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Home Publications Blogs Beat the Press A Way to Tax Corporations That They Cannot Escape

A Way to Tax Corporations That They Cannot Escape

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Wednesday, 29 May 2013 05:18

Eduardo Porter has a column discussing the increasing ability of corporations to escape income taxes. The idea is that they can play games on where their income originated so that it always shows up in countries with the lowest tax rates.

There are different possible responses to this problem. One is to follow the lead of many state governments which tax companies in proportion to the share of total sales that occur within the state. That seems like a reasonable path, but I remember an even surer route to collecting tax that was proposed some years back. (I apologize to the person who came up with this one, who I cannot remember.)

Suppose we give companies the option of giving the government an amount of non-voting stock (I would suggest something like a 30 percent stake) which would be treated exactly like the company's common stock, except without the voting privileges. This means that if the company distributes profits to the shareholders through dividends, then the government's shares get the exact same dividend. If it buys back 10 percent of its shares, then it also buys back 10 percent of the government's shares.

The beauty of this approach is that there is no way to escape the implicit taxation. In addition it has the enormously beneficial effect that there would no longer be any money in playing tax games. Companies could focus on doing business -- making better products or providing better services -- rather than gaming the tax code.

The share option can even be voluntary. If companies want to keep trying to play games with the tax system, they can refuse to go the route of giving shares to the government. Of course everyone will then know what these companies are doing, but that's their call.

Okay, this is too simple to ever make any headway in Washington, but it is something for the rest of us to think about.

 

Addendum:

A few additional items. Jonathan Cohn pointed me to E.F. Schumacher as the source of this share idea. Glad to have that tracked down.

Next, on the issue of companies not paying dividends, so what? The shares will rise in value in accordance with whatever the company keeps as retained earnings. We don't need them to pay it out as dividends.

To get to the more fundamental issues of how taxes work and why they are necessary, we want to reduce someone's purchasing power to leave room for what the government needs to spend. This system does exactly that. Money that otherwise would have gone into the pockets of other shareholders is instead pulled away from them by the government: mission accomplished.

There are issues with companies operating across national borders. If a U.S. company decides to invest heavily in Europe or Latin America then it will presumably be subject to taxes on its earnings in those countries. It then is effectively taxed on its after-tax earnings through this share ownership system. That doesn't really trouble me -- that is the way the tax code is supposed to work now. The structure of incentives created will encourage companies to invest overseas if it would be profitable after deducting whatever foreign taxes they would be forced to pay. That is what we would want.

Suppose foreign countries adopted the same system? I don't see a downside. They can offer an option of paying taxes or giving stock equal to some percentage of outstanding shares. Obviously a firm that just has a small operation in another country will never choose the share option. In terms of state taxes, they can tie their tax collections to the federal collections (dividends plus capital gains) using something like the unitary tax system.

Anyhow, I'm sure that there will be some twists on this one -- that is what corporate tax accountants exists for -- but I haven't heard anything to suggest that this is not workable.

Comments (22)Add Comment
Another way to stop tax avoidance
written by Robert Salzberg, May 29, 2013 6:32
While it doesn't seem like it, government has almost complete control over corporations because they only exist with the explicit permission of the state through charters.

Because many corporations never issue dividends, Dr. Baker's suggestion would miss lots of corporations.

The UK compels all UK based companies to pay a fee when their stock is traded no matter where in the world that trade happens.

We can't control which country a company pretends it is based, but we can set rules for corporations that want to do business in the US.

Say a corporation does 33% of it's total business in the US. The US could require, as a condition of doing business in the US, that the corporation pay taxes on 33% of it's profit to the US.
Taxing corporate income, not distributions
written by The General Welfare, May 29, 2013 7:01
A corporate income tax should tax corporate income, not merely distributions to shareholders. The stock proposal does not tax undistributed corporate income, although shareholders can still access it (by having the corporation spend it or by borrowing against unrealized capital gains).

A better solution would be to simply take seriously the (former) US rule that we tax the world wide income of US corporations, with a credit for taxes paid elsewhere on income primarily earned elsewhere. This rule should be expanded to include (1) the entire corporate group, to avoid the Apple/Starbucks problem, and (2) corporations incorporated abroad but headquartered in the US, to capture Tyco, and (3) corporate groups headquartered elsewhere with a US corporate subsidiary or US income.

These rules are basically the corporate equivalent of the way that many states tax human beings with income from multiple states. They eliminate the entire "Irish" income game simply and enforceably: Apple pays US tax on its "Irish" income unless it can prove that it already paid Irish tax.
But...
written by Hugh Sansom, May 29, 2013 7:26
Haven't firms been paying dividends at lower and lower rates in recent years? (One of the reasons that Apple's decision to pay a dividend was considered so surprising.) And wouldn't predictability from the standpoint of policymakers' budgeting be an issue?
...
written by dax, May 29, 2013 7:35
Wouldn't this imply that Google only pays taxes to the US? Or does Google issue shares to every nation in the world? How do we decide how many shares go to which nation?
Granting Charters
written by Jennifer, May 29, 2013 7:42
Yes, that would be a terrific "free market" solution, which is too simple to actually happen. But I also agree with Robert Salzberg the ability of corporations to even function is actually granted to them by the state, so the state should really have the ultimate power of what happens. This is the focus of Poclad (Program on Corporations, Law and Democracy. They have a terrific book called "Defying Corporations, Defining Democracy" which gives an extensive history of corporate power in the US. It puts the whole thing in a context of American history, the constitution, and also gives insights to how corporations have learned to manipulate state oversight to their advantage.
WTO and 'Free Trade' argeements are a sham
written by Robert Salzberg, May 29, 2013 7:55
The WTO and various 'free trade' agreements pretend that they just want to level the playing field. Nothing could be further from the truth. While working conditions like very limited bathroom breaks, and stories about workers dying in fires get some coverage, the real scam is that the WTO and 'free trade' agreements are basically tools to maximize the exploitation of the resources of countries with token nods towards labor rights and environmental protections. It all just empowers a race to the bottom.

The scam is totally exposed when you look at the corporate tax system among countries. While the WTO makes it illegal to subsidize the production of a product directly, allowing the same company to pay less or no corporate income tax is OK. Giving a corporation an equivalent subsidy directly for production or indirectly through a tax break has exactly the same economic effects in terms of competition among countries.

So if the WTO really wants a level playing field, why are they silent on corporate taxation unless the real goal is to maximize profit?
Clarification for previous post
written by Robert Salzberg, May 29, 2013 8:06
The WTO does regulate targeted tax credits for specific industries but I'm talking about the national corporate tax structures.
VAT
written by Charlie, May 29, 2013 8:24
A tax in proportion to sales is a VAT, and it is the solution that the EU group has adopted to solve the problem of high cross-border trade compared with domestic. You tax imports, while exempting exports (which are taxed by the importer). The use of VAT is the reason that corporate taxes can be lower elsewhere.

I don't like VAT, but in a race to the bottom, it at least gives you control over your fate (though it hasn't helped the EU overcome the issues of being locked into a common currency with no real central banking authority). If necessary to implement a VAT, I'd match a VAT which has a high rate on carbon consumption with a large negative income tax - perhaps matching the negative income tax to the amount of the tax collected on carbon.
...
written by skeptonomist, May 29, 2013 8:54
Porter ignores the fact that there has also been less and less personal taxation on those whose income derives from the capital/management side of corporations. Rates on high-bracket salaries, dividends and capital gains have come down in the last 30+ years - there is presumably a race to the bottom in this respect also. At any rate it is pointless to say that corporations should not be taxed when there is little likelihood of recovering the revenue in other ways.

Meanwhile corporations gain more political power through legislation and Supreme Court decisions. The solution is not to give more money to corporations, it is to reduce their political power. There should be specific taxes on corporations as long as they have the advantages of limited liability, or they should pay a monetary premium somehow, or there should be some degree of direct government and worker control - or all of these things. Corporations have become superpersons with few of the responsibilities either of individuals or governments.

Early big corporations, specifically the colonial corporations such as East India companies, had a very nationalistic bent. Not that colonialism was good, but the privileges of corporations which were granted for such purposes are now granted for the sole purpose of enriching capitalists, which has come to be considered a good in itself, and they now take precedent over national interests.
There Is Merit to a Simpler Corporate Tax Law
written by Juan, May 29, 2013 9:14
Large companies such as Apple hire large, expensive audit firms such as Ernst and Young to help strategize how to avoid paying taxes. Tax strategy fees run into the millions of dollars for companies like Apple. Indeed, a simpler tax code would relieve Apple and others of the burden of hiring 3rd party consultants to figure out ways to lower their tax bite.
...
written by watermelonpunch, May 29, 2013 9:18
Pretty sure a lot of people like corporations escaping taxes via complex gaming of the tax code.
A fair amount of rich people are making money, both on the profits made by avoiding taxes, and a lot of more ordinary people make their money in the tax gaming industry.

I have a hard time seeing any nice way out of this mess.
Any solution comes up against a fortified Catch 22.

Do I sound like Mel now? Sorry mom!
...
written by kharris, May 29, 2013 9:41
What Robert S and Jennifer seem to suggest is that the US business environment is similar in some ways to the electromagnetic spectrum - a valuable commodity that can be leased to those who make money from its use. This seems an entirely reasonable analogy. Efficiency in extracting value on behalf of the citizenry has long been subordinated to other interests in leasing public commodities - airwaves, grazing rights, mineral extraction rights. It would undoubtedly be the case that efficiency in extracting value on behalf of the citizenry would not be a high priority if our business environment were treated in similar manner. In fact, it already is the case. Many corporations pay no income tax now. Changing the system just for the sake of change doesn't held fund government operations or make the tax system more fair. That requires a political change.
...
written by Mark Jamison, May 29, 2013 10:05
Dr. Baker,

I wonder if you would consider discussing two separate ideas that would have a tremendous impact on corporate taxation:
1. Unified accounting so that there isn't a separate accounting for taxes. It seems that this would enhance transparency
2. A Gross Receipts Tax - This would address issues of regionalism since a corporate entity would pay tax on the revenues it received within a particular jurisdiction. It would also address issues of loading a corporation up with debt as a means of creating the appearance of smaller profit. I suppose there might be an argument that an unprofitable corporation shouldn't pay tax but an unprofitable corporation still uses national infrastructures including intellectual property law, physical infrastructures and the basic legal system. Paying for infrastructures along with externalities ought to be a basic cost of doing business - if you can't meet those responsibilities then perhaps you shouldn't be in business.
...
written by Last Mover, May 29, 2013 10:26
The beauty of this approach is that there is no way to escape the implicit taxation.


Now we know who was at the bottom of the IRS scandal don't we. Been nice knowin ya Dean Baker.
...
written by Wade, May 29, 2013 7:31
"To get to the more fundamental issues of how taxes work and why they are necessary, we want to reduce someone's purchasing power to leave room for what the government needs to spend."
What? I don't understand what you mean. I don't imagine that you're saying that the government can't (or shouldn't?) spend money unless it first collects it as taxes, but I can't see any other interpretation.
I'm sure you know that the government can simply print money, so it really doesn't need to tax in order to spend. And this won't always create inflation. The government just printed 800 billion dollars and gave it to the banks, and my wages have not gone up at all.
What the government does need is for people to believe that the dollars it prints are worth something.
Taxation is a method of creating in the people taxed a demand for dollars (to pay their taxes). Otherwise, they'd start using gold, or bit coins, or Euros, or barter to buy things, and then the dollars that the government prints really would be worth only the price of the paper they're printed on.
The government only accepts tax payments in dollars (try paying your taxes in gold next year), and that creates the value that the printed dollar has.
So what did you mean in the above statement?
...
written by Chris Engel, May 29, 2013 11:40
This idea isn't even implemented anywhere in the world (correct me if I'm wrong).

There needs to be some kind of pilot implementation before it gets any serious traction in US politics.
Exempting retained earnings
written by The General Welfare, May 30, 2013 6:48
Re the addendum. Schumacher's proposal means that companies that don't distribute earnings (as dividends or stock buy backs) don't pay corporate income tax.

To be sure, the value of the government shares may increase, but so what? The company retains full control of its surplus without any contribution towards collective expenses.

The incentive effects will be to encourage companies to retain more earnings -- that's probably fine. There is no reason to believe that companies do a worse job investing and spending than the stock market and the uber-wealthy who are its chief beneficiaries.

But the fiscal and political effects are terrible.

Fiscally, the state remains underfunded. Replacing a corporate income tax with a corporate distributions tax -- especially given that the taxpayer determines whether to have distributions -- will reduce collections from this source. Consequently, the essential sectors of the economy that private corporations neglect -- education, research, transportation, infrastructure, military, public health, safety, childcare, transition to sustainable energy, etc. -- remain underfunded.

Politically, the proposal will concentrate wealth and power even further, the last thing we need. As corporations grow ever larger and more powerful -- especially given the Supreme Court's protection of their spending on politicians and other forms of lobbying -- they are ever more able to shape the legal system to allow free riding, monopoly power, lower taxation on corporations and the rich, and other forms of Reverse Robin Hood state redistribution.
So buffet with 0 dividends pays no taxes...he would love this!
written by pete, May 30, 2013 10:59
this too can be gamed..anyway, considering the vast amount of ownership throught pension funds, IRAs, 401s and 403s, little folks already benefit from distributions. Passing the money through uncle sam (taxes then redistribution) seems unnecessary. Drop corporate taxes altogether, tax carbon, tax sugar, tax nicotine....all economists know that the best taxes are on things with negative externalities.
Buffett knows arithmetic
written by Dean, May 30, 2013 9:37
Pete,

I can assure you, he understands when 30 percent of his companies' earnings are being socked away by someone else.
We then become citizen exploiters
written by Scott ffolliott, May 30, 2013 9:51
"Suppose we give companies the option of giving the government an amount of non-voting stock ( i would suggest something like a 30 percent stake) which would be treated exactly like the company's common stock,"

We then become citizen exploiters pitting one worker against another. As we know from the evidence before our own eyes, that is a failed economic system.
Complexity is the problem
written by John B, May 30, 2013 11:54
I have long thought that tiers of corporations are the root of many problems.

Some corporations are investment vehicles.
Some are manufacturers of value, either physical manufacture or perhaps intellectual property, etc.

The problems start when slices, chunks and wedges of companies own and operate behind impenetrable screens of sub-ownership. Blind corporate structures.

Why not split all corporations into two categories - ones which are at the bottom of the pile - the manufacturers, and those at the top of the pile, the investment vehicles.

I propose limiting the whole corporate world to three or four levels:
One level at the bottom, which is prohibited from owning shares in other corporations;
Two or three levels of investment corporations and no more.
Tier One can own shares, but must be entirely privately owned, by real living persons or governments.
Tier Two can own shares in Tiers One, Two and Three corps but not manufacture, except via Bottom Tier subsidiaries.
Tier Three: similar.
Tier Four: Bottom Tier, may not own shares. Is a manufacturer of wealth via products, services, knowledge...

That should make the ownership merry-go-round comprehensible and give tax laws some bite.
Taxes reduce real aggregate demand
written by Ferridder, May 31, 2013 3:28
Wade, taxes also reduce the demand of the private sector for _real_ resources. If private sector demand plus government demand (plus net exports) are greater than the capacity of the economy to produce, the government needs to tax away the excess demand or face severe inflation.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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