3 possible solutions to international tax avoidance

Apple is the latest multinational to come under fire, but it's only taking advantage of what the law allows

Published May 24, 2013 6:17PM (EDT)

                            (AP/Lukas Barth)
(AP/Lukas Barth)

Both the WaPo and the NYT have articles today on a topic of great importance for the tax debate in advanced economies.  The pieces discuss how officials from the UK and European economies are being pushed by their citizens to go after the type of tax avoidance engaged in by Apple, Google, GE, and countless other multinationals.

There are at least two reasons this development is important.  First, technology and tax law have led the emergence of what international tax analyst Ed Kleinbard calls “stateless income,” a phenomenon that was on full display at the Apple hearing yesterday, where the company’s spokesperson said in so many words, “you can’t tax this income because it only exists where tax liabilities do not exist.”

It’s like some newly discovered physical particle that can only exist in a state of non-taxation.

Second, and this is very important to forthcoming policy, which is what this post is really about, a strong American argument in favor of territoriality, a regime favored by the multinationals but opposed by those who would shut down the types of tax sheltering on display yesterday, is that we have to go there because Europe is solidly there.  In fact, as these articles show, Europeans are closely questioning the costs and benefits of the current system.

There are no global estimates of how much revenue governments lose through tax avoidance or evasion schemes.

But recent research by the Organization for Economic Cooperation and Development (OECD) indicates that the problem is massive. Foreign direct investment, for example, in theory represents a long-term commitment by a firm in one country to owning productive capacity — a plant or building, for example — in another. But data show billions of dollars in foreign direct investment moving through small nations such as Bermuda and the Bahamas, suggesting that the money is not invested there but simply used to set up a corporate presence, for tax purposes, before moving to a final destination elsewhere.

So, what’s needed in this debate is a robust discussion of alternatives to territorial regimes for taxing international income.  I can’t do this justice right now (getting ready to go on MSNBC’s NOW at noon), but I encourage enterprising tax scholars and journalists to teach us about the relative pluses and minuses of these and other options.

“Tough territorial” As shown in the link above, territorial systems apply no home country taxes to foreign earnings by MNC’s.  “Tough” territorial un-exempts some portion of foreign earnings from home country taxes.  The larger the share that’s not exempted, the “tougher” the system.  Works a bit like minimum or alternative tax rules.

End deferral, lower the rate.  If US multinationals could not defer their foreign earnings (hold them abroad to avoid US taxes), they wouldn’t benefit from the machinations to make them stateless.  The extra revenue that this would generate could be used to lower the corporate rate.  The Apple guy said he’d support closing loopholes if it would buy his firm a lower rate, even if it meant they’d have to pay higher taxes.  Let’s see what he says to this.  (I’d be amazed if he would accept it, which is always the hitch with these “broader base, lower rate” appeals.)

Sales apportionment.  I mentioned this yesterday (see Apple link above)—here’s a piece by Bill Parks explaining the idea.  I also heard tax scholar Alan Auerbach support this alternative yesterday on the radio.  Firms pay taxes on their worldwide profits to country X based on the share of their sales in X.  No sales in the Caymans, no application of Cayman “tax law” to the earnings you book there.

It’s a solid, simple idea, but a knowledgeable friend views it as a version of a territorial system, because it’s conceivable that under this system an American firm, for example, would pay little or no taxes here if all their sales are made abroad (e.g., I believe that 2/3 of Apple’s sales come from  outside of the US).

Gotta run, but you get the idea.  There’s maybe some momentum for reform of this international tax avoidance problem, but you can’t beat something with nothing.  I’d love to see the echo chamber of this part of the debate filled with alternatives like these versus territoriality.

By Jared Bernstein

Jared Bernstein joined the Center on Budget and Policy Priorities in May 2011 as a Senior Fellow. From 2009 to 2011, Bernstein was the Chief Economist and Economic Adviser to Vice President Joe Biden. Follow his work via Twitter at @econjared and @centeronbudget.

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