Author: tarek

Senate Republican leader Mitch McConnell of Kentucky, who will lead the chamber as majority leader starting in January said Wednesday that tax reform is one priority he could pursue. But it’s unclear how the caucus he leads could possibly produce a tax reform that the public would support, given exit polling that indicates little interest among voters in the sort or revenue-neutral, rate-reducing tax overhaul that Republicans support.

Hart Research Associates conducted an exit poll for the AFL-CIO in states with key Senate races (Alaska, Arkansas, Colorado, Georgia, Iowa, Kansas, Kentucky, Louisiana, Michigan, North Carolina, New Hampshire).

Voters were asked, “Which one of the following do you think should be the higher priority for the president and Congress right now–(A) reducing taxes on businesses and individuals or (B) investing in key priorities like education, healthcare, and job creation?” A solid 67 percent said “investing in key priorities” and only 29 percent said “reducing taxes.”

It seems public opinion is particularly set against the idea tax reform that is revenue-neutral for corporations (which many Republicans and Democrats, including President Obama, have proposed).

To the question “What should revenue from closing corporate tax loopholes be used for?” 66 percent chose “reduce budget deficit and invest” while only 22 percent chose “reduce tax rate on corporations.”

And the public supports a worldwide tax system, which would subject American corporations’ profits to the same tax rates regardless of whether they are earned domestically or offshore. This is the very opposite of a territorial tax system, which would exempt the offshore profits of American corporations from U.S. taxes and which is the basis of Republican tax reform proposals.

A whopping 73 percent of voters said they would support “increasing taxes on the profits that American corporations make overseas, to ensure they pay as much on foreign profits as they do on profits made in the United States,” while only 21 percent said they would oppose this.

It’s not immediately obvious how pursuing his party’s unpopular positions on taxes could possibly be appealing for McConnell. But he may have no choice. In the House of Representatives, Paul Ryan will likely chair the Ways and Means Committee and could demand action on tax reform and force his hand.

Keep in mind that the tax reform proposal from the outgoing chairman, Dave Camp of Michigan, turned out to be a regressive $1.7 trillion tax cut and was abandoned by his caucus because it was thought to not cut taxes enough. Apparently House Republicans are determined to give away even more revenue and it’s unclear whether they would allow something as trivial as public opposition to change their plans. 

The outcome of Tuesday’s election surely will shape the direction of state tax policy in 2015 as tax shift proposals appear to be looming in a number of states. In states with budget shortfalls, it may be difficult for elected officials who campaigned on tax-cutting platforms  to balance that rhetoric with the realities and priorities of governing.

As a recent Standard & Poor’s study revealed, worsening income inequality makes it harder for states to pay for needed services (e.g. education, roads and bridges, public safety and public health) over time. Campaigns consist of soaring rhetoric on what candidate will do for the people. Governing puts that rhetoric to the test. State lawmakers, regardless of party affiliation, should focus on reckoning the reality of their constituents’–ordinary working people–daily lives rather than claim the outcome of the Tuesday’s election is license to impart policies that overwhelming benefit corporations and the wealthy at the expense of everyone else.

In coming weeks, ITEP will provide a comprehensive overview of state tax policy trends to anticipate in 2015 as well as a look at other states where tax policy will be a dominant issue.  For now, here’s a glance at some of the most important states to watch where the outcome of Tuesday’s election will surely shape tax policy decisions next year:

Arizona: Former ice cream magnate Doug Ducey cruised to victory over opponent Fred DuVal on a promise to eliminate the personal and corporate income tax. Ducey appeared to back away from his tax pledge in the waning days of the campaign, but it is likely that he will claim a mandate to push an anti-tax agenda, financed with drastic spending cuts. “If anyone needs to cut back,” he declared in his victory speech, “it will be government.” The state’s anemic economy and yawning budget gap could prove an obstacle to his plans.

Arkansas: Former Congressman Asa Hutchinson was elected governor besting former U.S. Rep. Mike Ross. This means that both the Arkansas legislative and executive branches will now be under one-party control. Hutchinson campaigned on a costly plan to cut the personal income tax by lowering tax rates for all but low-income households. News outlets have  quoted him saying that income tax reduction would be his “top and possibly only tax cutting priority.” Given one party control in Arkansas government, legislators will likely feel more inclined to push through tax cuts and potentially pursue more aggressive tax shift legislation (which has been on their agenda for years) that would eliminate income taxes and replace the lost revenue with regressive sales taxes.

Georgia: Gov. Nathan Deal won his campaign for reelection over challenger Jason Carter. Given that Republicans will continue to control both the House and the Senate, top state lawmakers are expected to pursue a tax-cutting agenda that will likely include extreme tax shift proposals.  Late last year, the Georgia Budget and Policy Institute published  a report (using ITEP data) showing that as many as four in five taxpayers would pay more in taxes if the state eliminated its income tax and replaced the revenue with sales taxes.  Georgia voters also approved the “Income Tax Straightjacket” a ballot initiative that amends the state’s constitution to keep the top income tax rate at 6 percent.

Illinois: Gov. Pat Quinn lost his bid for reelection to businessman Bruce Rauner. Taxes were a big issue in this campaign. Rauner’s position on how to handle the state’s temporary 5 percent income tax rate changed through the campaign. (The state’s temporary 5 percent income tax rate is set to fall to 3.75 percent in January). Initially he proposed allowing the temporary income tax hike to immediately expire, but he changed his position once the reality set in that as governor he would need to fill the $2 billion budget hole created by allowing the tax rate to fall. More recently, Rauner has said that he will allow the temporary tax increase to expire over four years and will keep property taxes at their current level. Rauner would make up $600 million of lost income tax revenue by broadening the sales tax base to include many business services such as advertising, printing and attorney fees. The Illinois House and Senate, which remain under Democratic control, may tackle the temporary income tax rate before Rauner takes office. Regardless, Illionois will be a state to watch in 2015 given the governor’s stand on taxes, divided government and  overwhelming voter approval of a referendum showing support for a millionaire’s tax.

Kansas – Given Kansas’s recent fiscal woes, the race between  Gov. Sam Brownback and House Minority Leader Paul Davis was thought to be a toss-up right until the polls closed. Ultimately, Gov. Brownback prevailed. Gov. Brownback’s record on taxes has made national headlines and the race was largely viewed as a referendum on his controversial tax cuts that benefited wealthy Kansans disproportionately, resulted in a bond rating downgrade, and left the state with a huge budget shortfall. Now that Kansans have re-elected Gov. Brownback,  he’ll be forced to deal with a budget shortfall through rolling back his tax cuts, raising other taxes, or reducing services. All eyes will continue to be on Kansas into 2015.

Maryland: Larry Hogan’s stunning upset over Lt. Gov. Anthony Brown in the gubernatorial race will likely result in gridlock rather than significant changes on tax policy. Hogan used outgoing Gov. Martin O’Malley’s tax increases as an effective cudgel against Brown, hammering away at his support among Democrats. Though Hogan has pledged to repeal as many of O’Malley’s tax policies as possible, he is unlikely to find support for his agenda in the Maryland state legislature, which remains overwhelmingly Democratic. A similar dynamic plagued his former boss, Republican Gov. Bob Erlich (2002-2006), who found himself stymied by a combative General Assembly. The likely result of divided government is gridlock.

Pennsylvania: Tom Wolf unseated Pennsylvania’s incumbent governor, Tom Corbett, in Tuesday’s election.  Corbett’s unpopularity stemmed from a number of his policy choices including cutting more than $1 billion in education spending and allowing a significant budget shortfall to develop in the state.  So, the top job of the newly elected governor will be determining how to close the budget gap (estimated to be between $1.7-$2 billion) while reinvesting state dollars in public education.  Look to Wolf to put forth several revenue raising ideas he first proposed on the campaign trail.  For starters, Wolf promised to enact a 5 percent severance tax on natural gas drilling to help fund education (Corbett opposed such a tax).  Wolf also wants to raise revenue through changes to the personal income tax which will also improve the fairness of the state’s tax system. Pennsylvania has a flat income tax rate of 3.07 percent and the Pennsylvania Supreme Court has ruled that the constitution bars the adoption of a graduated income tax. Wolf’s plan would raise the income tax rate but exempt income below a certain level. Wolf has said he intends  to use the extra revenue generated by his tax reform to increase the level of state aid to public schools and reduce Pennsylvanians’ property taxes.  While Wolf may face opposition to his progressive personal income tax plan, many Republican lawmakers could get on board with the idea of the state taking on a greater share of school funding if it would result in lower property taxes.

Wisconsin: Wisconsin Gov. Scott Walker won reelection by besting Trek Bicycle Executive Mary Burke. Gov. Walker ran on his record of cutting taxes. (During his time in office Governor Walker passed three rounds of property and personal income tax cuts). As a candidate Gov. Walker pledged that property taxes wouldn’t increase through 2018. Even more worrisome, Gov. Walker has said he wants to discuss income tax elimination. While telling voters that he’d like to eliminate their state income tax bills may sound good on the campaign trail, Wisconsinites should know that most taxpayers, especially middle- and low-income households, would likely pay more under his plan. An ITEP analysis found that if all revenue lost from income tax repeal were replaced with sales tax revenue the state’s sales tax rate would have to increase from 5 to 13.5 percent.  ITEP also found that the bottom 80 percent of state taxpayers would likely see a net tax hike if the sales tax were raised to offset the huge revenue loss associated with income tax elimination.

The media may be abuzz with Apple CEO Tim Cook’s essay in BusinessWeek yesterday, but they also should be paying attention to the company’s Securities and Exchange Commission filing this week. In its annual 10-K report, Apple reveals that, despite congressional hearings on its offshore tax dodging, the company continues to divert profits to tax havens.

The 10-K reports that Apple increased its offshore profits by $16 billion last year, which brings its total hoard to $137 billion. The company also discloses that it would pay a U.S. tax rate of 33 percent if it repatriates those earnings, down only slightly from prior years. Because the US tax would be reduced by any foreign tax the company has already paid, that means the company has paid almost no tax on the foreign income despite having substantial sales in countries where the corporate tax rate is in the mid-20s.

How does Apple do that? By shifting profits, through the use of tax haven subsidiaries, to countries that have little or no corporate income tax. Apple Operations International (AOI), the subsidiary which heads up the foreign group, was incorporated in Ireland but the company claims it is not resident in Ireland for tax purposes. In fact, the company claims that AOI isn’t “tax resident” anywhere in the world, so AOI files no corporate tax returns and pays no corporate tax. Apple has also negotiated a super-low tax rate for other subsidiaries in Ireland of only 2 percent—an arrangement that is under investigation by the European Commission as illegal state aid.

And speaking of other subsidiaries, the subcommittee memo from the Senate hearing identifies fifteen foreign subsidiaries associated with the company’s European operations (and that’s only Europe), yet Apple’s 10-K lists only four subsidiaries in its annual report. Apparently the company takes the position that the other subsidiaries aren’t “significant” under the SEC rules, not even its big Singapore subsidiary Apple South Asia Pte, Ltd. where it books sales in Asia and the Pacific. The company did list Braeburn Capital in Nevada, which helps Apple avoid state income taxes, but they forgot that Luxembourg subsidiary that helps them avoid income and value-added taxes all over Europe, Africa, and the Middle East by booking its iTunes sales there. Oops.

For goodness sakes, one clear finding of the Senate’s investigation was that Apple’s subs in offshore tax havens are playing a vital role in its tax avoidance. And yet even after this, the company persists in not disclosing the existence of these subs in its 10-K. There needs to be a higher standard for disclosing tax haven subs. Where is the SEC? Where is Congress?

CEO Cook’s very personal essay expresses his wish that he can be an inspiring example to people with similar struggles. We only wish Apple aspired to be an example of a good corporate citizen—one who contributed to the common welfare by paying its share of tax.

In addition to a number of tax proposals on the ballot this election, voters in Alaska, Oregon, and the District of Columbia will vote on ballot initiatives that would legalize marijuana for recreational use. These measures could also have future revenue implications. If these initiatives pass, they would set these jurisdictions on the path of Colorado and Washington, which already allow production and sale of marijuana to adults for recreational as well as medical purposes.

While Colorado and Washington marijuana markets are still a work in progress, both states have proven that taxes on marijuana can generate revenue. For example, since recreational marijuana sales began in January, Colorado has collected over $45 million in revenue from marijuana taxes and fees. Washington has collected $5.5 million in excise tax revenue from July 8 (the first day of sales) through October 7.

Here’s a breakdown of each state’s potential plan to tax marijuana and what level of revenues these states could expect to collect:

Oregon

Oregon’s marijuana ballot initiative would place a $35 per ounce excise tax on all marijuana flowers, a $10 per ounce excise tax on all marijuana leaves, and a $5 excise tax per immature marijuana plant. The revenue generated from these taxes would be earmarked such that 40 percent would go to the Common School Fund, 20 percent for mental health/alcohol/drug services, 15 percent for state police, 20 percent for local law enforcement, and 5 percent for the Oregon Health Authority. The Oregon Legislative Revenue Office estimates that this measure would raise $41 million from 2017 to 2019 , while the economic consulting firm ECONorthwest estimated that revenue would hit a much higher  $79 million over the same time period.

Alaska

Alaska’s marijuana ballot initiative would place a $50 per ounce excise tax on the sale of marijuana with the option of allowing the Department of Revenue to exempt or apply lower tax rates to certain parts of the marijuana plant. While the Alaska Department of Revenue has chosen not to issue a formal revenue estimate, a Colorado-based organization, the Marijuana Policy Group, has estimated that the measure would raise $73 million  from 2016 to 2020.

District of Columbia

Unlike the initiatives in Alaska and Oregon, Washington, D.C.’s ballot initiative does not explicitly lay out a taxation regime in the initiative text. The assumption, however, is that the D.C. Council will follow-up with legislation that puts in place a regulatory and taxation system for recreational marijuana. To this end, D.C. Councilmember David Grosso has proposed the Marijuana Legalization and Regulation Act, which would place a 6 percent excise tax on medical marijuana and a 15 percent excise tax on recreational marijuana.

Although there has been no official score of the bill, an estimate of a similar hypothetical marijuana tax in D.C. predicted it could raise $8.8 million. Whatever the amount raised, the proposed D.C. legislation would direct all of it into a dedicated marijuana fund, which would fund anti-drug abuse programs across D.C. agencies. 

San Francisco Giants fans, giddy from their team’s third World Series win in five years, would be forgiven for scoffing at the notion that their team’s reputation will be worth nothing in 15 years.

Yet an obscure federal tax law allows professional sports team owners to make just that assertion—and to financially benefit from it. A new analysis from the Financial Times suggests part of the impetus behind the L.A. Clippers’ absurd purchase price—at $2 billion, more than 3 times the previous record for an NBA franchise’s sale price—is that new owner Steve Ballmer may be able to receive a tax write off worth more than half of his purchase costs. The source of Ballmer’s tax break, which FT pegs at a cumulative $1 billion, is an obscure tax rule, enacted in 1993 and expanded a decade ago under former Texas Rangers owner George W. Bush, that lets Ballmer reduce his taxable income by the value of something called “goodwill.”

In this case, goodwill is the difference between the $2 billion Ballmer paid for the Clippers and the value of the team’s tangible assets, such as the ballpark and the land it sits on. Goodwill represents intangible assets as varied as media rights, the value of the Clippers logo, and the team’s reputation. Any company with a recognized logo, from Coca-Cola to Burger King, likely has some “goodwill” value associated with the logo and the company’s reputation.

Before 1993, companies were not allowed to gradually write off the value of intangible assets (goodwill) in the same way that they could write off the cost of machinery and equipment. This approach generally made sense because there’s no reason to assume the value of logos and trademarks will decline, let alone disappear. But in 1993, Congress made goodwill an amortizable expense—something to be gradually written off in the same way as items such as heavy machinery, which lose value over time.

The 1993 law allows companies to write off the goodwill of companies they acquire over the fifteen-year period following the acquisition. The law, a boon for corporations, explicitly excluded professional sports teams from using this tax break. But in 2004, President George W. Bush’s American Jobs Creation Act made sure that sports teams were invited to the party, extending the same treatment to sports team owners that had already been given to most other businesses.

The path from the 2004 law to the historically mediocre Clippers’ absurd purchase price seems clearer when one considers Ballmer may be able to get a tax break worth half the cost of the team.

It’s bad enough that the goodwill tax rule allows companies to deduct costs they may never incur—but it’s even worse that wealthy team owners can bid up the asking price of their teams as a tax shelter. In addressing this disturbing practice, Congress could certainly start by reversing the 2004 change allowing sports team owners to use the goodwill tax break, but a more complete response would be to gut the 1993 law.

NPR has the latest on Kansas Gov. Sam Brownback’s implosion, noting that since his tax cuts were enacted neighboring states have seen more robust job growth, and that revenue shortfalls have been double what state officials originally projected. Politico’s Morning Tax reports that, because the state must balance its budget each year, legislators have been forced to raid highway and reserve funds, as well as close the only school in the town of Marquette. Art Laffer, architect of the Brownback cuts and supply-side partisan, told NPR that it would be nonsense to expect people to quickly adjust to Kansas’ new tax codes, and that it could take a decade to see the promised results — so great news for Kansas schoolchildren! His take is a departure from state revenue secretary Nick Jordan, who predicted two years ago that the state would see noticeable growth in three years. Maybe 2015 will be the charm?

Speaking of disastrous tax cuts, Chris Fitzsimon of North Carolina Policy Watch wrote an op/ed in The Courier Tribune on the insanity that is North Carolina fiscal policy. He assails lawmakers for their 2013 tax breaks for corporations and the wealthy, noting, “Just three months into the new fiscal year, North Carolina has a revenue shortfall of just over $60 million and it may balloon to ten times that much before next June.” Quoting ITEP data, Fitzsimon warns that “the cost of the Robin Hood in reverse tax cut could reach $1.1 billion this year.” The cuts, initially projected to cost $513 million this year, will actually cost $704 million — a difference of $191 million, more than enough to pay for the $109 million in education funding that the legislature cut this summer. Meanwhile, the richest 1 percent of North Carolinians received, on average, a $10,000 tax break. I guess we found out where the money for teacher’s raises went.

Zach Schiller of Policy Matters Ohio has an op/ed in The Cleveland Plain Dealer opposing Gov. John Kasich’s proposed elimination of the state income tax. His case is convincing (and not just because it features ITEP data): over the past decade, Ohio has cut its income tax rates by almost 30 percent, just to see job losses of 2 percent while national employment increased by 4 percent. Moreover, shifting the tax burden from income to sales would give the wealthiest Ohioans tens of thousands of dollars in tax cuts while increasing taxes for the bottom fifth. Schiller gets it: “Proponents of income-tax repeal need to explain: Why should we add to growing income inequality and further slant the state and local tax system against low- and middle-income Ohioans so that the affluent can pay less?”

A new poll shows that the number of Massachusetts voters who support ballot Question 1 — a repeal of a law indexing the gas tax to inflation — is rising. A month ago, support for repeal stood at 36 percent, while 50 percent said they would vote no on Question 1. Today, support of and opposition to the ballot measure are equal, at 42 percent. Opponents of Question 1 argue that letting the value of gas tax revenue to erode over decades, as has been the case in numerous states, leads to higher costs in the long run since necessary maintenance is deferred. They also argue that taxes set as a rate already increase with inflation, so the approach outlined in the law is not a novel one. Supporters of Question believe that taxes should not increase without legislators publicly voting to do so.

Earlier this week the Tax Foundation released its “2015 State Business Tax Climate Index,” the latest in its annual series purporting to provide a single overall ranking of business tax structures in each of the 50 states. States scoring the best on the Index have one thing in common: there is a major tax, usually the income tax, which other states levy that the “best” states don’t. But the report has two major flaws: the Index itself is constructed in a way that is arbitrary at best, and, more vitally, it essentially pretends that tax revenues aren’t used for any public investment that businesses might find valuable.

As a 2013 report from Good Jobs First explains, the report’s Tax Climate Index is arrived at by separately ranking each of the major taxes levied by state and local governments—including corporate income, personal income, sales and property taxes—and then merging those rankings together in an arbitrary way to create a single mega-ranking. There is, of course, no obviously correct way of weighting the importance of these various taxes, and in fact different types (and sizes) of businesses in any given state will likely have very different opinions of the various taxes they pay. But the single most basic flaw of the Tax Foundation report is clearly stated in its title: it purports to rank “State Business Tax Climate” as a free-standing policy choice.

The folly of this approach can be seen most obviously in two findings of the report. First, the only states receiving a perfect “10” grade on any of their specific taxes are those that simply don’t levy the tax. Alaska gets a “10” for not levying a personal income tax. Nevada and Wyoming are awarded separate “10s” for the lack of personal or corporate income taxes. The obvious implication is that from the perspective of the State Business Tax Climate Index, the perfect business tax system is one that doesn’t tax *anything*.

Of course, this is an utterly irresponsible strategy. Architects of the major tax cut pushed through by North Carolina lawmakers last year—in which the state dramatically cut the personal and corporate income tax—are facing persistent criticism that the cuts were fiscally irresponsible, forcing damaging cuts to the state’s education system and likely creating a longer-term increase in local property taxes to pay for the cuts.
Fallout from these controversial cuts is even spilling over into statewide elections in the Tarheel State this fall. In the world of the State Business Tax Climate Index, however, North Carolina’s 2013 tax changes are cheerfully rung up as “the single largest rank jump in the history of the Index.”

This disconnect exists because (as, again, the Tax Foundation makes quite clear) the report is attempting to evaluate taxes taken on their own, without evaluating the impact taxes have on vital public investments. The problem with the report’s hermetically-sealed look at business taxes is that no policymaker reading the report is going to interpret it that way. The unambiguous message sent by these rankings is simply “you should cut business taxes.” In that important sense, the “Tax” in “State Business Tax Climate Index” is silent—it’s all too easy for readers to interpret this report as a recommendation on how states should improve their business climate, full stop.

Constructing a truly useful business climate index, one which attempted to quantify the impact of the spending cuts forced upon North Carolinians by last year’s tax plan on elements of the state’s infrastructure that businesses depend on, would be a herculean task. But the Tax Foundation’s one-sided approach to this task should not be mistaken for a second-best effort at this goal. At best, the report tells readers which states do the best job of pretending public investments don’t cost anything.

Ohio Sen. Rob Portman’s recent Bloomberg op-ed about corporate taxes reads like a catalogue of Chamber of Commerce talking points. He uses one misleading and inaccurate statement after another to argue that corporations will flee the United States unless we slash our corporate tax and adopt a so-called territorial tax system.          

The Nature of Corporate Inversions

Toeing the corporate line, Portman pretends that corporate inversions involve companies  physically leaving the United States. He writes that, “When companies leave the U.S., they take along jobs and investment, so inversions must end,” and he complains that the anti-inversion regulations issued by the Treasury Department on Sept. 22 do not address “the flaws in our tax system that drive our companies overseas.”

Inversion is actually a maneuver by which a corporation claims to the IRS that it is newly based offshore for tax purposes even though nothing about where the business is managed or located has changed. Congress can easily change the laws that allow this pretense, even if lawmakers are unable to settle on a broader overhaul of the tax system.

America’s Corporate Tax Rate

Portman makes use of the old canard that we have “the highest corporate tax rate in the developed world,” which is untrue or at best misleading. The U.S. may have the highest statutory corporate income tax rate among OECD countries, but the effective corporate income tax rate is quite low. CTJ and ITEP examined Fortune 500 corporations that were profitable each year from 2008 through 2012 and found that collectively they paid just 19.4 percent of their profits in corporate income taxes. A third of the companies paid less than 10 percent.

Even more interesting, the study also examined corporations that report earning at least a tenth of their profits offshore and found that two-thirds of these corporations actually paid lower effective rates in the United States than they paid in the other countries where they do business.

Of course, there are countries that have a much, much lower corporate tax rate than the United States or any OECD country. Bermuda and the Cayman Islands have corporate income tax rates of zero percent. Existing loopholes allow our corporations to claim that their profits are earned in these zero-tax countries (or to invert to countries like Ireland that make it even easier to do so). Lowering the U.S. tax rate from 35 percent to 25 percent as Portman advocates, would not solve that problem at all.

Worldwide vs. Territorial Taxation

Portman’s business-backed proposal would actually make corporate tax avoidance worse. He advocates for a territorial tax system, which would exempt corporations’ offshore profits. He ignores that fact that the territorial systems adopted by other OECD countries have caused a crisis of corporate tax avoidance that spurred the OECD’s Base Erosion and Profit Shifting (BEPS) project.

He further toes the corporate line by complaining that the United States imposes its corporate income tax “not only on income companies make at home, but also on income earned around the world,” but fails to mention the tax credit that prevents double taxation of these profits. He notes that corporations are allowed to defer U.S. tax on offshore profits until those profits are repatriated (brought to the U.S.). But his solution, a territorial system, would only expand deferral into an exemption for offshore profits, which is an even bigger break for any company that can make its profits appear to be earned in tax havens.

$2 Trillion Sitting Offshore

Another favored argument among corporations and their allies is to describe offshore profits as “trapped” outside the American economy by our tax system. Portman claims that “$2 trillion that could be reinvested in the U.S. economy sits in foreign bank accounts or is spent in other countries” and apparently the only solution is the sort of tax overhaul he advocates. Actually, the profits that could be repatriated are largely invested in the U.S. economy already, so any attempt to lure them here with lower taxes would be foolish. A December 2011 study of 27 corporations most likely to benefit from such a break concluded that in 2010, 46 percent of the profits held offshore were invested in U.S. assets like U.S. bank deposits, U.S. stocks, U.S. Treasury bonds and similar investments. Other offshore profits are invested in the assets of the offshore business and thus are not likely to be repatriated.

Short-term v. Long-term Revenue Effects

President Obama has said that tax reform overall should raise revenue, but the part affecting corporations and businesses should be “revenue-neutral,” meaning revenue saved from closing loopholes would be used to pay for tax rate reductions. Given that Congress used an alleged budget crisis to enact automatic spending cuts (which will be fully in effect again in 2016) to everything from Head Start to medical research, it’s utterly ridiculous that the President does not seek more revenue from corporations.

Portman wants to be even more generous to corporations than Obama. He complains that Treasury Secretary Jacob Lew has been “saying that the traditional, 10-year budget window shouldn’t apply” to the official estimates of any tax reform proposal. This may seem arcane, but it actually means that President Obama and Secretary Lew are trying to stop the sort of tricks included in the tax reform plan proposed by House Ways and Means chairman Dave Camp in February, which Camp claimed was revenue-neutral. CTJ concluded that the plan was revenue-neutral in the first decade but would then loose $1.7 trillion in the second decade.  

Who Pays the Corporate Income Tax?

The most unconvincing piece of Portman’s argument is that that the nation should want to lower the corporate income tax because it’s ultimately paid by working people. But in fact the Joint Committee on Taxation, which provides all official tax estimates used by Congress, concluded in 2013 that 75 percent of the corporate income tax is ultimately paid by owners of corporate stocks and other business assets (the owners of capital). This makes it a progressive tax.

Corporations are capturing a growing share of U.S. income while paying an ever-shrinking percentage of U.S. taxes. Quarterly after-tax U.S. profits have exponentially and continually increased since 2000, only falling briefly during the recession and now raising to the highest levels on record. The U.S. may have a corporate tax problem, but contrary to Portman and his corporate allies’ claims, the problem is not that we’re taxing corporations too much.

On October 21, fourteen Senators, including nine Republicans and five Democrats, sent a letter to Treasury Secretary Jacob Lew pleading to save a business tax break known as last-in, first-out  (LIFO) accounting, which both President Obama and Republican House Ways and Means Chairman Dave Camp have proposed to repeal as part of tax reform. Over 100 members of the House sent a similar letter to Camp in May. Here’s why defenders of LIFO are wrong.

LIFO is an inventory accounting method that allows some businesses to make their income for tax purposes look smaller than it otherwise would. We tend to think of profit this way: A company creates or purchases products at a cost of $90 and sells them for $100, resulting in a profit of $10. But consider a company that has built up an inventory of, say, barrels of whiskey at different points in time. The barrels it created or purchased five years ago may have cost $80, while those obtained this year cost $90. LIFO allows the company to tell the IRS that the barrels it sold today for $100 were those it most recently obtained (resulting in a $10 profit) rather than those it obtained five years ago (which would result in a profit of $20).

President Obama has proposed to repeal LIFO in his budget plans. Dave Camp, who will be retiring from Congress at the end of this year, included repeal of LIFO in the tax reform plan he released in February.

One reason is that LIFO is an unwarranted tax subsidy. When corporations that use LIFO report profits to their shareholders, they use normal accounting, not LIFO. In the example above, the company would tell shareholders that it made a profit of $20, so why should it be allowed to tell the IRS that it made a profit of just $10?

A second reason is that LIFO complicates tax and accounting rules. A third reason is that LIFO is not permitted under the International Financial Reporting Standards that have been adopted by several countries to streamline the rules for multinational companies, and thus is an obstacle to adoption of these rules by the United States.

The letter from the fourteen Senators supporting LIFO includes a couple of misleading statements. For example, the letter claims that “one of the most troubling effects of the proposed reform is the retroactive tax. If this reform is passed, the penalty to the businesses that used LIFO could extend decades into the past, forcing companies to pay off the ‘reserve’ to which they had legally been entitled.”

When supporters of LIFO talk about “LIFO reserves,” that’s a euphemism for untaxed profits. Returning to the example above, the company that has really profited $20 from selling a barrel of whiskey but is allowed under LIFO to tell the IRS it only had $10 of profit has a “reserve” of $10. In theory, the tax on this reserve is only being deferred, given that the goal of such a business is to sell all of its inventory eventually.

The letter goes on to state that subjecting these “reserves” to normal accounting and tax rules would be a “retroactive” tax increase. Because the idea of a retroactive tax increase seems unfair to most people, opponents of taxes have stretched the term “retroactive” to apply to any tax increase they want to stop. But in this case, the new rules proposed by Obama and Camp would apply to sales going forward. What would change is that a company would use normal accounting rules and assume that it has sold its oldest inventory, rather than its newest inventory. If one thinks of the difference between LIFO and the normal accounting rules as “reserves,” then it is true that companies will have to pay taxes they have deferred on these reserves as companies continue to earn profits from sales going forward.

But a retroactive tax on profits would, in contrast, be something like an increase in tax rates applied to previous years’ income so that additional taxes must be paid this year for income earned in the past — even for a company that has no profits at all this year.

Further, neither the Obama proposal nor the Camp proposal would come fully into effect immediately. Obama’s proposal would be phased in over ten years while Camp’s proposal would be phased in over four years starting in 2019.

LIFO should be repealed as Obama and Camp propose. But one should not overstate the importance of this reform. While Obama’s LIFO-elimination proposal would raise over $100 billion in the decade after enactment according to the Joint Committee on Taxation, it would raise considerably less revenue in years after that.

Because LIFO is largely a way to defer taxes rather than avoid them completely, repeal of LIFO mostly moves forward tax payments that would have otherwise occurred further out in the future. Some estimates suggest that in later years LIFO would raise around only $2 billion a year. Of course, lawmakers have bickered over far less than that.

There are two types of tax legislation Congress may enact after it returns to Washington for its lame duck session in November: bad policy and extremely bad policy. 

The Least Bad Scenario

Let’s start with the least terrible scenario, which would involve Congress enacting the Expire Act, the “tax extender” legislation approved by the Senate Finance committee in April. This bill would extend for two years a list of tax breaks so long that almost no one understands them all. (Except us, of course, see our report explaining them.)

The bill is an $85 billion deficit-financed handout to businesses at a time when lawmakers refuse to provide any help to working people hit hard by the recession unless the costs are somehow offset.

You want to extend emergency unemployment insurance? That must be paid for. Want to undo the automatic spending cuts that slashed Head Start and medical research before Congress curbed them last year? Savings were found elsewhere to prevent an increase in the deficit. But businesses get a free pass as Congress shovels another $85 billion in deficit-financed tax cuts at them. If Congress continues this tradition of extending these breaks every couple of years, the cost over the next decade will be around $700 billion.

The tax extenders are also mostly bad policy. Some provide subsidies to businesses for doing certain things, like investing in research or equipment, that they would have done anyway, resulting in a windfall for companies and no clear benefit to the rest of the taxpayers. As our report explains, some of the extenders even encourage offshore tax avoidance by corporations.

However, the damage of this bill pales in comparison to what the House of Representatives has pursued this year.

The Very Bad Scenario

Not satisfied with the Senate’s approach, the House voted to make several of these provisions permanent, which of course has a much bigger price tag and eliminates the possibility of ever getting rid of them, or at least reforming them. The question on everyone’s mind is whether or not House Republicans will demand that tax legislation enacted during the lame duck session must include at least some of these permanent provisions.

Research Credit

One tax break the House has voted to make permanent is the research credit, at a cost of $155 billion over a decade. CTJ has assailed the research credit for subsidizing activities that most Americans would not consider “research.”

“In fact, the definition of ‘research’ is so vague that Congress seems to be inviting companies to push the boundaries of the law and often cross it. The result is the type of trouble associated with accounting firms like Alliantgroup, which is managed by a former high-level staffer of Senator Chuck Grassley of Iowa and has former IRS commissioner Mark Everson serving as its vice chairman. Alliantgroup’s clients range from a hair care products maker who claimed its executives were doing ‘research,’ to a software company who was advised to claim that its purchasing manager was doing ‘research.’”

Bonus Depreciation

Another tax break the House has voted to make permanent is “bonus depreciation,” which is a significant expansion of existing breaks for business investment, at a cost of $269 billion over a decade. The Congressional Research Service’s (CRS) review of the research on bonus depreciation found that it does not affect the overwhelming majority of firms’ investment decisions and is an ineffective way to stimulate the economy.

Members of the House majority might clamor for some other tax cuts that they also approved this year.

Repeal of the Medical Device Tax

Enacted as part of healthcare reform, the medical device tax raises a critically needed $26 billion over the next ten years to help pay for the costs of expanding healthcare to millions of Americans. It’s interesting that the House is so eager to award the medical device company Medtronic, which has lobbied for repeal of the tax, even while the same corporation plans to “invert,” and claim to the IRS that it is a foreign company that is mostly not subject to U.S. corporate income taxes. 

Ban on State Taxes on Internet Access

While the argument for restricting state and local governments from placing any tax on internet access was weak back in 1998, it makes zero sense in 2014 to continue to coddle the goliath internet companies by allowing them to escape the kinds of taxes that states impose on other services.

Before leaving Washington, the House voted to combine these provisions into a staggering half-trillion-dollar giveaway as part of the so-called Jobs for America Act.

Wild Cards

Corporate Inversions

If Congress is going to throw $85 billion in tax cuts at corporations, it would seem logical to at least attach one of the proposals that would end the worst tax dodging we have seen in years: corporate inversions. Corporations are basically claiming to be foreign companies to avoid taxes. In a spectacular failure to take responsibility, Congress went home to campaign without closing the loopholes that make inversions possible. The chairman of the Senate Finance Committee, Sen. Ron Wyden, is said to be negotiating with the committee’s ranking Republican, Sen. Orrin Hatch. Sen. Hatch has declared that he could not agree to any anti-inversion legislation unless it met a list of impossible and bizarre conditions, including absolutely no revenue raised and steps taken towards a territorial tax system. A deal between Wyden and Hatch seems unlikely, but it could happen.

Two Offshore Corporate Tax Breaks

The House has not voted to make permanent the two tax extenders that provide breaks for corporations’ offshore profits — but there is reason to wonder if they will try before this Congress ends. One of these breaks is the active financing exception (the G.E. loophole), which provides an exception to the general rule that corporations cannot defer paying U.S. taxes on offshore income when it takes the form of interest (which is easy to manipulate for tax avoidance purposes). Another is the seemingly arcane “CFC look-through rule” which aided Apple’s infamous tax avoidance schemes.