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The idea is to tax corporations based on where sales are made, not where profits are reported. If a company has 50 percent of its sales in the U.S., the U.S. would tax 50 percent of its worldwide profits.

You've been hearing a lot about corporations "renouncing their U.S. citizenship" through "tax inversions." This is when a company buys or merges with a non-U.S. company and claims to no longer be based in the U.S. to get out of paying certain taxes. The company does, however, keep the same employees, executives, buildings, sales channels and customers it had inside the U.S. before the switch.

The epidemic of tax inversions represents just one of many ways corporations are dodging their taxes by taking advantage of our outdated and rigged corporate tax system. It is time for a serious debate about corporate taxes, and on Monday a new report by District Economics Group economist Michael Udell offered a bold new alternative that is so radically simple that even the most clever corporate tax accountant would have a hard time finding a way around its fair and universal proposition: If a company sells products or services in the U.S., it must pay taxes on the U.S. proportion of its worldwide sales.  

But first, let’s explore how today’s complexity enables corporate tax avoidance.  

Are We "Broke" Or Just Not Collecting The Taxes We Are Owed?

"America is broke," declared House Speaker John Boehner a few years ago. But clearly the country is not broke; we are just being robbed, as many corporations create ways of  avoiding, dodging, shirking and generally not paying their taxes. The share of federal revenue coming from corporate taxes has dropped from around 32 percent in 1952 to around 8.9 percent now. As a share of gross domestic product it has fallen from about 6 percent of GDP then to less than 2 percent now. Meanwhile the rest of us – including small domestic companies that don’t have armies of tax consultants – have to make up that shortfall, either through increases in things like payroll taxes, or through cuts in the things government does to make our lives better.

Our big problem is that the big, multinational corporations use so many tax avoidance techniques that it is difficult to keep up. One of the larger dodges is that we allow corporations to “defer” (i.e. never pay) taxes on profits made outside the U.S.. So they engage in all kinds of schemes to make it look like their profits are not made here. As a result many companies owe very little tax on the proceeds from their U.S. operations, and then defer their non-U.S. profits from being “brought home” to avoid paying the taxes on non-U.S. sales.

It is estimated that as much as or even more than $2 trillion of taxable profits are being hoarded outside of the U.S. because of deferral. Meanwhile, the corporations lobby for a "repatriation tax holiday" to let them bring these profits back with little or even no tax.

For example, currently Pfizer sells a whole lot of its medicines  inside the U.S., but claims to lose money here, resulting in little-or-no inside-U.S. tax to pay. A Bloomberg story on Pfizer’s tax schemes reports, "earnings before taxes outside the U.S. were $15 billion in 2011 while losses within the country were $2.2 billion. … These operating results appear to be inconsistent with your domestic and international revenues, which in 2011 were $26.9 billion and $40.5 billion, respectively."

So Pfizer piles up cash – as much as $73 billion of taxable profits were held outside the U.S. in 2012.

Whack-A-Mole

Even if these corporations do bring the money back, it is very difficult to pin down which countries may have already taxed them and by how much, so it is very difficult to compute their U.S. tax liability. If it very difficult to sort through the complex maze of corporate ownership and the use of schemes like “transfer pricing, advance pricing agreements, cost sharing agreements, interest allocation arrangements, and check-the-box regulations,” along with the rest of the ways corporations game the tax system.

So along with this maze of complexity in figuring out how much corporations owe, in most cases the tax system depends on the corporations themselves to accurately report and pay the correct amounts. Needless to say, the incentives can end up working against the revenue needs of the government. The end result is that, one way or another, the multinational corporations get away with paying a lower effective tax rate than they should.

Current System Hurts Purely Domestic Companies And Jobs

Another result of the confusing state of loopholism is that corporations that use offshore breaks and subsidiaries gain a big advantage over purely-U.S. companies. The worst consequence of this is that the current tax system encourages these corporations to locate jobs, manufacturing operations and profit centers in lower tax countries instead of here so they can take advantage of the same loopholes.

More and more companies are moving more and more of their jobs, production, profit centers and profits out of the country. That is our future if we continue to accept the current system and the endless job of trying to make it more fair and consistent.

A New Study Shows A Solution

Udell's report, "Single Sales Factor Apportionment of Global Profits to Broaden the Tax Base" shows that as an alternative to the U.S. corporate tax system – called a single sales factor apportioned corporate tax – would not only simplify the tax code and reduce the burden of corporate tax compliance, but also promote the principle that all businesses pay their fair share.

The idea of “single sales factor apportionment” is to tax corporations based on where sales are made, not where profits are reported. So the share of a corporation’s total profit that the U.S. would tax would be based solely on the share of the corporation’s worldwide sales that occur in the U.S. If a company shows 10 percent of its sales occur in the U.S., then the U.S. taxes the company on 10 percent of its worldwide profits.

This new system treats foreign multinationals just the same way it treats American multinational corporations – and the same way it treats smaller U.S. domestic companies.

Raises Revenue

As this new study calculates, “using 2010 data, that an alternative definition of a corporate tax base using a sales factor apportionment of global profits could be as much as 159 percent larger than the current tax base. This tax base can be more transparent by design and less costly to comply with, both for taxpayers and the tax authority.”

Once again, the country could collect as much as 159 percent more corporate taxes using this method. This is as much as $200 billion more in corporate income taxes these companies should be paying now but have found various ways to dodge. This could be additional revenue for the government to pay for the courts, roads, schools, military and the rest that these corporations benefit from, or could be used to reduce corporate taxes to a rate of 29 percent, rather than the current 35 percent.

Simple and Enforceable

Corporate profits and the resulting tax liability are very hard to verify and enforce. The study looks at current tax laws and the ways corporations currently are able to make it look as if profits are made in various countries, or just underreport their profits. It addresses “asymmetric information” – meaning they can report one thing in one place and something different in another.

One example the study looks at is the different between “two-party” and “three-party” reporting. Currently corporate taxes are “two-party” while individual taxes are “three-party.” The two parties for corporate taxes are the corporation and the government. The government has to rely on the corporation accurately reporting its tax liability and/or use audits to verify its reporting. With individual taxes, a third party – employers – reports the wages to the Internal Revenue Service, and the employee also does. This works because the employer wants to report paying the highest income because they get a deduction, while the employee wants to report low income. This conflicting interest helps guarantee there is honest reporting. Without this third party the only way to verify is an audit.

The study explains that using “single sales factor apportionment” introduces a third party into the calculation of multinational corporate profits. Corporations want to report high worldwide sales and profits to shareholders because that boosts stock price and increases executive bonuses. This adds to the simplicity of taxing these corporations based on the share of sales that occur in a given country.

Companies "Leaving" The U.S. Still Would Pay The Same Taxes

Implementing the single-sales factor tax system would mean that companies gain no advantage from renouncing their U.S. corporate citizenship through an inversion, as described above. They would still pay taxes to the U.S. government based on the percentage of sales they make inside of the U.S.. If half the company's (and subsidiaries') sales are inside the U.S. then the company is taxed on half of their total worldwide profits, including subsidiaries.

The details of the study are laid out with discussions of various “in the weeds” points that the tax policy geek community understands.

… economic activity is captured and because cross-border income stripping is netted out.  Global profits are defined as revenues less the sum of cost of goods sold, selling, general, and administrative expenses, and depreciation and amortization. (Research and development costs are included in administrative expense). This pre-tax, pre-interest expense, pre-other income definition of a tax base is shown in table 3 below. …

[. . .] estimated amounts of apportioned global profits are shown in the second row of table 5, and increase the financial statement sample’s U.S. apportioned global profits from $643 billion (table 3 above) to $1,196. Finally, these 14 industries accounted for 58 percent of business receipts for all corporate income tax returns (excluding financial services). Grossing up the U.S. apportioned global profits for the 14 industries to all corporations by (1/0.58) yields an estimate of apportioned global profits as $1,196 billion X (1/0.58) = $2,074 billion. This sales factor apportioned global profits tax base is 159 percent larger than the $801 billion of net income subject to tax reported for all corporations on 2010 returns.

You get the picture. Yikes! But it’s all there. Especially that last sentence, by the way: "This sales factor apportioned global profits tax base is 159 percent larger than the $801 billion of net income subject to tax reported for all corporations on 2010 returns (other than financial services)." That is a lot of opportunity to get the needed revenue to fund our roads, bridges, courts, schools and the rest of the things government does to make our lives – and the lives of our corporations – better.

The study shows that adopting sales factor apportionment could:

  • Redefine the corporate tax base, permitting lower rates, increased revenue or some combination of both.
  • Remove the incentives for U.S. multinational corporations to leave the U.S. through corporate inversions, and to leave their profits in offshore tax havens.
  • Level the playing field between purely domestic businesses and multinational corporations.
  • Reduce tax incentives to locate jobs and manufacturing operations in lower tax foreign nations, bringing opportunities for economic activity to the United States.
  • Maintain Congress’ ability to lower rates or increase revenue to execute policy.
  • Simplify accounting and reduce the burden of compliance on corporate taxpayers as well as administrators.

Take a look at "Single Sales Factor Apportionment of Global Profits to Broaden the Tax Base."

-----

This post originally appeared at Campaign for America's Future (CAF) at their Blog for OurFuture. I am a Fellow with CAF.  Sign up here for the CAF daily summary and/or for the Progress Breakfast.

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Comment Preferences

  •  Tip Jar (10+ / 0-)

    --
    Seeing The Forest -- Who is our economy FOR, anyway? Twitter: @dcjohnson

    by davej on Tue Jul 15, 2014 at 07:16:24 AM PDT

  •  dave - to what extent would the US need other (0+ / 0-)

    countries to adopt this policy so that corporate income wasn't taxed twice?

    "let's talk about that" uid 92953

    by VClib on Tue Jul 15, 2014 at 08:13:36 AM PDT

    •  I think (0+ / 0-)

      other countries only tax non-domestic corps on profits reported as made inside their country, as we do. This would only affect US companies that report profits that are far and above that country's share of sales.

      If we move to sales proportioned it will encourage our companies to report income and costs where they actually occur. For example, Google's $10 billion profit in Bermuda probably doesn't represent a lot of clicking going on there. So their incentive to report this as Bermuda income goes away, it will be taxed anyway.

      So it only affects US companies reporting profits in other countries to the extent they are engaged in avoidance. They are not reporting high profits in higher-tax countries.

      I think. I'm not sure what the report cited in the post says about this aspect.

      --
      Seeing The Forest -- Who is our economy FOR, anyway? Twitter: @dcjohnson

      by davej on Tue Jul 15, 2014 at 12:36:31 PM PDT

      [ Parent ]

  •  Easy to subvert and game with even greater (2+ / 0-)
    Recommended by:
    JJ In Illinois, VClib

    incentives to move jobs outside the US for much of US business.

    When major changes in policy are made it is an error to assume those subject to the policy don't change what they do to their best advantage.

    Consider a company that manufactures outside the US.

    When selling in the US, instead of being the entity that imports products as is the case today, it has the large retailers (CVS, Walmart, Amazon, etc.) and wholesalers import the products, with the sale made where manufactured outside the US.  The company's products are still sold into the US market, but no US taxes would be due under the diary's proposal.  The retailers and wholesalers then report the products as sold in the US.

    For companies that manufacture and sell in the US today, they now have the opportunity to cut their income taxes to zero by terminating all their US manufacturing employees and have their products made outside the US, then operate as the above.

    A much simpler and effective way to block corporate avoidance of US taxes through international transactions and encourage US employment by imposing the same US tax burden on imports as what we make in the US is a "subtraction income tax".  

    Without going into all the details, the entity that imports products and services into the US does not get to deduct the cost of the import from revenue, and what the US exports is not included in revenue.  In this way for trade agreement purposes it acts like a VAT but is far easier to administer and easier to make the transition.  International gaming of prices to reduce US taxes does not occur because foreign transactions and imports are not even in the tax calculation, so they cannot reduce US taxes due.

    The most important way to protect the environment is not to have more than one child.

    by nextstep on Tue Jul 15, 2014 at 09:00:23 AM PDT

    •  You are describing (0+ / 0-)

      the opposite of that this proposal would do. You need to read it again.

      A company selling inside the US would be taxed proportionally to their sales regardless of where manufacturing occurs. The "sales" is not about where it is manufactured, it is about where it is sold.

      In this proposal if a company making widgets has 10% of its sales of widgets inside the US, then 10% of its worldwide profits are taxable by the US. This means it does them no good to move manufacturing out of the US and claim the costs are incurred elsewhere.

      --
      Seeing The Forest -- Who is our economy FOR, anyway? Twitter: @dcjohnson

      by davej on Tue Jul 15, 2014 at 12:41:18 PM PDT

      [ Parent ]

      •  Look at the details of the transactions that (0+ / 0-)

        companies would use to reduce their taxes under the diary's proposal.

        Consider the case of Apple iPhones sold in US Walmart stores.

        Foxcom, a Chinese company, makes iPhones for Apple.  Apple takes title (ownership) at the Foxcom factory loading dock.  Apple sells Walmart-China iPhones for Walmart Global to sell in many countries, including China, Canada, US, Mexico, etc..  Apple sold the iPhones in China and no longer owns the iPhones, Walmart China owns the iPhones.

        Walmart China sells some of the iPhones to Walmart USA.  Walmart USA imports iPhones into the US and ships iPhones to US Walmart stores.  Apple has no US sales from these iPhones sold in US Walmart stores, only sales in China to Walmart China.

        The transactions work differently than you would like, as the companies operate within the law but in ways that are in their best interests.

        I have done International trade for over 20 years, including countries that have very different tax policies, currency controls, import controls, profit repatriation penalties, etc.  Business is extremely efficient in minimizing what they legally need to pay in global taxation and are quick to modify their business operations and transactions as needed.

        The most important way to protect the environment is not to have more than one child.

        by nextstep on Tue Jul 15, 2014 at 01:21:55 PM PDT

        [ Parent ]

        •  You really think (0+ / 0-)

          Apple is not reporting how many iPhones it sells in the US?

          You really think Walmart (or any other distributor) is going to let Apple stick Walmart with the tax bill?

          This is the advantage of using the three-party system instead of the current two-party system. We no longer need to rely on APple to report where they make profits if they have an incentive to report regional sales and worldwide profits. We tax Apple for the precent of their sales that are made in the US.

          --
          Seeing The Forest -- Who is our economy FOR, anyway? Twitter: @dcjohnson

          by davej on Tue Jul 15, 2014 at 02:18:29 PM PDT

          [ Parent ]

          •  In the above example the number of iPhones sold (0+ / 0-)

            by Apple in the US is exactly zero.  Apple sold iPhones in China to independent companies, and some of the iPhone went to the US and sold in the US by some other party.

            Apple could also change the model, and have Walmat-China buy from Foxcom directly and Apple gets a royalty for each phone sold under license.  In this case Apple never even owns the phone.

            The most important way to protect the environment is not to have more than one child.

            by nextstep on Tue Jul 15, 2014 at 03:24:30 PM PDT

            [ Parent ]

  •  2 questions.. (1+ / 0-)
    Recommended by:
    nextstep

    1. A business that has no presence in the US but sells billions of dollars of goods here would pay nothing?

    2. A US business that has most of its sales outside the US pays very little tax even though they are profitable?

    •  Incorrect (0+ / 0-)

      1) That company would owe taxes on its total worldwide profits, according to the share of sales made in the US.  If 10% of their sales are made in the US, they would owe US taxes of 10% of its worldwide profits.

      2) That is correct (but would rarely occur), and would act as an incentive to export, which if GREAT for our economy and jobs. Our current trade deficit is a measure of as much as 5.8 million lost jobs.

      --
      Seeing The Forest -- Who is our economy FOR, anyway? Twitter: @dcjohnson

      by davej on Tue Jul 15, 2014 at 12:49:03 PM PDT

      [ Parent ]

  •  Not sure that would work (1+ / 0-)
    Recommended by:
    VClib

    The issue seems to be that the system could be gamed by putting all of their production overseas and then selling to a US company for US distribution.  They would sell at prices which would leave that distribution company with little or no profits at all.  Net result?  Neither companies pays much--if any--taxes at all.

    This is similar to what is already being done by companies to make it look like their US operations are not profitable: by having their foreign manufacturers sell to theUS distributors at high prices, resulting in low profits to be taxed.

    What is REALLY needed is for countries to get together and draw a line on corporate tax rates so that they don't end up in a race to the bottom where everyone loses....except the corporations.

    •  Not correct (1+ / 0-)
      Recommended by:
      Dodgerdog1

      The company manufacturing the product would be reporting X% of its product sales inside the US, regardless of who distributed it. If the distributor says they bought outside the US at a high price and sold inside the US, they are the ones on the hook for the tax based on percentage of SALES inside the use regardless of COGS so they will instead report the transactions as US-based, and that shifts the tax liability to the manufacturer.

      This is the interesting part about "three party reporting." The company has an incentive to say it has great sales going on. They have an incentive to report profits. The distributor you refer to has incentive to report their sales and cost of goods -- what they paid to that manufacturer, but inside the US to shift that tax liability to the manufacturer.

      Also, if other countries enact the same tax regime all incentives to shift as you describe them are gone.

      --
      Seeing The Forest -- Who is our economy FOR, anyway? Twitter: @dcjohnson

      by davej on Tue Jul 15, 2014 at 12:54:16 PM PDT

      [ Parent ]

      •  Proposal does not reflect realities of trade. (0+ / 0-)

        The tax policy assumes a hopelessly simplified model of international trade, manufacturing tax calculations and pricing.

        Consider the case of a notebook computer made by Taiwanese company Acer, assembled in Taiwan, using an Intel microprocessor made in Israel, DRAM from Micron made in Japan, disk drive from Seagate made in Thailand, chips from Qualcomm made in Taiwan and Corning Glass made in Taiwan, CREE LEDs made in the US.  In addition there are 50 other companies that make components used in the notebook not all do business in the US.  Other than Acer all of the companies mentioned are US headquartered.  In addition, except for the CPU there are alternate vendors for the above mentioned parts that are not US companies depending upon vendor prices and availability the components used may change.  Acer then sells the notebook to HP in Taiwan to be sold as an HP branded computer around the world with some going to the US.

        The above reflects what happens when a US customer buys a notebook from HP in the US.  Unless the US only does the proposed tax on HP's profits, doing the tax calculation would be hopelessly complex for all the companies involved.  

        From other comments to the diary, it sounds as if a company is responsible for paying taxes based upon the profits of their vendors.  How do the companies set prices between them when business transactions are done in July 2014, when none of the companies involved know what their profits are in July, the second quarter or for the year 2014.

        The most important way to protect the environment is not to have more than one child.

        by nextstep on Tue Jul 15, 2014 at 03:10:10 PM PDT

        [ Parent ]

    •  Let me put it another way (0+ / 0-)

      What distribution company would exist "with little or no profits at all"?  Perhaps if it is a subsidiary of a manufacturer trying to game the system this way, but then as a subsidiary the parent company's profits are still on the line for US tax liability.

      Any company that is set up to make "little or no profits at all" is somehow a shell front, and that means the tax liability transfers to whatever company it is a shell front for. It exists so SOMEONE can profit. Attempts to avoid saying who is profiting would lead to them not selling anything here, as well as possible criminal liability.

      --
      Seeing The Forest -- Who is our economy FOR, anyway? Twitter: @dcjohnson

      by davej on Tue Jul 15, 2014 at 12:58:46 PM PDT

      [ Parent ]

      •  Most all of the companies shipping low cost (0+ / 0-)

        products from China to the US have a low profit on a return on sales basis, while the business has an attractive return on investment because of the very high sales volume.

        The most important way to protect the environment is not to have more than one child.

        by nextstep on Tue Jul 15, 2014 at 02:32:18 PM PDT

        [ Parent ]

  •  This is essentially the method by which (0+ / 0-)

    a business operating in more than one state determines its taxable income in each state for state income tax purposes (although it is more common to apportion income not just on the basis of revenue but to include payroll and property as factors as well).

    The problems that arise are inconsistent treatment of the situs of revenue, difficulty in determining where a sale occurs (particularly in the case of sales of services) and imprecise rules regarding the treatment of financial transactions.

    A further problem is that it requires coordination between the states;  inconsistent rules can lead to income being taxed in more than one state or no state at all.

    In the multistate context, the federal courts and voluntary cooperation between states mitigates these problems.  That would be more difficult--but not impossible--in an international context.

    "Well, I'm sure I'd feel much worse if I weren't under such heavy sedation..."--David St. Hubbins

    by Old Left Good Left on Tue Jul 15, 2014 at 02:53:33 PM PDT

  •  If only there were any will. (0+ / 0-)

    I'm afraid that there are other, more easily enforced ways to fix this problem, but it doesn't matter since any solutions would take a bloody revolution to implement.

    Any proposed measure that would do anything to help will never be heard of in any room where decisions are being made.

    "Those who can make you believe absurdities can make you commit atrocities." - Voltaire

    by Greyhound on Tue Jul 15, 2014 at 04:22:28 PM PDT

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