A stunning view of South Shore Beach in Bermuda, a country with a GDP of only $5.5 billion, though Fortune 500 companies claimed, in the most recent year for which statistics are available, that they harvested a total of $104 billion in profits from the island nation. (Photo by kansasphoto | Flickr CC 2.0)
This post originally appeared at The Nation.
The sleeper issue in Donald Trump’s tax-cutting agenda is a potential bombshell called the “territorial tax system.” It doesn’t get the headlines, or even much political discussion, so the public is clueless. The industrial titans of Silicon Valley like it like that. Their proposal would fundamentally alter the taxation of US multinational corporations, and beneficiaries would include celebrated brand names like Google, Microsoft and Apple.
Those tech giants and other globalized companies have been after Congress for years to make the switch to “territorial.” But corporate execs are not making their campaign noisy, because their so-called “tax reform” would be a dead turkey if citizens understood the threatening implications.
That seems unlikely. The big names of information technology are popular companies and, yes, global trade is complicated stuff, hard to explain in a few sentences. Scores of independent watchdogs — citizen organizations like Tax Analysts and Americans for Fair Taxation — are sounding the alarm and lobbying members of Congress. But it’s an uphill struggle, especially since the Democratic Party has not tried to alert voters and mobilize public opposition.
In my experience, this is how American democracy frequently fails its promise. Politicians privately blame people for indifference; I mostly blame politicians for ducking their obligations. In my decades as a political reporter, I have found that people of ordinary intelligence can usually see through the corporate smoke and understand complex issues if the pols explain things with plainspoken clarity.
Political parties used to be personal teachers, going door to door in neighborhoods, listening to gripes and opinions, plugging the party line and ticket. In modern politics, cynical candidates needn’t bother. They can parrot what the pollsters tell them people want to hear. I prefer politicians who tell people what they need to know.
So here are critical points about the “territorial” tax system people need to understand but corporate advocates won’t mention: If the scheme is passed, American companies with operations dispersed globally would pay US taxes only on the profits earned within the territory of the United States. In the current system, Washington attempts to tax multinationals on their worldwide earnings but fails miserably because the corporations have figured out fiendishly complicated ways to hide their profits in low-tax foreign countries. (That speaks to a separate but related item on the multinationals’ current wish list for tax reform: “forgiveness” for the roughly $600 billion in profits they would owe once they repatriate those profits, an issue I have addressed previously in this column.)
At first glance, the territorial approach sounds vaguely patriotic — an “America first” approach to the taxation of US multinational corporations. In reality, this new system would be more like the “Get Out of Jail Free” cards in the game of Monopoly. The legislation would allow an ingenious scam, in which America’s celebrated high-tech champions would be rewarded for abandoning the mother country if they decide the price is right.
The Institute on Taxation and Economic Policy (ITEP), a nonpartisan organization, has warned, “Corporations would have even greater incentives to engage in accounting gimmicks to make their US profits appear to be earned in offshore tax havens such as Bermuda and the Cayman Islands, where corporate profits are not taxed.”
The logic for companies is not complicated. Silicon Valley and other sectors like the drug industry are notorious for dodging US taxes. A basic technique involves assigning the supposed “ownership” of a company’s profit-making functions to affiliates in cooperating foreign nations. This works especially well for intangible assets like intellectual property — drug patents or hard-to-value high-tech innovations. The process reeks of fraud, but government enforcement has either been intimidated or overwhelmed by the volume of fictitious deals. The new territorial system does not in theory prohibit these fraudulent corporate arrangements with foreign countries; it merely ends Washington’s failed attempts to collect the taxes.
The examples of US companies doing fraudulent deals or ignoring the rules are so numerous they seem like business as usual. Bermuda, for instance, has a GDP of only $5.5 billion, but Fortune 500 companies claimed, in the most recent year for which statistics are available, that they harvested a total of $104 billion in profits from Bermuda. The European Union’s antitrust commissioner accuses Apple of funneling $15.2 billion in profits from two Irish subsidiaries to an unnamed office that had “no employees, no premises, no real activities.” And the commissioner has accused Amazon of an illegitimate tax agreement with Luxembourg, ordering that country to collect $293 million in unpaid taxes from the American retailer.
A 2017 policy paper from the Urban Institute, citing scholarly sources, traced the twists and turns of a single tax evasion without naming the company or its invention. Here’s how an American company hides its profits from the US tax collector:
Suppose a US high-tech company patents a new product and sells the patents to its Irish affiliate. If the product is not yet being marketed, the value of its patents is difficult to ascertain. The US parent company charges its Irish affiliate a low price, minimizing its taxable income from developing the new product. Once the product’s success is established, the Irish company can then charge a high royalty to a contract manufacturer in China, causing a large share of the profits of the corporate group to be reported to Ireland, with a 12.5 percent [tax] rate. Further techniques then can be used to shift the reported profit from Ireland to a subsidiary in the Cayman Islands or Bermuda, eliminating even the low Irish tax.
Warning to Nation readers: Do not try to use any of these maneuvers on your personal income tax. You might go to jail.
Would Trump’s version of territorial taxation stop US corporations from using these accounting tricks? Critics say of course not. We don’t know the official answer at this point, because private negotiations are still under way between the high-tech industry and congressional Republicans. Trump has allegedly left the details to Congress, but who knows whether that’s true.
Martin Lobel, a Washington lawyer who chairs the group Tax Analysts, said it is inconceivable that the GOP would shut down these tax gimmicks so favorable to big business. “There are no such things as ‘American multinationals,’” Lobel said. “These corporations are called multinationals for a reason. They will invest wherever they can make the most profit. If the tax code allows them to make more profits offshore, that is where they will invest, despite the millions of dollars of subsidies our tax code gives them.”
Lobel and other opponents of the territorial scheme point out that tax-dodging by multinationals injures Americans in broader ways. As ITEP explained: “The ability to avoid US taxes entirely on profits on foreign operations, rather than simply deferring taxes on those profits, would provide a strong incentive to locate real investment overseas rather than in the United States. Less investment in the United States would put downward pressure on the wages of American workers.”
The outcome of Trump’s tax-cutting agenda is imperiled because of the political chaos the president has inspired. Recode, an informed website that covers Silicon Valley, reports that the Information Technology Industry Council, which represents Apple, Google, Microsoft and others in Washington politics, supports the goal of a territorial system but has withheld endorsement because it isn’t satisfied with the details. In other words, the lobbyists are working the squeeze play that powerful interests typically apply at this stage of legislative debates.
It would help if the Democratic Party made some noise and raised some of the obvious arguments against shifting to territorial taxation. “If territorial becomes a public issue, Democrats will be against it,” Lobel predicted, “because Democrats represent small business and small business gets screwed by this, since they don’t get any benefits and it puts them at competitive disadvantage by the big multinationals.”
Reformers like Lobel suggest there is a plausible remedy for America’s confused tax system. Washington legislators could follow the model of a unitary system like the one California uses for its state taxes: It determines the tax liability by calculating a company’s profit in the state based on its sales, personnel and property — the same elements that businesses use in their investment decisions.
Lobel is not confident the public would rebel against the territorial system if the Democrats decline to take the lead. Party leaders are shy for the usual reasons: They are divided among themselves. Some of their best friends — and donors — are Silicon Valley billionaires, who generously support progressive social values and provide sustaining contributions to affiliated liberal organizations like the Center for American Progress.
Reforming and taxing multinationals is a divisive matter for Democratic leaders and other influential elites — though not for rank-and-file Democrats, who are overwhelmingly in favor of raising taxes on both multinationals and wealthy individuals. The passive silence at the top of the party and the boiling disappointment down below may be seen as a leading indicator of the party’s troubled future.
