Tax Foreign Corporate Profits by Ending Deferral

All of Washington seems to agree that tax loopholes should be closed. Yet, as a practical matter, closing some of the biggest loopholes is no easy thing because of their importance to individuals and the economy as a whole. Take a meat cleaver to the home mortgage interest deduction and you hurt a fragile housing sector. Whack the exclusion of employer health insurance and you upend our system of work-based coverage. Gut the deduction for contributing to 401(k)s and you overturn our private pension system. Water down the charitable tax deduction and you hurt the nonprofit sector. 

Now, a case can be made for reforming all these areas at some point, maybe even next year, but it's tricky to tackle this challenge right now for a bunch of reasons. That's a big reason why President Obama is so focused on raising tax rates. 

But here's a loophole that should be scrapped, and now: Congress should stop allowing corporations to defer paying taxes on overseas profits. Under deferral, corporations do not have to pay taxes on profits made overseas until they bring those profits home to the United States.

This loophole is a bad idea in both principle and practice. As a matter of principle, there is no compelling reason why income shouldn't be taxed when it's made. I can't imagine that New Jersey, where I live, would tolerate the idea of me piling up my income from New York, where I work, in a Manhattan bank account and keeping it there, untaxed, until I choose to transfer the money to an account in New Jersey. 

What's especially galling is even as corporations can defer paying taxes until later, or maybe never, they can take deductions now. That'd be like me saying to New Jersey: hey, my income is going to stay in Manhattan for who knows how long, but here's my tax return with a bunch of deductions and maybe even my demand for a refund. 

True, corporations do pay taxes to foreign governments on income made overseas. But many have become amazingly adept at shifting profits to subsidiaries they have established in countries with low or no taxes -- offshore tax havens. (As we have written about here extensively.) And while it is typical to hear it said that this is all "perfectly legal," corporations are often engaged in some pretty shady tactics. As the Center for Tax Justice commented in a recent analysis: 

U.S. corporations engage in convoluted transactions to make what are truly U.S. profits appear to be profits generated by a subsidiary corporation in one of these tax havens, so that they can indefinitely defer U.S. taxes and not pay foreign taxes either. In many cases the transaction only exists on paper and the subsidiary corporation is little more than a post office box in the Cayman Islands or Bermuda or some other tax haven.

For many U.S. corporations, the majority of “offshore” profits are really U.S. profits that have been shifted to offshore tax havens in this manner. Most corporations provide very little detail that would indicate whether their offshore profits result from real business operations abroad or from shifting profits (on paper) to tax havens.

So how can a subsidiary in, say, Bermuda be shown to make some huge profit? Well, one tactic is to shift ownership of a valuable patent or other intellectual property to a foreign subsidiary, which then collects generous royalties from the U.S.-based mother ship. 

Trying to figure out whether corporations are complying with the law is ridiculously hard given how Byzantine this stuff is and the formidable legal resources of major corporations. As the New York Times reported last year, for example, General Electric has nearly 1,000 people in its legal department, including former top IRS officials, and a big part of their job is to handle the accounting related to GE's numerous foreign subsidiaries, including ones that own some of the company's key intellectual property.

It all works out well for GE. In 2010, the "company reported worldwide profits of $14.2 billion, and said $5.1 billion of the total came from its operations in the United States. Its American tax bill? None. In fact, G.E. claimed a tax benefit of $3.2 billion."

Thanks to deferral, U.S. corporations now have a mountain of cash sitting offshore, much of which is in tax havens and has never been subjected to any taxes at all. As CTJ reported last week:

Among the Fortune 500 corporations, 290 have revealed that they, collectively, held nearly $1.6 trillion in profits outside the United States at the end of 2011. . . . Just 20 of the corporations — including household names like GE, Microsoft, Apple, IBM, Coca-Cola and Goldman Sachs — held $794 billion offshore, half of the total. 

A big hope of these corporations is that the U.S. will declare another "repatriation holiday" as Bush did in 2004, and allow them to bring home all this cash at a very low tax rate. Of course, such a holiday would just encourage them to pile up yet more cash and wait for the next holiday. 

President Obama hasn't talked about ending deferral outright, and that's a shame. It's also no surprise given how much money he has taken from corporate executives in companies that benefit handsomely from deferral, particularly in the tech sector: Microsoft and Google were were among the top three sources of cash for Obama's reelection effort. IBM and Apple were not far behind. 

However, the Obama Administration did put forward a plan in 2009 to reduce some of the abuses in this system, including the ability of companies to take deductions now while paying taxes later. That plan never went anywhere, and by 2012, the Administration was proposing several reforms that were more modest. These too have gone nowhere.

Now would be a good time to step up the push to properly tax foreign corporate profits.