Politics of Poverty

Paradise Papers: Five things to fix in the House tax bill

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Photo: Oxfam

Here is an agenda to take up if Congress really wanted to fix the shady business of international tax avoidance in the aftermath of Paradise Papers.

Last week, tax legislation rewarding the rich and big corporations was introduced in the House. Yesterday another leak shed light on the immoral business of offshore accountants and lawyers who help multinational companies and wealthy individuals avoid paying their fair share of taxes. Oxfam called for a pause on the tax bill and an investigation into the activities revealed by the Paradise Papers.

Let’s connect the dots: What does the proposed tax bill do to curb international tax avoidance? And what should it do?

Require public country-by-country reporting

The starting point is transparency. The system should not rely on courageous whistleblowers to expose immoral behavior. Multinational companies use accounting tricks to move their profits across borders to minimize their tax bills. Citizens cannot do the same so they end up picking up the tab.

It is time to remind companies that the ability to move capital across borders is a privilege, not a right. Despite globalization, we live in a world where democratic control is exercised at the national level. Citizens ought to have the right to know basic information about the activities of multinational companies (i.e., revenues, profits, taxes paid, assets, number of employees) in their country’s territory.

Starting this year such “country-by-country reports” are part of tax returns. However, the mandate of tax authorities is limited to enforcing the law. The problem – as the army of offshore lawyers likes to remind us – is that a lot of tax avoidance is legal: it exploits legal loopholes and mismatches across jurisdictions. Only an informed public debate can restore confidence in the integrity of the tax system.

The tax bill introduced last week does nothing to increase transparency of multinational companies’ accounts. Congress should adopt the country-by-country reporting section of the Stop Tax Havens Abuse Act or the Tax Fairness and Transparency Act.

End anonymous shell companies

Wealthy individuals are also able to exploit offshore tax havens. They do it by storing their wealth in companies they control. Some of these companies – commonly known as “shell companies” – don’t conduct any real economic activity; they are merely conduits to make wealth disappear for tax purposes. Some of them are also anonymous, which allows hiding wealth of criminal origins as well as evading tax.

The tax bill does nothing to tackle anonymous shell companies. Congress should adopt the Corporate Transparency Act, a bipartisan bill that would allow the federal government to collect the identity of the physical persons controlling and benefiting from companies incorporated in US states, and share that information with law enforcement authorities. Ultimately, we want public registers of companies indicating who owns them.

Exchange banking information with all countries

It used to be easy for individuals to evade tax on financial income simply by opening bank accounts abroad. Under the Obama Administration, a law called the Foreign Account Tax Compliance Act (FATCA) was adopted to compel foreign banks to automatically share the information about their US customers with the IRS. Later the US signed bilateral agreements with other countries to make this arrangement reciprocal: Share information about foreigners’ accounts in the US with the foreign authorities. Yet no agreement exists with many of the poorest countries – only four Sub-Saharan African countries have one.

The tax bill does nothing to resolve this issue. Congress should appropriate funding for technical assistance to enable poor countries to build the systems necessary to exchange banking information and protect the confidentiality of the data.

Tax offshore profits like domestic ones

Beyond transparency, it is essential to reduce opportunities for tax avoidance. The simplest way to do it is by charging the same tax rate on a company’s profits wherever they are earned or artificially moved to.

Current US law is actually close to doing that – except for one giant loophole that allows multinational companies to indefinitely defer paying the taxes they owe on their foreign profits. That results in Fortune 500 companies stashing over $2.6 trillion of profits offshore.

The tax bill will make that problem even worse. It would exempt future foreign profits from tax altogether, except for a new tax on “foreign high returns” that would charge half the normal rate on foreign profits in excess of “normal returns” (defined as the short term interest rate plus 7 percent). This system would not only encourage artificially moving profits offshore, it would also encourage offshoring jobs.

To be fair, the tax bill includes another provision that is meant to counter shifting US profits and jobs offshore: an excise tax on some payments between domestic companies and their foreign affiliates. However, this proposal came out of left field. It has far-reaching economic consequences. Multinational companies have started to fear that it would disrupt the way they carry on their core business across borders, not just the way they avoid tax. It would be irresponsible for Congress to adopt such a law within a week, which is insufficient to understand and debate its ramifications.

The best way to reduce opportunities for tax avoidance is simply to close the deferral loophole, which is what the Tax Fairness and Transparency Act would do, as well as take measures to prevent US companies from “inverting” into foreign companies, as proposed in the Corporate Tax Fairness Act.

Don’t reward past tax dodging

Last but not least, there is the question of what to do with that $2.6 trillion already stashed offshore.

The tax bill would have it taxed at a discounted rate (12 percent for cash holdings and 5 percent for non-cash, instead of the 35 percent rate owed). That would represent a half trillion dollar wealth transfer from ordinary taxpayers to the shareholders and executives of multinational companies.

This provision is outrageous. It is introduced in the name of incentivizing companies to invest more at home. But economists agree that incentives do not work retroactively. Even businessmen acknowledge as much. A US Senate investigation of a similar law passed in 2004 found that the 15 companies that benefited the most from the repatriation holiday cut more than 20,000 net jobs, decreased the pace of their research spending, and stashed more funds offshore.

The right solution is simply to require multinational companies to pay what they owe: 35 percent on their existing offshore profits, which is what the Corporate Tax Fairness Act requires. That would decrease the deficit by half a trillion dollars over ten years and ease the pressure on the budget – an important consideration given that the tax bill calls for bloating the deficit by one and a half trillion dollars over ten years and would therefore eventually lead to steep cuts in international assistance as well as popular programs like Medicare, Medicaid, and Social Security.

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