Why Is Treasury Protecting Tax Havens for Multinationals?

Everyone -- except Treasury, apparently -- agrees that our international tax system, which is based on transfer pricing, is broken. Because U.S. multinational companies are allowed to expense foreign costs as they are incurred and can wait to pay tax on foreign income until it is repatriated, they can avoid paying taxes that their domestic competitors must pay. That gives multinational companies a competitive advantage and incentives to move profits and jobs offshore through transfer pricing. Yet every IRS commissioner who has ever testified has admitted that the IRS cannot effectively police transfer pricing -- it's like policing the New Jersey Turnpike on a bicycle. But that hasn't stopped Treasury from opposing changes suggested by the OECD to prevent corporations from transferring profits to tax havens.

We must change our international tax system, if only to protect the interests of the shareholders of multinational companies. There is more than $1.7 trillion of unrepatriated profits offshore that could be used to pay dividends. During the last tax holiday, in which repatriated profits were taxed at only 5.25 percent, subsequent studies showed that most of the money repatriated was used to pay dividends, despite a provision in the legislation prohibiting that use. Because multinationals cannot use in the United States the $1.7 trillion of profits they have offshore, they pay lower dividends or have to borrow to pay for them.

We could easily fix our international tax system by following the same tax philosophy we have had since income taxes were imposed in 1913 -- that is, by requiring every U.S. multinational corporation to pay taxes as it earns profits, whether offshore or onshore, while allowing it a credit for taxes paid to foreign governments. That would help level the playing field between domestic and multinational corporations and encourage multinationals to pay more dividends to their shareholders. However, that system would not recognize how the world's economy has changed. In 1913 almost all corporations, even importers and exporters, were basically domestic operations. Now, multinational corporations are truly multinational and will invest wherever they think profits will be maximized.

The second solution for an international tax system, and one being pushed by multinational corporations, is to adopt territorial taxation and eliminate all U.S. taxes on foreign profits. Multinationals claim that would allow U.S. multinationals to compete more effectively against foreign multinationals. But those companies are called multinationals for a reason. General Electric Co., for example, may be led by U.S. executives and be based in the United States, but it invests wherever it thinks it can maximize profits. Indeed, failure to do that might be considered a breach of its fiduciary obligation to its shareholders.

Why then should we exempt multinationals from taxation and require domestic companies to pay taxes? We want to encourage the creation of domestic jobs and profits, not encourage their export.

Indeed, the abuses of transfer pricing are becoming more evident. Multinationals reported that 43 percent of their foreign profits came from tax havens that had only 7 percent of their actual foreign investments and only 4 percent of their foreign workers, according to the Congressional Research Service. That is why President Obama has publicly opposed a territorial system, but it doesn't appear Treasury believed him because it is opposing any system that isn't functionally territorial.

Territorial taxation has been pushed very quietly but very effectively by those who were bailed out of the economic collapse and by other groups controlled by multinational corporations, while the groups that supposedly represent small or domestic businesses have remained silent. In fact, House Ways and Means Committee Chair Dave Camp, R-Mich., has proposed at least three variations of a territorial tax. Not surprisingly, multinationals disfavor the territorial tax proposals that would require them to pay a minimum tax on their foreign earnings, even though their taxes would be lower than those paid by domestic corporations. The other major problem with Camp's proposals is that they are so complicated that the most likely beneficiaries will be the tax lawyers and accountants who are paid to find ways to avoid paying taxes. And the more complicated the rules, the more taxpayers will find ways to avoid paying taxes. That is particularly true now that the number of IRS auditors is being reduced.

The third way to fix our international tax system would be to apportion worldwide income and tax only that portion earned in the United States. Apportioning income could be accomplished by comparing U.S. property, personnel, and sales with a company's worldwide property, personnel, and sales and allocating that percentage of profit to the United States and subjecting it to U.S. tax. A simpler way would be to compare sales so that if 50 percent of a company's sales were in the United States, 50 percent of its profits would be deemed to have been earned in the United States and subject to U.S. tax. Both methods have been approved by the Supreme Court as accurately reflecting economic reality.

Unfortunately, when the OECD recognized that a formulary apportionment system would be the most effective way to prevent profit shifting to tax havens in its base erosion and profit shifting proposal, Treasury opposed it, claiming that the United States should focus on making sure that transfer prices are fair. But Treasury didn't explain how that was to be accomplished, given every IRS commissioners' testimony that the IRS could not police transfer pricing and the announced cutback in auditing.

Despite the abuse and waste, one can argue that saving our economy required Treasury to throw money at the big banks and Wall Street. But there is far less justification for taking a position that encourages multinational corporations to export jobs and profits, particularly when the president says he is trying to create more jobs for middle-income earners, whose share of GDP has declined over the last 30 years, while income growth for the top 1 percent has skyrocketed. Our elected representatives should be asking who Treasury represents -- taxpayers or multinationals. That might cost them a lot of campaign contributions, but it should earn them votes.