A Simplified Way to Tax Multinational Corporations

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This post first appeared at the Campaign for America’s Future blog.

Photo of tax return and US treasury check
(Photo: iStock)

You’ve been hearing a lot about corporations “renouncing their US citizenship” through “tax inversions.” This is when a company buys or merges with a non-US company and claims to no longer be based in the US 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 US 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of tax inversions represents just one of many ways corporations are dodging their taxes by taking advantage of our outdated and rigged corporate tax system.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 US, it must pay taxes on the US 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 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 US. 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 US operations, and then defer their non-US profits from being “brought home” to avoid paying the taxes on non-US sales.

It is estimated that as much as or even more than $2 trillion of taxable profits are being hoarded outside of the US 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 US, but claims to lose money here, resulting in little-or-no inside-US tax to pay. A Bloomberg story on Pfizer’s tax schemes reports, “earnings before taxes outside the US were $15 billion in 2011 while losses within the country were $2.2 billion. … These operating results appear to be inconsistent with [Pfizer's] domestic and international revenues, which in 2011 were $26.9 billion and $40.5 billion, respectively.”

So Pfizer piles up the cash – as much as $73 billion of taxable profits were held outside the US 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 US tax liability. It is 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 many other 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.

The 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-US 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 an alternative to the US 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 US would tax would be based solely on the share of the corporation’s worldwide sales that occur in the US. If a company shows 10 percent of its sales occur in the US, then the US 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 US domestic companies.

Raises Revenue

As this new study calculates, “using 2010 data… 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 prices 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 US Still Would Pay the Same Taxes

Implementing the single-sales factor tax system would mean that companies gain no advantage from renouncing their US corporate citizenship through an inversion, as described above. They would still pay taxes to the US government based on the percentage of sales they make inside of the US. If half the company’s (and subsidiaries’) sales are inside the US 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 US 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 US 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 US multinational corporations to leave the US 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.

Dave Johnson is a fellow with Campaign for America’s Future and a senior fellow with Renew California.
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  • Luke Iannuzzi

    The GOP will call it a tax increase and the Dem’s will be too scared to fight it and nothing will change.

  • AverageJoeSF

    This approach is straightforward, equitable, and sustainable. Unfortunately, while these characteristics are the hallmarks of good policy, they’re very rarely present in the laws that get through our legislature.

  • Anonymous

    bought and paid for legislature will never let it pass

  • LeAnn Larson Frobom

    And you would effectively have third party reporting, because most corporations must pay sales tax to state and local entities — so there is an independent way to verify the $ in US sales in many cases.

  • Richard

    It’s time to tax large corporations their fair share, and to close up all of these insidious loopholes.

  • Anonymous

    Most corporations do not pay local sales tax, as they do not sell retail.

  • Thaddeus Kozubal

    Why, if it wasn’t for all the lobbyists on K Street, we would have a more reasonable, more equitable tax system. Look how many people would be put out of work. Even though this sounds like a reasonable approach, that’s the very reason it will never be implemented. Why? No graft and corruption built in.

  • Thaddeus Kozubal

    It is time for a change to the present tax system, and no amnesty for the “immigrants.”

  • Anonymous

    I say keep lowering taxes on corporations, cut government spending on education and medicare. Then privatize government services. Oh, and I forgot, make it harder for the poor to vote. The winning combination for the Koch brothers and Kansas.

  • Anonymous

    I like the idea, but I would take it one step further. Determine the ratio of earnings to US wages for similar products made here in the US. Then fine any company 100% of the amount that imputed earnings exceed that ratio to their US wages. So, for example, if the target ratio were 1:4, and a company had $1,000,000 of excess, they could give it all to the IRS as a fine or increase payroll of US workers by $800,000 and earnings by $200,000. Execs would decide where they could add US payroll to get the biggest return rather than tax and redistribute. Workers would gain self-respect and extra wage-based purchasing power would heal our economy.

  • Anonymous

    Of course, none of these changes will take place until we have a major economic collapse as in 1933 where everyone becomes frightened that we may lose our economy and our democracy. No one knows how long that will be, but the time appears to be measured in years, not decades. When the time does come, we need some viable ideas of how to rebuild our economy so that the gross profits of corporations are divided between stockholders and workers in an economically sustainable manner. Today we have historically high corporate earnings and historically low wages as a percentage of GDP. The idea I have proposed above would apply to all corporations — domestic, international and multinational.

  • Anonymous

    Except for a couple of minor details…

    For a multinational (non US) corporation like say Toyota or Fiat Chrysler Automobiles or any US corporation that inverts, the US and IRS would only have jurisdiction and visibility into the US subsidiary.

    So they’d only see the sales, profits, etc of Toyota USA or FCA USA or say Pfizer USA.

    So laws like the ones proposed are rainbow in the sky dreams that would only cause a further acceleration of US corporations inverting to overseas re-incorporation.

    Besides that, there are so many ways to get around regulations like this, as to make this totally laughable, even if miraculously it could be passed into law.

    Just as an example, Toyota could have all its dealers purchase the cars directly from Toyota Japan, so all of Toyota’s sales actually happen in Japan, and then ship the cars to the purchasing dealer (which is an independent business). So Toyota sales in the US would be zero. And it would pay no taxes.

    Similarly, Ford, even without an inversion, could move all its production to Mexico and Canada, have its dealers buy directly from Ford Mexico and Ford Canada subsidiaries, and have zero sales in the US to be taxed.

  • Pete Joachim

    If a company is losing $ selling products and servicing the USA, why are they doing it? Clearly, it is lie. USA is the best consumer of pharma products. So of course they are making $ here – regardless of the tax shenanigans.

  • David Morse

    Wouldn’t that require them to lie to their shareholders? Certainly, straw men sales are nothing new and would have to be addressed. But it would be so much easier to find them this way.

  • Tommy Carrig

    The US consumes 80% of the pharmaceutical prescriptions.
    Who were the biggest Pharma contributors in the 2011-2012 cycle?
    Pfizer led the pack, spending $1.8 million on campaign donations of it’s $73B held outside US. Other drug manufacturers spending in excess of $1 million each during the last election cycle were Amgen, Merck, Abbott Laboratories and AstraZeneca.

    Pretty cheap to buy the legislation compared to the price of the tax.
    Until the legislators change, the fair tax will be another good idea that … you know.
    If they need military aid/protection where will they find it and who will pay for it?

    One guess!
    They are weakening their own structure that they rely on!

  • macman777

    As far as it goes if is a fairly well put together argument. However, it only addresses revenue from taxes. I don’t know about anyone else but I believe the real problem is spending. If the Fed spent no more than they took in the there wouldn’t be a deficit. Simple solution to a really stupid problem.

  • catman

    Sounds simple and effective. But I’m growing cynical – I’m afraid that by the time lobbyists were done ‘helping’ Congress write this change to the tax code, corporate tax accountants would be provided with plenty of loopholes to slide through

  • Brad

    who said it has to be retail? Every company sells something. That thing would be taxed, retail or not.

  • Anonymous

    Depending on the state, only the final sale to the end user is taxed. Even then, lots of stuff isn’t taxed; I’m in the capital equipment business; if equipment is used in the production process, it isn’t taxed.

  • sirald66

    “Needless to say, the incentives can end up working against the revenue needs of the government.”

    Their revenue “needs” are actually profit “wants”. Big difference.

  • Anonymous

    So the system is rigged and the riggers have bought immunity for themselves and they are bringing the whole thing down, no governing body can withstand the degree of corruption of crony capitalism very long…

  • Anonymous

    Company A Revenue = 100 Expenses = 90
    Company B Revenue = 100 Expenses = 60

    Revenues are monies received less discounts, and are used to pay expenses. Profit is money left after expenses. So, how would your schema work for companies A and B.

    And technically, aren’t you taxed on profit v.v. after deductions have been taken out?

  • Fred Grosso

    Until people in this country get the will to do what is right we will have these problems.

  • Anonymous

    My Uncle
    Riley got an almost new red GMC Canyon just by some parttime working online
    with a laptop. visit their website C­a­s­h­f­i­g­.­C­O­M­

  • Joe Carnett

    GOP WILL NEVER GO 4 IT

  • NotARedneck

    This is where a properly administered VAT (Value Added Tax) at the federal level is essential. The regressive nature of this tax can be easily overcome by giving rebates to those who file tax returns and have low income.

  • Anonymous

    Taxation has multiple goals: to fund projects for the public good, to discourage socially harmful activity, and to prevent the harmful concentration of wealth. VAT does the first.

  • Anonymous

    It is long past time to rework the entire tax structure. Simplify for everyone and remove loopholes. A simple federal sales tax would generate huge revenues from the corporations goods being sold in the US. It is not only corporations that dodge taxes on a regular basis. Each taxpayer can easily dodge using deductions. There is also great expense, having a large entity, like the IRS policing the system.

  • ML

    Then you would tax the royalties for what was purchased in the US. (Shell company does 20 mil in US sales-pays pfizer 2 million in royalites-tax the 2million in royalties). Or just tax the whole transaction as the shell game is obvious but that would require the law to have teeth so regulators could go after companies who try to game the system. Also. It isn’t difficult to follow the money nor predict it and plan accordingly within the law.

  • http://www.strugglinghomeownerssharestories.com/ sandyjean412

    We built roads and highways and buildings in Afghanistan, while letting our own infrastructure deteriorate. What’s wrong with our country?

  • http://www.strugglinghomeownerssharestories.com/ sandyjean412

    You’re so discerning!

  • David L. Allison

    No, capitalists have profit wants. Governments have revenue needs.

  • David L. Allison

    Tax levied on Gross profits makes sense. Less confusion and fewer deductions.

  • David L. Allison

    Austerity is a demonstrated failure. Reducing the number of federal, State and local government employees has been a disaster for everyone except the one percent. The Federal government is neither a person nor a corporation or even a business. It is different from all of those and has different responsibilities.

  • Anonymous

    Corporate taxes may be better assessed at the shareholder end. No tax on corporations unless they retain earnings, retained earnings would be taxed at the highest personal income tax level including SS and Medicare tax. If they distribute earnings the share holder is tax at an earned income level including Social Security and Medicare tax and the corporations pays no tax on distributed income. Eliminate the term passive income it is a scam.

  • Robert Slaven

    I like this. Question: Would a national sales tax do the same thing? I’m thinking of something like Canada’s federal Goods and Services Tax (GST). Might be even easier to implement. Give a GST credit to lower-income families. The other key thing to do? Tax capital gains and dividends at the same rate as “earned” income.

  • Anonymous

    Sounds good but congress has to pass it into law and congress no longer passes laws that help the middle class. Good idea though.

  • Dean Wormer

    There is no such thing as “gross profits”. “Gross” refers to total income *before* expenses (i.e. wages and salary, material costs, supplies, taxes, etc.). “Net” profits are what is left over *after* expenses. SanPas is correct.

  • Anonymous

    Remove all laws concerning corporate tax. Install a minimum sales tax. Period. Sellit here, pay tax here. No foreign corporations should be able to sell ANYTHING to any Government agency, Fed, State, or local.

  • Brad

    Somewhere along the line, that equipment was taxed. Who manufactured it and who did you buy it from?

  • Anonymous

    In Virginia, equipment used in the manufacturing process is not taxed, period.

  • Anonymous

    “The share of federal revenue coming from corporate taxes has dropped from around 32 percent in 1952 to 8.9 percent now. ” Good idea, good article. Big companies are shifting taxes onto the rest of us. Profits of two million piles of a million dollars each have been hidden by US corporations. Take a thousand piles of $ 1 bills. Multiply that by a thousand. That’s a million. Multiply that by a thousand. That’s a billion, or a thousand million. Multiply that by a thousand. That’s a trillion, or a thousand piles of a billion dollars each, or a million piles of a million dollars each. Double this and you get $2 trillion dollars. That is how much that big US corporations are hiding oversees to avoid paying their fair share in taxes and causing the rest of us to have to shoulder the responsibility.

  • Abba Okoro

    TAX TAX TAX is that all you people can think about?

  • Abba Okoro

    Create a fair tax program

  • Abba Okoro

    They pay 10% of annual revenues more you will ever pay in a lifetime

  • Abba Okoro

    Country’s got bigger problems man

  • Abba Okoro

    Define “The poor”
    BTW the Private sector does everything better than government

  • Abba Okoro

    Why should we pay taxes on services we don’t even need?

  • Anonymous

    Territorial Tax System. Google that. Read up on it. The rest of the educated, advanced, dare I say some of them liberal, nations of the world use the Territorial Tax System.

    Under the Territorial Tax System any corporation only owns taxes on the income they earn in any specific country to that same specific nation. All incomes earned in some other jurisdiction are tax free. Thus Germans do not feel that they are owned tax income on any German corporate profits anywhere on planet earth. Nor to the Swedish, Swiss or Japanese among dozens of other nations.

    We, Mexico, South Korea and Chile use the Corporate Repatriation Tax (CRT) in which we feel, we as the imperial masters of the universe, are entitled to all earnings made by every corporation on the planet. And if we do not get it they are shurking their patriotic duties to render unto Caesar.

    As a Liberal, but educated Liberal, I find few things about America to be more embarrassing than their almost Pavlovian desire to tax any money earned by anyone, anywhere, at any time, as long as it is corporate.

    Meanwhile the US economic system is stifled by the lack of monies flowing unimpeded back home to enter and cycle endlessly through the US financial system.

  • pekadede

    Great idea. But what is needed now is an international approach whereby all the major countries of the world sign up to an agreement that they will all do this together. In a globalized economy, single states working on their own to address these issues is not the best way forward. The G20 meeting in Brisbane, Australia, later this year would be a good place to start.

  • Wynn Ray

    Payroll taxes ARE NOT PAYED BY CORPORATIONS. They are payed by individuals, no matter where they work. Corporations merely send the money to the Gov. You cannot increase payroll taxes to meet your corporate tax debt, this is illegal.

  • Anonymous

    This is too complicated. Just tax the dollars themselves. Every dollar spent sends a tiny percentage to the Federal Reserve (or the National Bank, which we SHOULD have). This taxes every dollar without fail and eliminates any need for tax returns/audits/paperwork. Either do something simple and obvious, or stop complaining.

  • Anonymous

    This will just create more middle men in the supply chain and drive the prices up for consumers.

    What is stopping a reseller domiciled in a non-US country from becoming the sole customer interface with, for instance, Apple? All US customers who want Apple products would have to buy through the non-US reseller. Under SSFA taxation, Apple would record the revenues as non-US because the non-US reseller purchased them, not the US customers. The non-US reseller would have to pay the taxes, but perhaps that’s just fine with Apple, Apple’s shareholders, and the reseller.

  • Windell Cotton

    Make a flat Tax of 50% on all corporation profits. If they are really “people” then they need to pay taxes like rich “people.”

  • Veteran

    When America gets 50 million Americans to register to vote, corp personhood will no longer rule this country. Silence is acceptance. Non voters surrender this country by their silence. Corps can’t afford to buy off that many voters when added to the current bases. Too unpredictable, and their corp greed won’t throw money at it.

  • Douglas Cohn

    Be nice if it was true but whether you have 10 million or 200 million brainwashed people voting they are still brainwashed

  • Douglas Cohn

    First they must remove the unlimited funding to candidates. All Candidates should have to use only money from a pool and whether they are from rural Tennessee or NYCity that is all they get to spend. NO more no less. That gives every person an equal chance of getting in office.

    Secondly since that will never happen then limit corporations to contribute based on how much tax they have paid in the past 5 years. For every billion paid per year they can contribute 1 million to a candidate. Paid must be literal not on paper from expenses.

  • Douglas Cohn

    Very true

  • Anonymous

    So, our leaders, who are supposed to govern and maintain the common good. Perhaps a pay cut is in order hmm? I’m thinking minimum wage. Or perhaps maybe you folks that keep on reelecting knuckleheads back to office should really take a rethink on who you are going to back next time. I do know that if ya’ll (by this I mean all you peoples that don’t vote or participate) maintain this apathetic don’t give a hoot attitude, that nothing decent will ever happen. It is far and past the time we lobby everyone we all know to register, get educated on the issues of each candidate and actually vote. Forgive the poor grammar, thanks for taking the time to read my comment. Have a great one.. Scoreboarding.