à r.l.,
has just a few dozen employees, according to corporate documents filed in that
nation and a current executive. The only indication of the subsidiary’s presence
outside is a letterbox with a lopsided slip of paper reading “ITUNES SARL.”
Luxembourg has just half a million residents. But when customers across Europe,
Africa or the Middle East — and potentially elsewhere — download a song,
television show or app, the sale is recorded in this small country, according to
current and former executives. In 2011, iTunes S.à r.l.’s revenue exceeded $1
billion, according to an Apple executive, representing roughly 20 percent of
iTunes’s worldwide sales.
The advantages of Luxembourg are simple, say Apple executives. The country has
promised to tax the payments collected by Apple and numerous other tech
corporations at low rates if they route transactions through Luxembourg. Taxes
that would have otherwise gone to the governments of Britain, France, the United
States and dozens of other nations go to Luxembourg instead, at discounted
rates.
“We set up in Luxembourg because of the favorable taxes,” said Robert Hatta, who
helped oversee Apple’s iTunes retail marketing and sales for European markets
until 2007. “Downloads are different from tractors or steel because there’s
nothing you can touch, so it doesn’t matter if your computer is in France or
England. If you’re buying from Luxembourg, it’s a relationship with Luxembourg.”
An Apple spokesman declined to comment on the Luxembourg operations.
Downloadable goods illustrate how modern tax systems have become increasingly
ill equipped for an economy dominated by electronic commerce. Apple, say former
executives, has been particularly talented at identifying legal tax loopholes
and hiring accountants who, as much as iPhone designers, are known for their
innovation. In the 1980s, for instance, Apple was among the first major
corporations to designate overseas distributors as “commissionaires,” rather
than retailers, said Michael Rashkin, Apple’s first director of tax policy, who
helped set up the system before leaving in 1999.
To customers the designation was virtually unnoticeable. But because
commissionaires never technically take possession of inventory — which would
require them to recognize taxes — the structure allowed a salesman in high-tax
Germany, for example, to sell computers on behalf of a subsidiary in low-tax
Singapore. Hence, most of those profits would be taxed at Singaporean, rather
than German, rates.
The Double Irish
In the late 1980s, Apple was among the pioneers in creating a tax structure —
known as the Double Irish — that allowed the company to move profits into tax
havens around the world, said Tim Jenkins, who helped set up the system as an
Apple European finance manager until 1994.
Apple created two Irish subsidiaries — today named Apple Operations
International and Apple Sales International — and built a glass-encased factory
amid the green fields of Cork. The Irish government offered Apple tax breaks in
exchange for jobs, according to former executives with knowledge of the
relationship.
But the bigger advantage was that the arrangement allowed Apple to send
royalties on patents developed in California to Ireland. The transfer was
internal, and simply moved funds from one part of the company to a subsidiary
overseas. But as a result, some profits were taxed at the Irish rate of
approximately 12.5 percent, rather than at the American statutory rate of 35
percent. In 2004, Ireland, a nation of less than 5 million, was home to more
than one-third of Apple’s worldwide revenues, according to company filings.
(Apple has not released more recent estimates.)
Moreover, the second Irish subsidiary — the “Double” — allowed other profits to
flow to tax-free companies in the Caribbean. Apple has assigned partial
ownership of its Irish subsidiaries to Baldwin Holdings Unlimited in the British
Virgin Islands, a tax haven, according to documents filed there and in Ireland.
Baldwin Holdings has no listed offices or telephone number, and its only listed
director is Peter Oppenheimer, Apple’s chief financial officer, who lives and
works in Cupertino. Baldwin apples are known for their hardiness while
traveling.
Finally, because of Ireland’s treaties with European nations, some of Apple’s
profits could travel virtually tax-free through the Netherlands — the Dutch
Sandwich — which made them essentially invisible to outside observers and tax
authorities.
Robert Promm, Apple’s controller in the mid-1990s, called the strategy “the
worst-kept secret in Europe.”
It is unclear precisely how Apple’s overseas finances now function. In 2006, the
company reorganized its Irish divisions as unlimited corporations, which have
few requirements to disclose financial information.
However, tax experts say that strategies like the Double Irish help explain how
Apple has managed to keep its international taxes to 3.2 percent of foreign
profits last year, to 2.2 percent in 2010, and in the single digits for the last
half-decade, according to the company’s corporate filings.
Apple declined to comment on its operations in Ireland, the Netherlands and the
British Virgin Islands.
Apple reported in its last annual disclosures that $24 billion — or 70 percent —
of its total $34.2 billion in pretax profits were earned abroad, and 30 percent
were earned in the United States. But Mr. Sullivan, the former Treasury
Department economist who today writes for the trade publication Tax Analysts,
said that “given that all of the marketing and products are designed here, and
the patents were created in California, that number should probably be at least
50 percent.”
If profits were evenly divided between the United States and foreign countries,
Apple’s federal tax bill would have increased by about $2.4 billion last year,
he said, because a larger amount of its profits would have been subject to the
United States’ higher corporate income tax rate.
“Apple, like many other multinationals, is using perfectly legal methods to keep
a significant portion of their profits out of the hands of the I.R.S.,” Mr.
Sullivan said. “And when America’s most profitable companies pay less, the
general public has to pay more.”
Other tax experts, like Edward D. Kleinbard, former chief of staff of the
Congressional Joint Committee on Taxation, have reached similar conclusions.
“This tax avoidance strategy used by Apple and other multinationals doesn’t just
minimize the companies’ U.S. taxes,” said Mr. Kleinbard, now a professor of tax
law at the University of Southern California. “It’s German tax and French tax
and tax in the U.K. and elsewhere.”
One downside for companies using such strategies is that when money is sent
overseas, it cannot be returned to the United States without incurring a new tax
bill.
However, that might change. Apple, which holds $74 billion offshore, last year
aligned itself with more than four dozen companies and organizations urging
Congress for a “repatriation holiday” that would permit American businesses to
bring money home without owing large taxes. The coalition, which includes
Google, Microsoft and Pfizer, has hired dozens of lobbyists to push for the
measure, which has not yet come up for vote. The tax break would cost the
federal government $79 billion over the next decade, according to a
Congressional report.
Fallout in California
In one of his last public appearances before his death, Steven P. Jobs, Apple’s
chief executive, addressed Cupertino’s City Council last June, seeking approval
to build a new headquarters.
Most of the Council was effusive in its praise of the proposal. But one
councilwoman, Kris Wang, had questions.
How will residents benefit? she asked. Perhaps Apple could provide free wireless
Internet to Cupertino, she suggested, something Google had done in neighboring
Mountain View.
“See, I’m a simpleton; I’ve always had this view that we pay taxes, and the city
should do those things,” Mr. Jobs replied, according to a video of the meeting.
“That’s why we pay taxes. Now, if we can get out of paying taxes, I’ll be glad
to put up Wi-Fi.”
He suggested that, if the City Council were unhappy, perhaps Apple could move.
The company is Cupertino’s largest taxpayer, with more than $8 million in
property taxes assessed by local officials last year.
Ms. Wang dropped her suggestion.
Cupertino, Ms. Wang said in an interview, has real financial problems. “We’re
proud to have Apple here,” said Ms. Wang, who has since left the Council. “But
how do you get them to feel more connected?”
Other residents argue that Apple does enough as Cupertino’s largest employer and
that tech companies, in general, have buoyed California’s economy. Apple’s
workers eat in local restaurants, serve on local boards and donate to local
causes. Silicon Valley’s many millionaires pay personal state income taxes. In
its statement, Apple said its “international growth is creating jobs
domestically, since we oversee most of our operations from California.”
“The vast majority of our global work force remains in the U.S.,” the statement
continued, “with more than 47,000 full-time employees in all 50 states.”
Moreover, Apple has given nearby Stanford University more than $50 million in
the last two years. The company has also donated $50 million to an African aid
organization. In its statement, Apple said: “We have contributed to many
charitable causes but have never sought publicity for doing so. Our focus has
been on doing the right thing, not getting credit for it. In 2011, we
dramatically expanded the number of deserving organizations we support by
initiating a matching gift program for our employees.”
Still, some, including De Anza College’s president, Mr. Murphy, say the
philanthropy and job creation do not offset Apple’s and other companies’
decisions to circumvent taxes. Within 20 minutes of the financially ailing
school are the global headquarters of Google, Facebook, Intel, Hewlett-Packard
and Cisco.
“When it comes time for all these companies — Google and Apple and Facebook and
the rest — to pay their fair share, there’s a knee-jerk resistance,” Mr. Murphy
said. “They’re philosophically antitax, and it’s decimating the state.”
“But I’m not complaining,” he added. “We can’t afford to upset these guys. We
need every dollar we can get.”
The corporate tax system is a mess. The United States has one
of the highest corporate tax rates in the world, but too many businesses still
don’t contribute their fair share of revenue, in large part because of numerous
loopholes, subsidies and other opportunities for tax avoidance. While some
industries and companies pay little or no tax because they qualify for generous
breaks or have really good lawyers, others are taxed heavily.
There is no doubt that a system that is more competitive, more efficient — the
current mind-numbing complexity makes planning far too difficult — and more fair
would be a plus for the economy. President Obama’s framework for business tax
reform, released on Wednesday, is a welcome start for a much-needed debate on
comprehensive tax reform. But we already have two big concerns.
While the administration insists that business tax reform should not add to the
deficit, the country needs to raise more revenue to care for an aging
population, rebuild infrastructure, improve education and tackle the deficit.
Corporations, which benefit from all of those, should, as a matter of necessity
and fairness, pay more.
Our other concern is that like all tax reform, the potential for gaming the
process is ever present and unless it is vigilantly managed could actually
reduce revenue and add to the deficit.
Take the framework’s central reform: reducing the top corporate rate from 35
percent to 28 percent, while at the same time doing away with loopholes and
subsidies. In theory, it is a sound approach, which would reduce complexity
while bringing the rate in line with that of other advanced nations without
busting the budget. But, even if they made it past the lobbyists, the specific
loophole closers in Mr. Obama’s new framework — including ending subsidies for
oil and gas exploration, corporate jets and private equity partners — are far
too small to make up for dropping the top rate.
As for the big money subsidies that would have to be cut or ended to pay for a
lower rate — including less generous depreciation and reduced deductibility of
interest on corporate debt — the White House merely presents them as part of a
menu of options for “consideration.”
The framework’s call for a minimum corporate tax on the foreign earnings of
American companies is a step in the right direction. Under current law, various
tax provisions and tactics allow companies to reduce or defer taxes by shifting
ever more production and profits overseas. But the idea is blunted by the
framework’s failure to say what the minimum tax rate should be.
Nor does the framework broach other reforms like taxing foreign profits when
they are earned rather than when they are repatriated to the United States —
that could ultimately be more effective in getting multinationals to pay more.
Even with its shortcomings, Mr. Obama’s proposal presents a needed contrast to
the Republicans’ approach to corporate taxes. Last year, Dave Camp, the chairman
of the House Ways and Means Committee, proposed a top corporate rate of 25
percent without saying how he would pay for the tax cut. Mitt Romney has done
somewhat better, calling for a 25 percent rate to be coupled with “broadening”
the corporate tax base, which generally means closing loopholes. But he has yet
to say which tax breaks he would end.
Serious reform requires specific proposals, tough trade-offs and hard numbers
attached. Without all of those, this effort could too easily be hijacked by
powerful corporations and their high-paid lobbyists.
November
27, 2011
The New York Times
By PAUL KRUGMAN
The
supercommittee was a superdud — and we should be glad. Nonetheless, at some
point we’ll have to rein in budget deficits. And when we do, here’s a thought:
How about making increased revenue an important part of the deal?
And I don’t just mean a return to Clinton-era tax rates. Why should 1990s taxes
be considered the outer limit of revenue collection? Think about it: The
long-run budget outlook has darkened, which means that some hard choices must be
made. Why should those choices only involve spending cuts? Why not also push
some taxes above their levels in the 1990s?
Let me suggest two areas in which it would make a lot of sense to raise taxes in
earnest, not just return them to pre-Bush levels: taxes on very high incomes and
taxes on financial transactions.
About those high incomes: In my last column I suggested that the very rich, who
have had huge income gains over the last 30 years, should pay more in taxes. I
got many responses from readers, with a common theme being that this was silly,
that even confiscatory taxes on the wealthy couldn’t possibly raise enough money
to matter.
Folks, you’re living in the past. Once upon a time America was a middle-class
nation, in which the super-elite’s income was no big deal. But that was another
country.
The I.R.S. reports that in 2007, that is, before the economic crisis, the top
0.1 percent of taxpayers — roughly speaking, people with annual incomes over $2
million — had a combined income of more than a trillion dollars. That’s a lot of
money, and it wouldn’t be hard to devise taxes that would raise a significant
amount of revenue from those super-high-income individuals.
For example, a recent report by the nonpartisan Tax Policy Center points out
that before 1980 very-high-income individuals fell into tax brackets well above
the 35 percent top rate that applies today. According to the center’s analysis,
restoring those high-income brackets would have raised $78 billion in 2007, or
more than half a percent of G.D.P. I’ve extrapolated that number using
Congressional Budget Office projections, and what I get for the next decade is
that high-income taxation could shave more than $1 trillion off the deficit.
It’s instructive to compare that estimate with the savings from the kinds of
proposals that are actually circulating in Washington these days. Consider, for
example, proposals to raise the age of Medicare eligibility to 67, dealing a
major blow to millions of Americans. How much money would that save?
Well, none from the point of view of the nation as a whole, since we would be
pushing seniors out of Medicare and into private insurance, which has
substantially higher costs. True, it would reduce federal spending — but not by
much. The budget office estimates that outlays would fall by only $125 billion
over the next decade, as the age increase phased in. And even when fully phased
in, this partial dismantling of Medicare would reduce the deficit only about a
third as much as could be achieved with higher taxes on the very rich.
So raising taxes on the very rich could make a serious contribution to deficit
reduction. Don’t believe anyone who claims otherwise.
And then there’s the idea of taxing financial transactions, which have exploded
in recent decades. The economic value of all this trading is dubious at best. In
fact, there’s considerable evidence suggesting that too much trading is going
on. Still, nobody is proposing a punitive tax. On the table, instead, are
proposals like the one recently made by Senator Tom Harkin and Representative
Peter DeFazio for a tiny fee on financial transactions.
And here’s the thing: Because there are so many transactions, such a fee could
yield several hundred billion dollars in revenue over the next decade. Again,
this compares favorably with the savings from many of the harsh spending cuts
being proposed in the name of fiscal responsibility.
But wouldn’t such a tax hurt economic growth? As I said, the evidence suggests
not — if anything, it suggests that to the extent that taxing financial
transactions reduces the volume of wheeling and dealing, that would be a good
thing.
And it’s instructive, too, to note that some countries already have financial
transactions taxes — and that among those who do are Hong Kong and Singapore. If
some conservative starts claiming that such taxes are an unwarranted government
intrusion, you might want to ask him why such taxes are imposed by the two
countries that score highest on the Heritage Foundation’s Index of Economic
Freedom.
Now, the tax ideas I’ve just mentioned wouldn’t be enough, by themselves, to fix
our deficit. But the same is true of proposals for spending cuts. The point I’m
making here isn’t that taxes are all we need; it is that they could and should
be a significant part of the solution.
General
Electric, the nation’s largest corporation, had a very good year in 2010.
The company reported worldwide profits of $14.2 billion, and said $5.1 billion
of the total came from its operations in the United States.
Its American tax bill? None. In fact, G.E. claimed a tax benefit of $3.2
billion.
That may be hard to fathom for the millions of American business owners and
households now preparing their own returns, but low taxes are nothing new for
G.E. The company has been cutting the percentage of its American profits paid to
the Internal Revenue Service for years, resulting in a far lower rate than at
most multinational companies.
Its extraordinary success is based on an aggressive strategy that mixes fierce
lobbying for tax breaks and innovative accounting that enables it to concentrate
its profits offshore. G.E.’s giant tax department, led by a bow-tied former
Treasury official named John Samuels, is often referred to as the world’s best
tax law firm. Indeed, the company’s slogan “Imagination at Work” fits this
department well. The team includes former officials not just from the Treasury,
but also from the I.R.S. and virtually all the tax-writing committees in
Congress.
While General Electric is one of the most skilled at reducing its tax burden,
many other companies have become better at this as well. Although the top
corporate tax rate in the United States is 35 percent, one of the highest in the
world, companies have been increasingly using a maze of shelters, tax credits
and subsidies to pay far less.
In a regulatory filing just a week before the Japanese disaster put a spotlight
on the company’s nuclear reactor business, G.E. reported that its tax burden was
7.4 percent of its American profits, about a third of the average reported by
other American multinationals. Even those figures are overstated, because they
include taxes that will be paid only if the company brings its overseas profits
back to the United States. With those profits still offshore, G.E. is
effectively getting money back.
Such strategies, as well as changes in tax laws that encouraged some businesses
and professionals to file as individuals, have pushed down the corporate share
of the nation’s tax receipts — from 30 percent of all federal revenue in the
mid-1950s to 6.6 percent in 2009.
Yet many companies say the current level is so high it hobbles them in competing
with foreign rivals. Even as the government faces a mounting budget deficit, the
talk in Washington is about lower rates. President Obama has said he is
considering an overhaul of the corporate tax system, with an eye to lowering the
top rate, ending some tax subsidies and loopholes and generating the same amount
of revenue. He has designated G.E.’s chief executive, Jeffrey R. Immelt, as his
liaison to the business community and as the chairman of the President’s Council
on Jobs and Competitiveness, and it is expected to discuss corporate taxes.
“He understands what it takes for America to compete in the global economy,” Mr.
Obama said of Mr. Immelt, on his appointment in January, after touring a G.E.
factory in upstate New York that makes turbines and generators for sale around
the world.
A review of company filings and Congressional records shows that one of the most
striking advantages of General Electric is its ability to lobby for, win and
take advantage of tax breaks.
Over the last decade, G.E. has spent tens of millions of dollars to push for
changes in tax law, from more generous depreciation schedules on jet engines to
“green energy” credits for its wind turbines. But the most lucrative of these
measures allows G.E. to operate a vast leasing and lending business abroad with
profits that face little foreign taxes and no American taxes as long as the
money remains overseas.
Company officials say that these measures are necessary for G.E. to compete
against global rivals and that they are acting as responsible citizens. “G.E. is
committed to acting with integrity in relation to our tax obligations,” said
Anne Eisele, a spokeswoman. “We are committed to complying with tax rules and
paying all legally obliged taxes. At the same time, we have a responsibility to
our shareholders to legally minimize our costs.”
The assortment of tax breaks G.E. has won in Washington has provided a
significant short-term gain for the company’s executives and shareholders. While
the financial crisis led G.E. to post a loss in the United States in 2009,
regulatory filings show that in the last five years, G.E. has accumulated $26
billion in American profits, and received a net tax benefit from the I.R.S. of
$4.1 billion.
But critics say the use of so many shelters amounts to corporate welfare,
allowing G.E. not just to avoid taxes on profitable overseas lending but also to
amass tax credits and write-offs that can be used to reduce taxes on billions of
dollars of profit from domestic manufacturing. They say that the assertive tax
avoidance of multinationals like G.E. not only shortchanges the Treasury, but
also harms the economy by discouraging investment and hiring in the United
States.
“In a rational system, a corporation’s tax department would be there to make
sure a company complied with the law,” said Len Burman, a former Treasury
official who now is a scholar at the nonpartisan Tax Policy Center. “But in our
system, there are corporations that view their tax departments as a profit
center, and the effects on public policy can be negative.”
The shelters are so crucial to G.E.’s bottom line that when Congress threatened
to let the most lucrative one expire in 2008, the company came out in full
force. G.E. officials worked with dozens of financial companies to send letters
to Congress and hired a bevy of outside lobbyists.
The head of its tax team, Mr. Samuels, met with Representative Charles B.
Rangel, then chairman of the Ways and Means Committee, which would decide the
fate of the tax break. As he sat with the committee’s staff members outside Mr.
Rangel’s office, Mr. Samuels dropped to his knee and pretended to beg for the
provision to be extended — a flourish made in jest, he said through a
spokeswoman.
That day, Mr. Rangel reversed his opposition to the tax break, according to
other Democrats on the committee.
The following month, Mr. Rangel and Mr. Immelt stood together at St. Nicholas
Park in Harlem as G.E. announced that its foundation had awarded $30 million to
New York City schools, including $11 million to benefit various schools in Mr.
Rangel’s district. Joel I. Klein, then the schools chancellor, and Mayor Michael
R. Bloomberg, who presided, said it was the largest gift ever to the city’s
schools.
G.E. officials say the donation was granted solely on the merit of the project.
“The foundation goes to great lengths to ensure grant decisions are not
influenced by company government relations or lobbying priorities,” Ms. Eisele
said.
Mr. Rangel, who was censured by Congress last year for soliciting donations from
corporations and executives with business before his committee, said this month
that the donation was unrelated to his official actions.
Defying Reagan’s Legacy
General Electric has been a household name for generations, with light bulbs,
electric fans, refrigerators and other appliances in millions of American homes.
But today the consumer appliance division accounts for less than 6 percent of
revenue, while lending accounts for more than 30 percent. Industrial, commercial
and medical equipment like power plant turbines and jet engines account for
about 50 percent. Its industrial work includes everything from wind farms to
nuclear energy projects like the troubled plant in Japan, built in the 1970s.
Because its lending division, GE Capital, has provided more than half of the
company’s profit in some recent years, many Wall Street analysts view G.E. not
as a manufacturer but as an unregulated lender that also makes dishwashers and
M.R.I. machines.
As it has evolved, the company has used, and in some cases pioneered, aggressive
strategies to lower its tax bill. In the mid-1980s, President Ronald Reagan
overhauled the tax system after learning that G.E. — a company for which he had
once worked as a commercial pitchman — was among dozens of corporations that had
used accounting gamesmanship to avoid paying any taxes.
“I didn’t realize things had gotten that far out of line,” Mr. Reagan told the
Treasury secretary, Donald T. Regan, according to Mr. Regan’s 1988 memoir. The
president supported a change that closed loopholes and required G.E. to pay a
far higher effective rate, up to 32.5 percent.
That pendulum began to swing back in the late 1990s. G.E. and other financial
services firms won a change in tax law that would allow multinationals to avoid
taxes on some kinds of banking and insurance income. The change meant that if
G.E. financed the sale of a jet engine or generator in Ireland, for example, the
company would no longer have to pay American tax on the interest income as long
as the profits remained offshore.
Known as active financing, the tax break proved to be beneficial for investment
banks, brokerage firms, auto and farm equipment companies, and lenders like GE
Capital. This tax break allowed G.E. to avoid taxes on lending income from
abroad, and permitted the company to amass tax credits, write-offs and
depreciation. Those benefits are then used to offset taxes on its American
manufacturing profits.
G.E. subsequently ramped up its lending business.
As the company expanded abroad, the portion of its profits booked in low-tax
countries such as Ireland and Singapore grew far faster. From 1996 through 1998,
its profits and revenue in the United States were in sync — 73 percent of the
company’s total. Over the last three years, though, 46 percent of the company’s
revenue was in the United States, but just 18 percent of its profits.
Martin A. Sullivan, a tax economist for the trade publication Tax Analysts, said
that booking such a large percentage of its profits in low-tax countries has
“allowed G.E. to bring its U.S. effective tax rate to rock-bottom levels.”
G.E. officials say the disparity between American revenue and American profit is
the result of ordinary business factors, such as investment in overseas markets
and heavy lending losses in the United States recently. The company also says
the nation’s workers benefit when G.E. profits overseas.
“We believe that winning in markets outside the United States increases U.S.
exports and jobs,” Mr. Samuels said through a spokeswoman. “If U.S. companies
aren’t competitive outside of their home market, it will mean fewer, not more,
jobs in the United States, as the business will go to a non-U.S. competitor.”
The company does not specify how much of its global tax savings derive from
active financing, but called it “significant” in its annual report. Stock
analysts estimate the tax benefit to G.E. to be hundreds of millions of dollars
a year.
“Cracking down on offshore profit-shifting by financial companies like G.E. was
one of the important achievements of President Reagan’s 1986 Tax Reform Act,”
said Robert S. McIntyre, director of the liberal group Citizens for Tax Justice,
who played a key role in those changes. “The fact that Congress was snookered
into undermining that reform at the behest of companies like G.E. is an insult
not just to Reagan, but to all the ordinary American taxpayers who have to foot
the bill for G.E.’s rampant tax sheltering.”
A
Full-Court Press
Minimizing taxes is so important at G.E. that Mr. Samuels has placed tax
strategists in decision-making positions in many major manufacturing facilities
and businesses around the globe. Mr. Samuels, a graduate of Vanderbilt
University and the University of Chicago Law School, declined to be interviewed
for this article. Company officials acknowledged that the tax department had
expanded since he joined the company in 1988, and said it now had 975 employees.
At a tax symposium in 2007, a G.E. tax official said the department’s “mission
statement” consisted of 19 rules and urged employees to divide their time evenly
between ensuring compliance with the law and “looking to exploit opportunities
to reduce tax.”
Transforming the most creative strategies of the tax team into law is another
extensive operation. G.E. spends heavily on lobbying: more than $200 million
over the last decade, according to the Center for Responsive Politics. Records
filed with election officials show a significant portion of that money was
devoted to tax legislation. G.E. has even turned setbacks into successes with
Congressional help. After the World Trade Organization forced the United States
to halt $5 billion a year in export subsidies to G.E. and other manufacturers,
the company’s lawyers and lobbyists became deeply involved in rewriting a
portion of the corporate tax code, according to news reports after the 2002
decision and a Congressional staff member.
By the time the measure — the American Jobs Creation Act — was signed into law
by President George W. Bush in 2004, it contained more than $13 billion a year
in tax breaks for corporations, many very beneficial to G.E. One provision
allowed companies to defer taxes on overseas profits from leasing planes to
airlines. It was so generous — and so tailored to G.E. and a handful of other
companies — that staff members on the House Ways and Means Committee publicly
complained that G.E. would reap “an overwhelming percentage” of the estimated
$100 million in annual tax savings.
According to its 2007 regulatory filing, the company saved more than $1 billion
in American taxes because of that law in the three years after it was enacted.
By 2008, however, concern over the growing cost of overseas tax loopholes put
G.E. and other corporations on the defensive. With Democrats in control of both
houses of Congress, momentum was building to let the active financing exception
expire. Mr. Rangel of the Ways and Means Committee indicated that he favored
letting it end and directing the new revenue — an estimated $4 billion a year —
to other priorities.
G.E. pushed back. In addition to the $18 million allocated to its in-house
lobbying department, the company spent more than $3 million in 2008 on lobbying
firms assigned to the task.
Mr. Rangel dropped his opposition to the tax break. Representative Joseph
Crowley, Democrat of New York, said he had helped sway Mr. Rangel by arguing
that the tax break would help Citigroup, a major employer in Mr. Crowley’s
district.
G.E. officials say that neither Mr. Samuels nor any lobbyists working on behalf
of the company discussed the possibility of a charitable donation with Mr.
Rangel. The only contact was made in late 2007, a company spokesman said, when
Mr. Immelt called to inform Mr. Rangel that the foundation was giving money to
schools in his district.
But in 2008, when Mr. Rangel was criticized for using Congressional stationery
to solicit donations for a City College of New York school being built in his
honor, Mr. Rangel said he had appealed to G.E. executives to make the $30
million donation to New York City schools.
G.E. had nothing to do with the City College project, he said at a July 2008
news conference in Washington. “And I didn’t send them any letter,” Mr. Rangel
said, adding that he “leaned on them to help us out in the city of New York as
they have throughout the country. But my point there was that I do know that the
C.E.O. there is connected with the foundation.”
In an interview this month, Mr. Rangel offered a different version of events —
saying he didn’t remember ever discussing it with Mr. Immelt and was unaware of
the foundation’s donation until the mayor’s office called him in June, before
the announcement and after Mr. Rangel had dropped his opposition to the tax
break.
Asked to explain the discrepancies between his accounts, Mr. Rangel replied, “I
have no idea.”
Value to
Americans?
While G.E.’s declining tax rates have bolstered profits and helped the company
continue paying dividends to shareholders during the economic downturn, some tax
experts question what taxpayers are getting in return. Since 2002, the company
has eliminated a fifth of its work force in the United States while increasing
overseas employment. In that time, G.E.’s accumulated offshore profits have
risen to $92 billion from $15 billion.
“That G.E. can almost set its own tax rate shows how very much we need reform,”
said Representative Lloyd Doggett, Democrat of Texas, who has proposed closing
many corporate tax shelters. “Our tax system should encourage job creation and
investment in America and end these tax incentives for exporting jobs and
dodging responsibility for the cost of securing our country.”
As the Obama administration and leaders in Congress consider proposals to revamp
the corporate tax code, G.E. is well prepared to defend its interests. The
company spent $4.1 million on outside lobbyists last year, including four
boutique firms that specialize in tax policy.
“We are a diverse company, so there are a lot of issues that the government
considers, that Congress considers, that affect our shareholders,” said Gary
Sheffer, a G.E. spokesman. “So we want to be sure our voice is heard.”
