Author: tarek

Last week the energy giant Kinder Morgan Energy Partners announced that it will restructure itself into a traditional C corporation, moving away from the “master limited partnership” (MLP) structure it helped to popularize almost a quarter century ago. While C corporations pay corporate income tax on their profits, the income of MLP’s is passed through to its individual partners and taxed (at least in theory) under personal income tax rules, so these companies can bypass the corporate income tax entirely.

Unlike most partnerships, MLP’s are publicly traded. Soon after the first MLP was created in the early 1980s, Congress clamped down on the use of this form: a 1987 law treats most publicly-traded partnerships as corporations for tax purposes. But lobbyists for the extractive industries got an exception for energy companies, including those engaged in exploration, refining and even “fracking.” IRS private letter rulings have gradually expanded the scope of the energy-related activities that MLP’s can engage in, and as a result the number and value of these tax-exempt entities has grown dramatically

Kinder Morgan appears to be swimming against this tide. By all accounts, the company’s sheer size is making the MLP form too unwieldly, and may even be hindering the correct valuation of their assets: Kinder Morgan actually forecasts that moving to the C form will constitute a smart tax move, apparently because they expect many of their depreciable assets to be given a sharply higher valuation after the deal goes through. Or maybe there’s more that we don’t know. Perhaps the merger to a corporate form will be followed by an inversion transaction or just more aggressive offshore profit-shifting.

Kinder Morgan’s announcement came on the same day that a Treasury Department spokesperson signaled Treasury’s concern about the growing number of MLP’s and its effect on future federal tax revenues. The Obama administration’s concern about MLP’s is understandable: earlier this year, a General Accounting Office (GAO) report found that, because of the complexity of partnerships, the Internal Revenue Service simply doesn’t have the resources to audit these business structures, even when they suspect them of wrongdoing.

Treasury seems to be considering halting the gradual expansion in the scope of these partnerships. Maybe it’s time for Congress to shut them down altogether. For every Kinder Morgan abandoning the MLP form as too complicated, there are dozens of others lining up to take advantage of this hole in the tax system. Companies, particularly large publicly-traded ones, shouldn’t be able to just restructure to take advantage of the tax-dodge flavor of the day. At a time when the corporate tax is under siege from companies seeking to invert to tax havens, spinning off REITs, or just agressively shifting profits offshore, the MLP invasion is a clear example of a tax break that Congress could stop in its tracks.

The ongoing wave of American corporations inverting, or reincorporating as offshore companies to avoid U.S. taxes, has resulted in a bewildering variety of solutions being debated in Washington and in the editorial pages. A new report from Citizens for Tax Justice explains how these proposals differ and which are most effective.

The proposals vary in several ways. Some target inversion by stopping the IRS from recognizing the “foreign” status of a corporation that has not actually moved abroad except on paper, while others target the tax dodging practices that inversion facilitates and which provide its true motivation.

Contrary to corporate lobbyists’ claims, corporations do not seek to become foreign for tax purposes simply because other countries have lower statutory corporate tax rates. They do it because inversion makes it easier to use accounting tricks to dodge U.S. taxes. For example, an inverted company can strip earnings out of the American business by making large interest payments to the ostensible foreign company that owns it, and it can use accounting tricks to move offshore profits into the U.S. without triggering the tax normally due when U.S. companies repatriate offshore profits.

An American corporation can accomplish these feats after it creates, through inversion, the pretense that it’s owned by a foreign company, even if this change exists only on paper. So, in addition to changing the basic rules about when an American corporation will be recognized as having become a foreign one (the basic proposal to crack down on inversions), many people in Washington are also thinking about ending these two tax dodges to eliminate the incentives to invert.

Another difference between the proposals being debated is that one approach would do this through legislation while another would accomplish this through regulatory changes under existing law. The regulatory route is important in case Congress fails to provide a legislative solution — which seems increasingly likely given some of the impossible conditions key lawmakers have placed on approving any legislative solution.

There is nothing inevitable about corporate inversions. There is no fundamental reason why corporations that are American in every sense and that benefit from taxpayer-funded services should be allowed to pretend they are foreign when it comes time to pay taxes. Congress and the White House have the tools to solve this problem, and simply need to choose the right ones.

Voters in 36 states will be choosing governors this November. Over the next several months, the Tax Justice Blog 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 Pennsylvania.

Pennsylvania Gov. Tom Corbett (R) is fighting for his political life in the Keystone State, where he has trailed his challenger, businessman Tom Wolf (D), by double digits for much of his reelection campaign. With election only months away, Corbett has sought to portray Wolf as a tax-and-spend hypocrite – eliciting a sharp response from Wolf and pushing tax issues to the forefront of the race.

There are many competing theories for Corbett’s unpopularity with voters, from the fallout over the Penn State abuse controversy to his overly conservative views on social issues, but his tax and spending policies have alienated liberals and conservatives alike. Progressives expressed outraged when he cut more than $1billion from education budgets at the beginning of his term – disproportionately harming districts with large numbers of low-income students – while anti-tax conservatives were equally dismayed by his transportation plan, which raised the gas tax and motorists fees to fund roads and bridges. Wolf has also assailed Corbett’s gas tax increase (though critics point out Wolf has also praised the bipartisan transportation plan of which the tax is a key component.)

Earlier this month, Wolf released the vague outlines of his plan to make the state’s tax system more progressive, while still providing middle-class Pennsylvanians a tax break. 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. In an interview, Wolf gave a hypothetical scenario with a 5 percent income tax rate and a uniform exemption of the first $30,000 of income. An individual making $40,000 could expect a tax break of $421, while an individual making $250,000 would pay an additional $4,825. Wolf plans to use the extra revenue generated by his tax reform to increase the level of state aid to public schools and provide Pennsylvanians with property tax relief. It is uncertain if his plan will survive legal and financial scrutiny.

Because of the regressive nature of the state income tax, Pennsylvanians have one of the highest property tax rates in the nation. Wolf wants to see the state’s share of local education spending increase to 50 percent — currently, the state foots a third of the bill for schools, while property taxes cover 40 percent. Corbett argues that local jurisdictions have raised property taxes to cover the increasing cost of pensions rather than the schools themselves, and that an increase in the income tax is not necessary. Corbett has also accused Wolf of scheming in increase taxes on the middle class, rather than lower them.

Another flashpoint between the two candidates is a potential severance tax on the extraction of oil and natural gas – a potent issue in Pennsylvania, where the economy has been buttressed in recent years by hydraulic fracking along the Marcellus Shale. Wolf has campaigned on a 5 percent severance tax to fund education, arguing that the tax would be passed onto consumers in other states, rather than Pennsylvania residents. Corbett has refused to endorse a severance tax, despite calls for such a tax from some members of his own party. In 2012, Corbett enacted an impact fee on oil and gas companies that has since raised $630 million, which critics allege is much less revenue than a severance tax would raise. Recently, Corbett has backed off of his staunch opposition to a severance tax, given the state’s $1 billion budget shortfall, though he insists that any new taxes be tied to efforts to reduce the cost of pensions for educators and state employees.

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 Maryland.

Maryland’s gubernatorial election pits current Lt. Gov. Anthony Brown (D) against former state official and businessman Larry Hogan (R). Current governor (and possible presidential candidate) Martin O’Malley (D) is not on the ballot, but the election is widely seen as a referendum on his stewardship, most notably the tax increases passed during his tenure.

Like Brown’s primary challenger Doug Gansler, Hogan has sought to make tax increases a campaign issue. Change Maryland, an organization founded by Hogan in 2011, claims that the O’Malley-Brown administration passed 40 separate tax and fee increases that will cost Marylanders an additional $20 billion by 2018. Hogan further argues that the tax increases have made Maryland’s business climate less competitive, and forced wealthier residents to flee the state. To back up his claims, Hogan cites a recent Gallup poll that that found 47 percent of Marylanders would move to another state if they could, and the loss of 10 out of 13 of the state’s Fortune 500 companies. Hogan has pledged to reverse as many of O’Malley’s tax increases as possible, particularly personal and corporate income taxes, as well as cut more than a billion dollars in wasteful spending.

Polling suggests Hogan’s anti-tax message has failed to gain traction – Brown leads him 50 percent to 37 percent. Many Marylanders believe the tax increases were necessary to make or maintain investments in transportation, education and other priorities, and they credit O’Malley for his balanced approach of spending cuts and revenue increases during tough economic times.

Furthermore, many of Hogan’s claims have been called into question. The Maryland Center on Economic Policy asserts that studies showing Maryland losing billions of dollars in income due to out-migration use inflated numbers that don’t account for new income generated by other Maryland residents taking the jobs and businesses left behind. In fact, about 97 percent of households leaving Maryland between 1993 and 2011 were replaced by households moving in from other states. The organization also notes that anti-tax critics attribute out-migration to tax policy, when in reality residents have myriad reasons for moving – and taxes rank far below family, friends and even weather when making moving decisions.

Hogan’s claim that the state lost 10 out of 13 Fortune 500 companies during O’Malley’s tenure doesn’t hold up to scrutiny. In 2006, the year O’Malley was elected, Maryland had 5 Fortune 500 companies and 12 Fortune 1000 companies – not 13 Fortune 500 companies, as Hogan alleges. A cursory search of Fortune 500 lists between 2006 and 2013 shows that the number of Fortune 500 companies based in Maryland has been remarkably steady, between 4 and 6 each year; results for Fortune 1000 companies are similar, between 11 and 13. The Fortune 500 companies that left the state – Black and Decker, Constellation Energy, and Coventry Health Care – were acquired by other companies (Black and Decker maintains a headquarters in Towson.)

Brown, for his part, has kept a low profile on tax issues. He has pledged to create a new commission to study comprehensive tax reform within his first 100 days in office, and says he does not foresee the need for any new taxes in the future. His campaign has also pushed back against Hogan’s association with former Governor Bob Ehrlich’s (R) administration, claiming that Ehrlich oversaw one of the largest expansions of government, taxes and fees in state history (Hogan served at Ehrlich’s appointment secretary).

Both candidates support an exemption for veteran’s pensions from the state personal income tax, with Brown’s endorsement of the proposal coming a day after Hogan’s. Both candidates have been cautious on the recent change to Maryland’s estate tax law, which will raise the estate tax threshold from $1 million to $5.34 million. When asked about the estate earlier this year, Brown demurred, saying that any tax reform should be comprehensive, while Hogan has made no public statement on the bill. 

All is quiet in the streets of the nation’s capital as members of Congress have fled to their home districts for their annual August recess. But as is the case every August in recent years, our elected officials left a lot of unfinished business.

Among this incomplete work is the future of “bonus depreciation,” which is as contradictory as it sounds. This huge tax break allows companies to accelerate tax write offs for equipment and other infrastructure investment. First enacted to address the recession during the George W. Bush administration, it has been repeatedly re-enacted, expanded during the most recent economic collapse and finally expired at the end of 2013.

Defenders of bonus depreciation argue that this special tax break gives businesses a needed incentive to engage in risky infrastructure investments. But, as we noted previously, the Congressional Research Service published a report last month concluding that bonus depreciation doesn’t appear to have a meaningful impact on corporate investment decisions. In fact, the CRS argued, the only thing bonus depreciation is less good at than encouraging short-term investment is encouraging long-term investment.

Just when it seems the case for bonus depreciation cannot get any weaker, now business leaders have admitted that it has no effect on investment. A new survey from Bloomberg BNA confirms the CRS’s finding that the expiration of bonus depreciation is hardly ruffling a feather among most Fortune 500 corporations. BNA surveyed 100 leaders at large U.S. businesses to find out how, if at all, changes in bonus depreciation and related tax rules are affecting their decisions on capital expenditures, and found that 83 percent of these business leaders believed the expiration of these tax breaks has not affected their capital expenditures in 2014.

Nonetheless, the House of Representatives voted in July to make bonus depreciation permanent (at which point the term “bonus” would apparently no longer describe this break) at a projected cost of $276 billion over a decade.

While CEOs say this break doesn’t spur investment, this doesn’t mean that the business community is indifferent about the fate of bonus depreciation, of course.  Even if businesses aren’t basing their decisions on these tax breaks, they certainly would welcome their extension. As former Treasury Secretary Paul O’Neill put it, “I never made an investment decision based on the tax code…If you are giving money away I will take it. If you want to give me inducements for something I am going to do anyway, I will take it. But good business people do not do things because of inducements.” 

And, Washington being Washington, some lawmakers are quite interested not just in extending bonus depreciation but in broadening its scope. California Rep. Jeff Denham is renewing his call to make bonus depreciation a permanent feature of the tax code—and to extend this tax break to businesses investing in “fruit- and nut-bearing trees and vines,” presumably to benefit almond growers in his district. The bill passed by the U.S. House of Representatives last month would do both of these things.

The Senate has taken a different approach. The Senate Finance Committee approved a bill that would extend bonus depreciation, along with a package of additional tax breaks that mostly benefit businesses, for just two years. While the House has voted to make certain tax breaks (including bonus depreciation and several others) permanent, the Senate seems content to stick with Congress’s traditional, but very problematic, practice of extending such tax breaks (the infamous tax extenders) for a couple of years at a time. The nation would be better served if bonus depreciation, along with the rest of these tax breaks, were allowed to die. 

You’d have to be living under a rock at this point (or mysteriously uninterested in tax policy – but then why would you be reading this) to not know about the fiscal crisis in Kansas. This recent USA Today article (which quotes smart folks at Missouri Budget Project and the Kansas Center for Economic Growth) does a really splendid job of relaying the absolute latest happenings in Missouri and Kansas (sneak peek – Missouri may be a little better off because their tax cuts are dependent on revenue growth, and Kansas has just gotten a fiscal vote of no confidence from another bond rating agency).

Here’s the drama in a nutshell: Governor Sam Brownback declared that his 2012 plan to gradually repeal the state’s income tax would be “a real live experiment” in supply-side economics. He pushed through two consecutive years of income tax cuts that disproportionately benefited the richest Kansans (while actually hiking taxes on the state’s poorest residents), assuring the public these cuts would pay for themselves. (ITEP has done a ton of work analyzing the various tax cut proposals; peruse them here, here, and here.) Yet, Kansas ended this fiscal year $338 million short of total projected revenue, forcing the state to drain reserve funds to pay the bills.

The news continues to be grim.  And now, the inability of Brownback and the legislature to make these tax cuts add up has created a new problem: bond rating agencies think Kansas’ poor recent fiscal management makes the state less credit-worthy. Standard and Poor’s downgraded the state’s credit rating this week, meaning that every time the state chooses to borrow money to fund long-term capital investments such as roads and bridges, it will cost the state more to do so.

So, perhaps not surprisingly, Governor Brownback is in a close fight for reelection and even a number of notable fellow Republicans aren’t supporting him. Kansas seems to be sputtering and on a downward spiral, but in a move that leaves many tax analysts scratching our heads it appears that Missouri wants a little of what Kansas is laying down.  

In fact, lawmakers in Jefferson City enacted mammoth income tax cuts this spring that overwhelmingly benefit high-income taxpayers. The income tax cuts that were contentiously passed this year included a drop in the top income tax rate and a new deduction for business income. ITEP found that under this legislation the poorest 20 percent of Missourians will see a tax cut averaging just $6, while the top one percent of families will enjoy an average tax cut of $7,792 once the cuts are fully phased in.

This story isn’t going away anytime soon and it’s good to see journalists like those from respected newspapers covering this story in such depth.

According to the Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF), an estimated $7 and $10 billion is lost in federal and state tax revenue annually due to cigarette smuggling, which is astounding considering that total federal and state tobacco tax collections were about $32 billion in 2013. This means that as much as a quarter of all tobacco tax revenue is being lost each year.

One of the biggest drivers of the extensive cigarette smuggling is the substantial differences in state excise taxes. For example, Virginia’s state tax is only 30 cents on a pack of 20 cigarettes, whereas New York’s combined state and city excise tax is 19.5 times higher at $5.85 per pack. From a practical perspective, this means that an individual could evade $166,500 in tobacco taxes by simply buying up 50 cases of cigarettes in Virginia, driving them to New York City and then illegally reselling them to retailers in the city.

While some level of smuggling may be inevitable due to the high profitability of this enterprise, the good news is that there are a host of simple measures that state governments can take to combat the flow of cigarette smuggling, including simply increasing the quality of tobacco tax stamps and better record keeping by retailers. Lawmakers in Virginia and Maryland, for instance, have already started to crack down on cigarette smuggling by stepping up enforcement and increasing criminal penalties on smugglers.

On the federal level, Rep. Lloyd Doggett has proposed the Smuggled Tobacco Prevention (STOP) Act, which would require unique markings on tobacco products for tracking purposes, ban the use of tobacco manufacturing equipment to unlicensed persons, require better disclosure by export warehouses and increase the penalty on tobacco smuggling offenses. Taken together, these measures provide the critical framework needed for federal and state authorities to significantly stem the flow of cigarette smuggling.

Taking a step back, it’s important for state and federal lawmakers to remember that tobacco taxes are most useful as a mechanism to discourage smoking, rather than a particularly desirable revenue source given that they are regressive and the amount of revenue they generate declines over time. Still, allowing tax evasion to erode this revenue source at the state and federal level is simply unacceptable.

What’s the biggest difference between small and large cigars or pipe and roll-your-own tobacco? Their level of taxation, according to the Government Accountability Office (GAO), which estimates that tobacco companies have managed to dodge an estimated $3.7 billion in federal excise taxes since 2009 by superficially repackaging their products to fit within the legal definitions of the least taxed forms of tobacco.

A Senate Finance Committee hearing last week examined the egregious methods tobacco companies use to accomplish this. One panelist related in his testimony (PDF) that Desperado Tobacco had literally pasted a label saying “pipe tobacco” onto its existing roll-your-own tobacco packages so it could avoid the higher rate on roll-your-own tobacco. Perhaps even more stunning, another panelist noted during the hearing that some companies had added cat litter to small cigars to add enough weight to their product so that it fit the definition of the lower taxed “large cigars.”

What’s driving these outrageous tactics is the substantial difference in the way each product is taxed. For example, roll-your-own tobacco is taxed by the federal government at a rate of $24.78 per pound compared to the $2.83 per pound rate on pipe tobacco. Similarly, small cigars are taxed at a rate of $50.33 per thousand, whereas large cigars are taxed as a percentage of the manufacturer’s price, which in many cases results in a tax of about half that for small cigars. These differences in tax levels are so significant that according to the GAO, over the past few years there has been a dramatic rise (PDF) in both the purchase of large cigars and pipe tobacco along with a simultaneous collapse in the market for small cigars and roll-your-own tobacco, as consumers flock to the lower-priced alternatives.

The best way to solve this tax avoidance by tobacco companies would be for Congress to equalize the level of taxation of the varying tobacco products, which would once and for all end the incentive for companies to repackage their product to fit the different product definitions. In the event of congressional inaction, the Alcohol and Tobacco Tax and Trade Bureau (TTB) also has authority to issue clearer definitions between the varying tobacco products. For example, TTB could require that large cigars be defined as being six rather than three pounds per thousand. But it’s unlikely that any definitions the bureau could issue would adequately solve the problem of companies gaming their products.

While tobacco taxes are not the best source of revenue given that they are regressive and decline over time, they still provide billions in much needed revenue at the state and federal level to offset some of the social costs of smoking. For these reasons, lawmakers should put an end to the ridiculous games tobacco companies are playing to avoid paying taxes.

While Congress’s attention has been riveted on the saga of a handful of corporations making high-profile attempts to invert to foreign countries, Microsoft’s recent announcement that it’s holding a staggering $92.9 billion offshore is a stark reminder of the far more consequential tax avoidance practiced by Fortune 500 companies that remain based in the United States.

Microsoft admits in its annual financial report that it would owe $29.6 billion if it paid taxes on the cash it’s stashing offshore. In the past year, Microsoft moved $16 billion offshore, which is more than the total amount the much-maligned inverter Medtronic currently holds abroad. Only General Electric and Apple disclose having more offshore cash than Microsoft.

Even more important, the company’s annual report essentially admits that the vast majority of its offshore profits are being held (at least on paper) in jurisdictions with tax rates very close to zero. Microsoft estimates that if these profits were brought back to the United States, it would pay an effective tax rate of just under 32 percent. Since the U.S. tax on repatriated profits is 35 percent minus any taxes previously paid to foreign jurisdictions, this suggests that the company has paid an overall tax rate of about 3 percent on these profits to date.  

While the company is required to disclose all its “significant” foreign subsidiaries, none of the 12 subsidiaries the company now discloses are in places with 3 percent tax rates. As the Wall Street Journal reported last year, Microsoft used to disclose “more than 100” subsidiaries. Academic research suggests that in at least some cases, large multinationals that disclose fewer subsidiaries are doing so not because the subsidiaries no longer exist, but because they don’t want to disclose them.

As we have recently noted, companies know they can get away with this because of a loose accounting rule that only requires they disclose “significant” subsidiaries. It’s within the power of Congress and federal regulators to require big multinationals to disclose all of their foreign subsidiaries—including the beach tax haven subsidiaries that tech companies have found so helpful in shifting their U.S. profits abroad.

The wall-to-wall media coverage that has been lavished on corporate tax inversions has shed welcome light on the topic of offshore income shifting, and Walgreen’s recent decision to at least postpone its inversion suggests that this attention has had a positive effect. But for every company currently contemplating an inversion, there are 10 major multinationals that continue shifting their profits offshore the old-fashioned way. Congress shouldn’t lose sight of this broader, worrisome trend.

Yesterday voters in Missouri soundly defeated Amendment 7, a ballot measure that would have raised the sales tax by three-fourths of a cent to fund transportation needs.

Sales taxes are largely regressive, capturing a larger share of income from the poor than from more affluent people. The move to temporarily raise the state sales tax to pay for roads and bridges comes just months after the state legislature overrode Gov. Jay Nixon’s veto and passed income tax cuts that overwhelmingly benefit high-income taxpayers.

The vote defeating the sales tax increase sends a message to lawmakers to go back to the drawing board in terms of finding ways to pay for needed infrastructure. Lawmakers projected the new sales tax to generate $5.4 billion over ten years for transportation projects across the state. Now that the sales tax hike has been defeated critical work won’t begin on the more than 800 projects the Missouri Department of Transportation identified as “critical safety improvements.”

In what has been called “a study in bad behavior” the fact that lawmakers put a tax hike before the voters after just passing income tax cuts boggles the mind. Lawmakers in Jefferson City recently approved mammoth income tax cuts that overwhelmingly benefit high income taxpayers, yet seemed to have few qualms about asking voters to support a regressive sales tax hike that would have actually raised taxes on low income families. The income tax cuts that were contentiously passed this year included a drop in the top income tax rate and a new deduction for business income. ITEP found that under this legislation the poorest 20 percent of Missourians will see a tax cut averaging just $6, while the top one percent of families will enjoy an average tax cut of $7,792 once the cuts are fully phased in.

Lawmakers clearly see the need for increased transportation funding–why put a sales tax on the ballot if that isn’t so–but they arguably wouldn’t need to raise $500 million in new sales tax revenue if they hadn’t just cut an even larger amount of income tax revenue.

Lawmakers’ procrastination on this issue is the root cause of Missouri’s transportation funding shortfall. The state’s has raised it current 17-cent gas tax in 18 years, and it isn’t generating the revenue necessary to keep up with demands on Missouri’s infrastructure. If lawmakers don’t act, ITEP estimates that Missouri’s gas tax rate will reach an all-time inflation-adjusted low by 2020. In 2011, ITEP found the state’s gas tax rate would need to be increased by 9.6 cents just to return its purchasing power to the level it had when it was last raised back in 1996. Right now, Missouri’s gas tax is lower than the tax in all of its neighboring state except Oklahoma. Increasing and indexing the gas tax is a better solution for Missouri’s transportation woes because fuel taxes are a very good proxy for the wear and tear vehicles put on the road. However, the gas tax would also have a worrying impact on tax fairness that can be overcome by introducing a targeted low-income tax credit.

Given the defeat of Amendment 7 what’s to happen to Missouri’s crumbling infrastructure? Transportation commissioners are set to meet to discuss next steps. Let’s hope Missouri lawmakers also regroup and look toward other funding alternatives. Surely it’s not too much to ask that Missourians have safe bridges and quality roads that are paid for in fair and sustainable ways.