New Proposals from Congressman Pocan and CTJ to Stop Corporate Inversions

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The crisis of corporate inversions remains unresolved in Congress, but some new proposals could set the stage for a resolution.

An August report from CTJ explained that the inversion crisis really consists of three related problems. The first is that American corporations are able to use mergers with smaller foreign corporations to claim a foreign address for tax purposes even though almost nothing has changed about their business, management, or ownership. This problem would be addressed by the Stop Corporate Inversions Act introduced by Rep. Sander Levin and Sen. Carl Levin in May.

The second problem is that those corporations claiming to be based abroad (and corporations that really are based abroad) are able to use “earnings stripping” to make profits earned in the United States appear to be earned in countries where they will be taxed more lightly or not at all. This problem would be addressed very effectively by a new proposal from Congressman Mark Pocan of Wisconsin, and less effectively addressed by a proposal introduced by Senator Charles Schumer last week.

The third problem is that profits American corporations earn offshore through their subsidiaries are supposed to be taxed by the U.S. when they are brought to the United States, but after becoming “foreign,” corporations are able to use accounting tricks to escape that rule. An op-ed from Citizens for Tax Justice and Americans for Tax Fairness explains how this problem can be resolved by requiring corporations that give up their American citizenship to pay taxes they have deferred on these profits, just as individuals who give up their American citizenship must pay any tax on capital gains they have deferred. A CTJ report also explains this idea in detail.

The following describes these proposals in more detail.

Earnings Stripping

As CTJ’s August report explained, earnings are stripped out of the U.S. when a U.S. corporation (which after inversion is technically the subsidiary of a foreign parent corporation) borrows money from its foreign parent corporation, to which it makes large interest payments that wipe out U.S. income for tax purposes. The loan is really an accounting gimmick, since all the related corporations involved are really one company that is simply shifting money from one part to the other.

The August report explained that the strongest proposal to address this is the one President Obama proposed as part of his fiscal year 2015 budget plan — which has now been introduced as legislation for the first time by Rep. Pocan. When the President proposed this provision, the Joint Committee on Taxation estimated that it would raise $41 billion over a decade.

It would, with good reason, apply to all corporations, not just those that have inverted. It would allow a multinational corporation doing business in the U.S. to take deductions for interest payments to its foreign affiliates only to the extent that the U.S. entity’s share of the interest expenses of the entire corporate group (the entire group of corporations owned by the same parent corporation) is proportionate to its share of the corporate group’s earnings (calculated by adding back interest deductions and certain other deductible items). A corporation doing business in the U.S. could choose instead to be subject to a different rule, limiting deductions for interest payments to ten percent of its income.

Sen. Schumer’s proposal is much more similar to the one that President Obama included in his previous budget plans, which is much weaker. Schumer’s proposal only applies to inverted corporations. Most importantly, it would bar an inverted American corporation from taking deductions for interest payments to a foreign parent company in excess of 25 percent of its income. The current rule sets the limit at 50 percent.

Accumulated Offshore Profits

The U.S. theoretically taxes all the profits of American corporations, including the profits earned by their offshore subsidiaries. (The U.S. corporate income tax is reduced by whatever corporate income tax has been paid on these profits to foreign governments.) But U.S. corporations are allowed to defer paying U.S. tax until these profits are officially brought to the U.S., which may never happen. As a result, one of the key questions is what will become of the offshore profits that American corporations’ subsidiaries have accumulated offshore after they invert.

In The Hill, CTJ and ATF point out that deferral is a break we give American corporations, supposedly to help them compete with corporations based in other countries. It therefore makes no sense to continue giving corporations this break once they declare that they are no longer American. In other words, the profits held offshore by a corporation that announces a new foreign address should be subject to U.S. taxes as if they are repatriated to the U.S. at that point. This would only be fair, and would certainly discourage inversions. 

What’s the Matter with Kansas Is What Ails All 50 States

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It’s easy to hold up Kansas as the poster child for regressive tax policies gone awry.

By now it’s apparent Gov. Sam Brownback and his allies in the state legislature were wrong when they predicted lopsided tax cuts would boost the state’s economy.  The state will have trouble funding priorities such as education and services for the disabled since its revenue is hundreds of millions less than projected. And just last month, Standard & Poor’s downgraded the state’s bond rating because Brownback’s tax cuts cost far more than promised.

But make no mistake. The tax cuts, which disproportionately benefited higher-income earners and corporations, made worse an already regressive tax code. And in that sense, Kansas is not alone.

When all taxes assessed by state and local governments are taken into account, every state imposes higher effective tax rates on low-income families than the richest tax payers. On average, the lowest income households (bottom 20 percent) pay 11.1 percent of their income in state taxes, middle income households pay about 9.4 percent and the top 1 percent only pay 5.6 percent. This means state tax systems are actually making it harder for families to escape poverty.

Given a high poverty rate, stagnant wages and eroding family wealth, it’s perplexing that governors and state legislatures are getting away with selling the public the bill of goods that is trickle-down economics. We don’t all do better when the wealthy prosper at the expense of everyone else. In fact, we’re all worse for the wear and tear.

State and local data on income and poverty released today by the U.S. Census reveal, as did the national numbers, that not much has changed since the previous year and poverty remains significantly higher than before the Great Recession took hold. Most state poverty rates held steady. Three states experienced an increase in the number or share of residents living in poverty, and two states had a decline.

As I mentioned in a previous post, new Census poverty data is newsworthy more so because we’ve all become desensitized to a poverty rate that continually grew throughout the 2000s and remains higher (currently 2 percentage points) than it was before the Great Recession.

But when experts project the youngest generations may be worse off than their parents, or when median family income is 8 percent less today that it was in 2007, or when poverty is near generational highs, we all should pay attention, especially our elected officials.

The Institute on Taxation and Economic Policy today released a study, State Tax Codes as Poverty Fighting Tools, which examines four specific tax policies in each of the 50 states. The report recommends that states should enact or expand refundable Earned Income Tax Credits (EITC), offer refundable property tax credits for low-income homeowners and renters, create refundable, targeted low-income credits to help offset regressive sales and excise taxes, and increase the value of existing child- related tax credits. The full report includes state-by-state analysis of current polices.

Specifically, the report notes, “In most states, a true remedy for state tax unfairness would require comprehensive tax reform. Short of this, lawmakers should use their states’ tax systems as a means of providing affordable, effective and targeted assistance to people living in or close to poverty in their states.”

This is certainly a better approach than soaking the poor. A Standard & Poor’s study released earlier this week demonstrated that growing income inequality is a reason states are failing to collect enough revenue to meet their needs. It’s easy to surmise that, as wealth concentrates at the top and incomes stagnate for low- and middle-income people, states’ tax the poor more strategies result in flat or declining revenue and ultimately more difficulty funding priorities from education to infrastructure.

There’s a better way. A recent report from Citizens for Tax Justice reveals the average single-parent, two-child family receives a $4,550 income boost with the federal EITC, and a two-parent, two-child low-income, working household receives a boost of $5,790.  Twenty-five states and the District of Columbia offer state Earned Income Tax Credits based on the federal EITC, and a May 2014 report from ITEP outlines how this is an effective tool.

We are under no illusion that progressive taxation will solve poverty, but it can play a big role in mitigating poverty. And the harsh reality is that no state is fully living up to that promise. What is painfully clear, as Kansas tax cuts have demonstrated, is that adding more regressive tax cuts to an already unfair tax structure exacerbates poverty, shortchanges families, and starves states of funds to invest in vital services on which we all rely.

Tax Policy and the Race for the Governor’s Mansion: Massachusetts Edition

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Voters in 36 states will be choosing governors this November. Over the next several months, the Tax Justice Digest will be highlighting 2014 gubernatorial races where taxes are proving to be a key issue. Today’s post is about the race for Governor in Massachusetts.

mass.jpgMassachusetts Attorney General Martha Coakley (D) will face former cabinet official Charlie Baker (R) in November, after both candidates won their respective primaries last Tuesday. This being so-called “Taxachussetts” (a nickname we do not quite agree with), tax policy is a hot item on most voters’ agendas – though not necessarily the issue candidates want to focus on.

Both Coakley and Baker have avoided any big proposals on taxes, hoping to prevent any unforced campaign errors. Coakley has called for new services, like an extended school day and universal prekindergarten, but has so far failed to say how she would pay for them. Baker wants modest, targeted tax cuts, like an increase in the state’s EITC and a small reduction in the state’s income tax rate – from 5.2 percent to 5 percent (Massachusetts is one of seven states with a flat person income tax.) Both candidates have so far refused to rule out a tax increase.

Baker’s positions are a huge departure from his previous run for governor, when he promised to cut corporate, income and sales tax rates to 5 percent while slashing 5,000 government jobs and eliminating some of the state’s health and human services agencies. He also signed an anti-tax pledge during that campaign, and has caught heat from fellow Republicans for not signing again this go around.

Baker has sought to keep the focus (and pressure) on Coakley, whom he alleges will raise taxes by billions of dollars to pay for her proposals. He cited a study by the Massachusetts Budget and Policy Center that found expanding full-day prekindergarten in public schools would cost $1.48 billion every year and  Coakley’s universal prekindergarten pledge has been slammed as an “empty promise” without a funding plan. Coakley’s campaign has fired back, arguing that she wants to provide vouchers for children on the prekindergarten waiting list, and that this would cost only $150 million over four years.

Baker saw an opportunity to pounce when Coakley fumbled a question about the state’s gas tax; she was asked what the current per-gallon rate was, and said 10 cents. The actual rate is 24 cents. Baker has used the gaffe to portray Coakley as out of touch with voter’s concerns, and to tout his support of a ballot initiative that would repeal a law passed last year that indexes the gas tax to inflation. Coakley supports the indexing provision, which lawmakers enacted as a much needed reform to help fund transportation projects in the state. 

Will the OECD’s Recommendations to Stop Corporate Tax Dodging Actually Work?

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On September 16, the Organization for Economic Cooperation and Development (OECD) released the first part of its recommendations to implement its 2013 “Action Plan on Base Erosion and Profit Shifting.” Base erosion and profit shifting, or BEPS as it’s known among international tax experts, is the fancy way of describing tax dodging by corporations that use offshore tax havens. CTJ criticized the action plan in 2013 for not going far enough, and it remains to be seen how much good can be accomplished with the reforms that OECD now recommends.

At the same time, the OECD recommendations are surely a step in the right direction. This is important because many members of Congress, including the top Republicans on the House and Senate committees with jurisdiction over taxes, consider even the OECD’s mild reforms to be asking too much of corporations. Rep. Dave Camp and Senator Orrin Hatch issued a statement in June making clear that they would likely oppose enacting OECD’s recommendations into law. Neither has issued any further statement on the matter.

According to one international law expert, it will likely be five to ten years before many countries enact the recommendations into law. But some countries, like the U.K., France and Australia are expected to be early adopters of the changes, and corporations would need to change their reporting methods in order to comply at least in those countries. This could make it easier for other governments to follow.

Some of the significant recommended changes include the following:

—End the ability of corporations to take advantage of loopholes like the U.S.’s “check-the-box,” which essentially allows a company to characterize a tax haven subsidiary in different ways to different governments so that the profits funneled there are taxed by no government at all. (Such tax haven entities are often euphemistically called “hybrid instruments.”)

For example, right now an American corporation can have an Irish subsidiary that pays royalties to its own subsidiary in Bermuda, which it characterizes as a separate corporation for Irish tax purposes so that it can deduct the interest payments from its Irish taxable income. But the American parent company can tell the U.S. government that the Bermuda subsidiary is just a branch of the Irish company and the payment was a payment internal to the company, meaning there is no profit to be taxed.

—End the shifting of corporate profits through certain countries to take advantage of tax treaties in schemes like the “Dutch sandwich.” In the example above, the Irish government might apply a withholding tax to payments made to Bermuda, but not if they are first routed through a country like Netherlands that has a tax treaty with Ireland precluding such withholding taxes. In theory, developed countries have negotiated such treaties with countries they trust to not facilitate tax avoidance. But the system has obviously broken down, as parties to such treaties including Ireland and the Netherlands are now facilitating tax avoidance by huge corporations like Google and Apple.

—Require country-by-country reporting of sales, profits and taxes paid by corporations to tax authorities, who would then have a better handle on when and how these tax avoidance schemes are being carried out. While it would be helpful to have this information made available to tax authorities who do not currently have it, a much stronger reform would make this information public for all to see. In the U.S., the I.R.S. already collects this type of information (which is necessary for certain purposes like the calculation of foreign tax credits in the American system). Providing information to the government makes a difference only to the extent that corporations are doing something that is actually illegal, but the entire point of the BEPS project is that corporations are able to abuse the system legally, thanks to various tax loopholes. The success or failure of the OECD’s attempts to close those loopholes will be known only to the extent that tax reformers, lawmakers and the public can actually see where profits are booked and what taxes are paid by multinational corporations in different countries.

—Implement new rules determining how intangible assets (like patents and royalties) are valued for transfer pricing. This is intended to address one of the thorniest questions and one that the OECD may not be able to solve without more dramatic reforms. When the OECD’s action plan was first released in 2013, CTJ was skeptical that it could work because

“…the OECD does not call on governments to fundamentally abandon the tax systems that have caused these problems — the “deferral” system in the U.S. and the “territorial” system that many other countries have — but only suggests modest changes around the edges. Both of these tax systems require tax enforcement authorities to accept the pretense that a web of “subsidiary corporations” in different countries are truly different companies, even when they are all completely controlled by a CEO in, say New York or Connecticut or London. This leaves tax enforcement authorities with the impossible task of divining which profits are “earned” by a subsidiary company that is nothing more than a post office box in Bermuda, and which profits are earned by the American or European corporation that controls that Bermuda subsidiary.”

Transfer pricing rules require multinational corporations to deal with their offshore subsidiaries at “arm’s length.” This means that, for example, a corporation based in New York that transfers a patent to its offshore subsidiary should, in theory, charge that subsidiary the same price that it would charge to an unrelated company. And if the New York-based corporation pays royalties to the offshore subsidiary for the use of that patent, those royalties should be comparable to what would be paid to an unrelated company.

But this system has broken down. As we have argued before, when a company like Apple or Microsoft transfers a patent for a completely new invention to one of its offshore subsidiaries, how can the IRS even know what the market value of that patent would be? And tech companies are not the only problem. The IRS apparently found the arm’s length standard unenforceable against Caterpillar when that company transferred the rights to 85 percent of its profits from selling spare parts to a Swiss subsidiary that had almost nothing to do with the actual business.

A more dramatic reform could eliminate the problems associated with transfer pricing. For example, CTJ’s tax reform plan would end the rule allowing American corporations to defer U.S. profits on its offshore subsidiaries’ profits. With deferral repealed, an American corporation would pay the same tax rate no matter where its profits were earned and would therefore have no incentive to make profits appear as if they were earned in a zero-tax country.

State Rundown 9/17: Virginia Gas Tax, Tesla’s Sweetheart Deal

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TESLA1.jpgVirginia’s gasoline tax will increase by 45 percent on January 1, 2015 if Congress fails to pass a law (the Marketplace Fairness Act) granting states the power to collect sales tax on online purchases. The increase, passed by lawmakers as part of a 2013 transportation spending plan, will cost motorists about 5 more cents per gallon. Rep. Bob Goodlatte, a Virginia congressman and Chairman of the House Judiciary Committee, is responsible for holding up the internet sales tax legislation, allegedly due to the deep pockets of his tech company supporters. Goodlatte’s opponents have accused the congressman of backing the interests of his donors over those of his constituents.

The New York Times reports that Kansas Gov. Sam Brownback (R) faces a revolt from his base over the deep and painful tax cuts he pushed for two years ago. The article quotes staunch conservative voter Konrad Hastings: “[Brownback] is leading Kansas down. We’re going to be bankrupt in two or three years if we keep going his way.” The state’s projected budget shortfalls are in the hundreds of millions of dollars annually, and over 100 Republican state officials have endorsed Gov. Brownback’s challenger, Paul Davis (D).

Using ITEP data, financial services website Wallet Hub released its ranking of the most and least fair state tax systems of 2014. To rank the states, Wallet Hub conducted a national survey, which found that both liberals and conservatives believe a progressive tax system is most fair. Then they compared this against ITEP’s finding that the average local and state tax burden is hugely regressive. Washington took the prize as the least fair state using Wallet Hub’s methodology, while Texas and Florida had the dubious distinction of being states where the top 1 percent are most undertaxed while the bottom 20 percent are most overtaxed. Congrats, I guess?

Nevada has agreed to a $1.25 billion economic incentives package for Tesla Motors, which plans to build a high-tech battery factory outside Reno. The figure is more than double the $500 million Tesla CEO Elon Musk was asking for, and amounts to almost $200,000 per anticipated job created. The deal contains “clawbacks,” clauses that allow states to demand repayment of giveaways if the promised investment is not forthcoming, but experience shows that these clauses are rarely invoked. California Gov. Jerry Brown, who fought for the factory but resisted ponying up millions in incentives, noted that the deal would be good for his state anyway since Tesla Motors is still headquartered in Palo Alto.


Poverty Data Not Surprising, No Matter How You Spin It

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The top 20 percent of households captured more of the nation’s collective income (51 percent) than the rest of population, according to the Census report Income and Poverty in the United States: 2013 released today.

This is consistent with what we know about worsening income inequality in this nation.

Median household income remained relatively stagnant in 2013 at $51,939, a mere $180 more than the previous year, giving average families no more buying power than they had the year before and 8 percent less than they did in 2007, just before the throes of the economic recession.

This is consistent with what working people all over the nation are saying: They work harder and harder, but they can’t get ahead.

The poverty rate dipped by half a percentage point to 14.5 percent, but that number is nothing to cheer about as it still represents generational highs.  

Child poverty declined by 2 percent, one of the bright spots in the report. But overall, what’s most notable about the data is that the numbers aren’t shocking. Troubling? Yes. Surprising? No.

In recent years, myriad studies have affirmed the nation’s growing income divide and economic mobility problem. Just yesterday, Standard & Poor’s released a study that revealed states are struggling to raise enough revenue because of income inequality. Institute on Taxation and Economic Policy experts noted that state tax systems are largely regressive. So, of course, as wealth concentrates at the top states, which tax poor and moderate-income families more than the rich, aren’t able to raise enough money to fully fund basic priorities.

A study released in June by the Russell Sage Foundation revealed that from 2003 to 2013, the net worth of the median American household fell, adjusted for inflation, by more than a third, but the best-off families experienced double-digit growth in their real net worth.  In 2013, a UC Berkeley economist released a study revealing income inequality in the United States is at its highest level since 1928, just before the Great Depression.

Today’s data on poverty and income simply confirms what other data sets have repeatedly revealed. Clearly, we don’t have a problem aggregating and analyzing data in these parts. Our problem is getting lawmakers to agree on policy solutions.

Just as the Census data are predictable, so, too, are the rallying cries. There will be calls for investments in proven poverty-alleviating programs such as job training and early education. At the same time, there will be calls from the extreme right that blame the poor for being poor and call for pull-yourself-up-from-your-bootstraps (even if you have neither boot, nor strap) “solutions.”

As I started writing this piece for, I envisioned it as a way to highlight how progressive tax policies can play a big role in reducing income inequality. The Institute on Taxation and Economic Policy and Citizens for Tax Justice have plenty of research that supports this, which you can read here, here, here, and here. You’ll want to read these pieces if you have any doubt that tax policy makes a significant difference.    

But we need lawmakers to recognize every day–not just the day some new study reveals a new data set—that worsening income inequality and high poverty is not good for the nation and its families in the short or long term. Child poverty declined, but it’s still high. How many children were born into poverty in the year since the Census’s last report on poverty? And what will the economy look like 20 or more years from now if millions of children and their families continue  lacking the resources it takes to thrive?

Census data will confirm what we already know again next year and the next if policymakers don’t take action. Our elected officials must be willing to explore policy solutions that address widening income inequality and poverty with the same level of urgency that they expend raising money for their next campaign.

New S&P Report Helps Make the Case for Progressive State Taxes

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The latest report from Standard & Poor’s Rating Services reminds us that progressive tax reform can help mitigate income inequality and ensure states have enough revenue to fund their basic needs.

As has been documented by everyone from the Federal Reserve Board to Thomas Piketty, the share of income and wealth accruing to the very best-off Americans has grown substantially over the past century. The problem worsened in the years immediately following the financial crisis. This trend raises important philosophical questions about whether low-income Americans really have the same opportunities to share in the American dream that the wealthiest have been granted.

But Standard & Poor’s new report finds that there’s also a more mundane, practical reason to be concerned about inequality: it can make it harder and harder for state tax systems to pay for needed services over time. The more income that goes to the wealthy, the slower a state’s revenue grows. Digging deeper, S&P also found that not all states have been affected in the same way by rising inequality. States relying heavily on sales taxes tend to be hardest hit by growing income inequality, while states relying heavily on personal income don’t see the same negative impact.

This finding shouldn’t be surprising. As we have argued before, it doesn’t make sense to balance state tax systems on the backs of those with the least income.  When the top 20 percent of the income distribution has as much income as the poorest 80 percent put together, relying disproportionately on the poorest Americans to fund state services is not the path to a sustainable, growing revenue stream. The vast majority of states allow their very best-off residents to pay much lower effective tax rates than their middle- and low-income families must pay—so when the richest taxpayers grow even richer, these exploding incomes hardly make a ripple in state tax collections. And when the same states see incomes stagnate or even decline at the bottom of the income distribution it has a palpable, devastating effect on state revenue.

Conversely, when states like California enact progressive personal income tax changes that require the best-off taxpayers to pay something close to the same tax rates applicable to middle-income families, growth in income inequality doesn’t appear to damage state revenue growth significantly.

But the clear trend at the state level has been exactly the opposite: regressive tax systems relying more heavily on sales tax and less on the progressive personal income tax. Far more typical of the most salient tax “reform” ideas afoot at the state level these days is Kansas Gov. Sam Brownback’s hatchet job on the state income tax. And, as a front-page New York Times article reminds us today, states considering a shift from income to sales taxes are likely to regret it. S&P and Moody’s have recently downgraded Kansas’s bond rating precisely because reckless income tax cuts have endangered the state’s ability to pay for needed public investments.

Income inequality and declining state tax revenues are both serious issues that go to the heart of our ability to provide economic opportunity for individuals and businesses. Because of growing income inequality, it is more important than ever for states to move toward a more progressive tax system. Regressive tax systems hitch their wagons to those with shrinking or stagnant incomes.  Progressive tax reform is needed to make our tax code more fair and ensure that income inequality does not do damage to states’ ability to collect adequate revenue over the long-term.

Impact of the EITC and Child Tax Credit in Addressing Poverty

September 15, 2014 01:30 PM | | Bookmark and Share

Read this report in PDF.

The federal Earned Income Tax Credit (EITC) and Child Tax Credit (CTC) are among the most important anti-poverty programs in America. The table below examines two types of families living below the official poverty line — those with one parent and two children and those with two parents and three children — and the impact that the EITC and CTC has on them.[1]

The table also demonstrates that a significant amount of this impact comes from an expansion in both credits, which was first enacted in 2009 and will expire at the end of 2017 if Congress does not act. The figures are estimates produced by the Institute on Taxation and Economic Policy (ITEP) microsimulation model.

The EITC is a refundable credit equal to a certain percentage of earnings (40 percent of earnings for a family with two children, for example) up to a maximum amount (a maximum credit of $5,460 for a family with two children in 2014). It is phased out at higher income levels. The CTC is a credit equal to a maximum of $1,000 per child. The refundable part of the CTC is equal to 15 percent of earnings (above a specific threshold) up to the maximum of $1,000 per child.

Both credits were expanded—temporarily—in the American Recovery and Reinvestment Act of 2009 (ARRA). The EITC was given a higher credit rate (45 percent) for families with three or more children, and the income level at which the credit begins to phase out was raised for families headed by married couples.

The CTC was adjusted so that the refundable part of the credit is equal to 15 percent of earnings above $3,000, rather than the higher threshold in permanent law (which would be $13,600 in 2014).

These expansions of the EITC and CTC have been extended several times and are now scheduled to expire at the end of 2017.

The table on the first page illustrates that the average one-parent, two-child family living below the poverty line this year will receive $4,550 from the EITC and CTC this year, which boosts those families’ incomes by a little over a third on average. Of that amount, $880 is the result of the 2009 expansions in the CTC, which boosts those families’ incomes by 7 percent on average. (The expansions of the EITC would not impact a family without married parents or three or more children.)

The table also illustrates that the average two-parent, three-child families living below the poverty line will receive $5,790 from the EITC and CTC, which boosts those families’ incomes by 30 percent on average. Of that amount, $1,580 is the result of the 2009 expansions of the credits, which boosts these families’ incomes by 8 percent.

Several empirical studies have found that the EITC increases hours worked by the poor. These studies have also found that the EITC has had a particularly strong effect in increasing the hours worked by low-income single parents, and there is evidence that it had a larger impact on hours worked than did the work requirements and benefit limits enacted as part of welfare reform.[2]

The refundable part of the CTC is likely to have similar impacts. The EITC and the refundable part of the CTC are credits equal to a certain percentage of earnings, meaning these refundable tax credits are only available to those who work.



[1] In 2014, the Census Bureau’s official poverty threshold, which is adjusted for inflation each year, will likely be roughly $19,000 for families with one parent and two children and $28,000 for families with two parents and three children.

[2] Chuck Marr, Jimmy Charite, and Chye-Ching Huang, “Earned Income Tax Credit Promotes Work, Encourages Children’s Success at School, Research Finds,” Center on Budget and Policy Priorities, revised April 9, 2013,

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Tax Policy and the Race for the Governor’s Mansion: Ohio Edition

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Voters in 36 states will be choosing governors this November. Over the next several months, the Tax Justice Digest will be highlighting 2014 gubernatorial races where taxes are proving to be a key issue. Today’s post is about the race for Governor in Ohio.

Current Ohio Governor (and former Congressman) John Kasich (R) is running for reelection against Cuyahoga County Executive Ed Fitzgerald (D). Fitzgerald’s stand on economic issues is promising, in terms of taxes he’s said “that the wealthy should pay their fair share.” It would be hard to find a sitting governor who has done more to ensure the opposite than Gov. Kasich.

Since his election in 2011 Governor Kasich has championed his own series of regressive tax cuts including income tax rate reductions and creating a special new tax break for “pass through” businesses, while providing much smaller tax breaks to low- and middle-income families. Read about ITEP’s work analyzing Governor Kasich’s tax plans here and here.

Governor Kasich hasn’t been shy about his hopes for his next term proclaiming, “I want to work for more tax cuts.” This race isn’t likely one that will capture much attention for fans of the horserace come November, but the outcome will most certainly have a significant impact on Ohio taxpayers. 

Inverting Corporations Should Be Required to Pay Taxes Owed on Profits Held Offshore

September 11, 2014 11:18 PM | | Bookmark and Share

Read this report in PDF.

The pace of corporate inversions has increased in the last decade but only recently has this practice begun to make headlines with known American brands such as Burger King announcing plans to become foreign companies for tax purposes. A company inverts when, technically, it merges with and becomes a subsidiary of a foreign company. The practice is under fire because many American corporations undergo inversions to subsequently reduce their U.S. tax bill, either through earnings stripping to avoid U.S. taxes on future profits, or, by avoiding U.S. taxes on profits already earned and accumulated offshore.

This document focuses on the latter, tax avoidance on profits already accumulated offshore, and argues that this problem can be addressed by requiring payment of the U.S. tax that has been deferred on these offshore profits at the point when a corporation officially becomes controlled by a foreign company, whether through inversion or through other means. This reform would be akin to the requirement that individuals pay income taxes on unrealized capital gains when they renounce their U.S. citizenship.

Individuals and corporations are both allowed to defer paying U.S. taxes on key parts of their income. Under current law, wealthy individuals are required to give up this benefit when they renounce their American citizenship, while profitable corporations are not.

The tax code allows American individuals to defer paying income taxes on capital gains (appreciation of their assets) until they sell their assets. But wealthy individuals who renounce their U.S. citizenship lose this benefit and are required to pay tax on unrealized capital gains.[1]

American corporations are allowed to defer paying income taxes on profits earned by their offshore subsidiaries until those profits are brought to the U.S., but under current law are not required to give up that benefit even after being acquired by a foreign owner. This more generous treatment of corporations has no apparent rationale and seems to be an accident of history rather than the intent of Congress.

Legislative history (explained below) suggests that Congress preserved deferral to help American multinational corporations compete with foreign-based multinational corporations. There is no reason to continue this tax break for corporations once they declare that they are no longer American.

Ending deferral in this situation would also remove a significant incentive for corporations to undergo inversions and could complement other legislative proposals to prevent inversions.

This document uses the term “American corporation” or “U.S. corporation” to describe what the tax code calls a “domestic” corporation, one that is “organized in the United States or under the law of any State.”[2] A foreign corporation is one that is not domestic.[3] We use the term “offshore subsidiary” of an American corporation to describe what the tax code calls a “controlled foreign corporation,” or CFC.[4]

Deferral Facilitates Tax Avoidance

Income that is subject to the federal income tax includes dividends and other payments made from corporations.[5] That is true whether the dividend is income received by an individual or another corporation. Profits earned outside the United States by a foreign corporation are not subject to federal income tax except when those profits are paid (usually as a dividend) to a U.S. individual or domestic corporation that owns the foreign corporation.[6] This means, in effect, that a U.S. corporation is allowed to defer paying federal income tax on profits earned by foreign corporations that it owns (earned by its offshore subsidiaries) until those profits are repatriated (until they are paid to the U.S. corporation as a dividend or similar payment).  

This general approach has been in place since the enactment of the federal income tax. By the 1960s, American corporations widely recognized they could simply create a shell corporation in a country with very low or no corporate tax (an offshore tax haven) and use accounting tricks to make profits earned in the United States appear to be earned in the tax haven. For example, a domestic corporation might claim that it owns a foreign corporation in a tax haven and that this tax haven corporation holds the logos used by the domestic corporation. The domestic corporation claims that it must therefore pay (to the tax haven corporation) royalties that wipe out its U.S. income for tax purposes.

In reality, the domestic corporation and the foreign corporation are owned by the same people and operate as one company, so this arrangement is a gimmick that allows tax accountants to move money between different parts of the same company. But because the IRS recognizes the corporations as separate entities, the domestic corporation can defer paying taxes on these profits indefinitely.

To address this, President Kennedy proposed ending deferral of federal corporate income tax on most profits generated by American corporations’ offshore subsidiaries in most circumstances.[7] What Congress ultimately enacted was the part of the tax code commonly referred to as subpart F, which ended deferral only for certain kinds of “passive” income (such as royalties in the example above) paid from a “controlled foreign corporation,” (CFC) which is defined as a foreign corporation that is majority owned by U.S. shareholders, including domestic corporations.[8]

There are numerous loopholes in subpart F and today it is quite clear that much of the income that U.S. corporations report as earned by their CFCs (their offshore subsidiaries) is actually income earned in the United States or another country with a normal tax system but manipulated to appear as though it is earned in offshore tax havens.[9]

Today, American multinational corporations have an estimated $2 trillion in offshore subsidiary profits that have not been repatriated to the U.S., and $1 trillion of that amount is likely in cash or cash equivalents that could fairly easily be repatriated. Because American corporations only pay U.S. income tax on these profits when they are repatriated, they have an incentive to declare them offshore “permanently reinvested earnings” rather than repatriating them to the U.S.

As discussed below, after an inversion, the corporation can route its offshore “permanently reinvested earnings” through the ostensible foreign parent company or through its subsidiaries to indirectly get the money into the hands of the U.S. shareholders without triggering the tax that is normally due upon repatriation. The simplest way to end this tax dodge is to tax these profits accumulated by offshore subsidiaries as if they had been repatriated at the point when their U.S. parent corporation inverts. This would remove much of the benefit of inversion. 

Profits Held Offshore Have Not Been Taxed by the U.S. — and Will Never Be After Inversion

Domestic corporations have an incentive to not repatriate the profits of their offshore subsidiaries (profits of their CFCs). This is most true of those profits that are earned in the U.S. or another country with a normal tax system and then manipulated to appear to be earned in a tax haven. The U.S. federal income tax bill on repatriated profits is reduced by the amount of income taxes paid to foreign governments. So, profits earned in a country with a normal tax system are subject to much less than the full U.S. corporate income tax rate upon repatriation. But profits that are earned (at least officially) in a tax haven with a zero tax rate would be subject to the full U.S. statutory corporate income tax rate of 35 percent upon repatriation.

Several corporations, including Apple, Microsoft, Nike, Safeway, Wells Fargo, Citigroup and others have disclosed that if they repatriated their offshore subsidiary profits, the effective U.S. federal income tax due would be close to the full 35 percent statutory rate. This implies that they have paid little taxes to foreign governments because these profits are largely in tax havens.[10]

Some American corporations may never repatriate these offshore profits because they can access these profits indirectly. For example, to fund a share buyback last year, instead of repatriating any of its massive offshore cash holdings, Apple issued bonds at negligible interest rates made possible by its offshore cash.[11]

Nonetheless, many American multinational corporations seek ways to, in effect, move these offshore profits into the hands of shareholders without paying U.S. federal income tax that is due upon repatriation.

Subpart F includes a section designed to address this, section 956. Before section 956 was enacted in the 1960s, an American corporation could get around the tax by having an offshore subsidiary make an investment in its American operations that was not actually a dividend payment to the American parent company, and thus not considered a taxable repatriation. For example, the offshore subsidiary could lend money to, or guarantee a loan to, its American parent company in a way that has the same effect as paying a dividend to the American parent company. Section 956 was enacted to treat such investments as repatriations and to impose U.S. tax at that point.

Section 956 applies to investments made by the offshore subsidiaries in related American companies. A major problem is that 956 does not apply if the offshore subsidiaries “hopscotch” over their American parent company, investing or lending instead to a foreign company that has ostensibly acquired the American corporation after an inversion, or to other foreign companies that are subsidiaries of the foreign parent company, which can then funnel that money to the U.S. operations or shareholders of the U.S. company without triggering U.S. tax.

Proposals to Address Avoidance of Repatriation Tax After Inversion

One proposal, reported to be included in draft legislation by Rep. Sander Levin of Michigan, would amend section 956 to make it apply when the investment is done indirectly, routed through a foreign parent company after an inversion or through one of the other companies that is owned by the foreign parent company.[12] Another approach would be for the Treasury Department to issue regulations that would have the same effect, which seem to be authorized by section 956 and other parts of the tax code.[13] These approaches are described in detail in another report from Citizens for Tax Justice.[14]

One alternative that has not received much attention is the one described in this report. It would simply treat accumulated offshore profits as repatriated at the point when the American corporation is officially acquired by a foreign one. Whether this acquisition takes the form of an inversion, in which owners of the American corporation are not really giving up control, or a genuine takeover by a foreign buyer does not matter. Congress preserved deferral (despite President Kennedy’s proposal to largely end it) apparently as a way to help American multinational corporations compete with multinational corporations. There is no rationale for continuing to extend this tax break to corporations once they declare that they are no longer American.

This approach would dramatically reduce incentives for some corporations to invert. For example, the medical device maker Medtronic, which is merging with Covidien and plans to change its corporate address to Ireland, has $20.5 billion in permanently reinvested earnings offshore, and $13.9 billion of that is cash or cash equivalents (the profits the company is most likely to repatriate). Medtronic even acknowledges that if it repatriates these profits it would pay U.S. income taxes on them at an effective rate in the range of 25 to 30 percent, implying that much of the profits are in tax havens. [15] A major motivation for the inversion may be the desire to officially bring offshore cash to the United States without paying taxes.

Similarly, the pharmaceutical giant Pfizer, which attempted (and may attempt again) to obtain the U.K.-based drug maker AstraZeneca, has $69 billion in permanently reinvested earnings offshore. Given that Pfizer has 128 subsidiaries in countries characterized as tax havens by the Government Accountability Office, it would not be surprising if Pfizer has paid very little in foreign taxes on these profits.[16]

Under the reform described in this report, an inversion would cause these profits to be taxed as if they were repatriated. It is very unlikely that Pfizer and Medtronic and companies in similar situations would then pursue inversions.


[1] Section 877A of the tax code subjects individuals who expatriate to certain tax provisions if they have a net worth of over $2 million, had an average personal income tax liability over the previous five years above a certain amount ($157,000 for 2014) or failed to pay taxes during the previous five years. Even if one of these criteria is met, a large amount of capital gains income is excluded (the first $680,000 is excluded in 2014). Revenue Procedure 2013-35.

[2] IRC sec. 7701(a)(4).

[3] IRC sec. 7701(a)(5).

[4] IRC sec. 957.

[5] IRC sec. 61.

[6] IRC sec. 11.

[7] Thomas L. Hungerford, “The Simple Fix to the Problem of How to Tax Multinational Corporations — Ending Deferral,” Economic Policy Institute, March 31, 2014.

[8] IRC sec. 957.

[9] Citizens for Tax Justice, “American Corporations Tell IRS the Majority of Their Offshore Profits Are in 12 Tax Havens,” May 27, 2014. As this report explains, the countries with zero corporate income tax rates or loopholes that facilitate massive tax avoidance are mostly countries that have little in the way of opportunities for real business activities. The figures clearly show that the profits that American corporations report to the IRS that they earn in these countries cannot possibly represent real business profits but are instead profits earned in countries with a normal tax system like the U.S. and then manipulated to appear to be earned in tax havens.

[10] Citizens for Tax Justice, “Dozens of Companies Admit Using Tax Havens,” May 19, 2014.

[11] Kitty Richards and John Craig, “Offshore Corporate Profits: The Only Thing ‘Trapped’ Is Tax Revenue,” Center for American Progress, January 9, 2014.

[12] This follows the advice of a former chief of staff to the Joint Committee on Taxation. See Edward D. Kleinbard, “’Competitiveness’ Has Nothing to Do with It,” August 5, 2014.

[13] Stephen E. Shay, “Mr. Secretary, Take the Tax Juice Out of Corporate Inversions,” Tax Notes, July 28, 2014.

[14] Citizens for Tax Justice, “Proposals to Resolve the Crisis of Corporate Inversions,” August 21, 2014.

[15] Citizens for Tax Justice, “Medtronic: Still Offshoring,” June 26, 2014.

[16] Richard Phillips, Steve Wamhoff, Dan Smith, “Offshore Shell Games 2014: The Use of Offshore Tax Havens by Fortune 500 Companies,” June 2014.

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