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Friday, April 1, 2011

Kleinbard: The Global Tax Avoidance Dance

Edward D. Kleinbard (USC), The Global Tax Avoidance Dance:

America's most successful multinationals make great products and offer superior services. But they have another, less enviable quality in common -- they have become world leaders in tax avoidance. General Electric's global effective tax rate for 2010 was 7.4%. Pfizer's was 11.9%; Cisco came in at 17.5%. The nominal U.S. corporate tax rate is 35%.

Each company has its own tax story, but all -- like other multinationals -- have for years relied heavily on low-taxed foreign income to drive down their worldwide tax obligations, including those of their U.S. businesses.

American multinationals claim they are taxed on their worldwide income, but in reality the "active" income they earn through foreign subsidiaries is not taxed in this country until the cash is repatriated. In addition, financial accounting practices (the lens through which we view these firms because their tax returns are not public) permit a company not to book any U.S. tax liability on foreign earnings if the firm states that the income is "indefinitely invested" abroad.

General Electric has $94 billion in indefinitely reinvested earnings. The total for corporate America is more than $1 trillion. 


If the story was simply that U.S. firms have successfully expanded into international markets and are paying taxes abroad at lower rates, one could argue that there is no U.S. tax mischief afoot. But these are not the facts.

Tax collectors in the U.S. and in high-tax foreign countries are the direct victims of the tax avoidance, but we all suffer from the resulting budget deficits and distorted investment decisions that firms make as a result of their ability to generate what I call "stateless income" -- income derived from selling goods and services in a high-tax country but that, through internal tax legerdemain, surfaces in a low-taxed affiliate. ...

It's true that the U.S. corporate tax rate, at 35%, is too high relative to its economic peers, about 28% on average. (Click here for data on the 31 member states of the OECD; the 28% figure is an unweighted average of the larger OECD members. Click here for the "BRICs" and other non-OECD countries.) But the solution is not to reward U.S. multinationals for concocting and implementing worldwide tax-minimization schemes.

The only feasible solution is to lower the U.S. rate to a level comparable with global norms and to pay for the reduction in part by introducing worldwide tax consolidation for U.S. firms, just as they today consolidate their worldwide operations for financial accounting purposes.

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Comments

Kleinbard should know better than to use the term "tax avoidance" in his piece. What these companies are doing is not tax avoidance as defined in tax law. Tax deferral and other Congressionally-mandated tax benefits (credits, deductions, and exemptions) provided by the tax code do not constitute tax avoidance. I suspect Kleinbard does not think when he claims a personal exemption on his individual tax return that he is engaging in "tax avoidance".

Posted by: Tax Geek | Apr 1, 2011 8:00:15 AM

I would state that the US tax rate is 40%. 35% federal and 5% state(net of federal deduction.) The US rate is therfore more than a third greater than the average, leaving less after tax income.

Corporations respond rationally when legally reducing their tax rate to the same extent as they rationally reduce their manufacturing costs. This is proper behavior. What their "fair share" might be is an ideological question to be answered through the political process.

I have spent 35 years proudly helping my employers/clients pay less tax. And whether law school professors see their role as teachers of tax policy or teachers of tax practitioners, the overwhelming majority of their students will make their living reducing taxes.

I am completely unqualified to speak on tax policy, other than to anectdotally recall how clients have responded to tax stimuli over the last 35 years. I am, however, certain that whatever laws are passed I will still be able to help clients pay less tax.

Posted by: Ed D | Apr 1, 2011 10:22:42 AM

At the risk of torturing myself and others unduly, let me respond to the two anonymous comments above. "Tax avoidance" is the standard term in the academic literature for tax reduction planning strategies. (The literature reserves "tax evasion" for unlawful efforts to minimize tax liability.) As it happens, I agree that the term can create confusion, and I generally refrain from using it in my two long papers on this topic (Stateless Income – http://ssrn.com/abstract=1791769. The Lessons of Stateless Income – http://ssrn.com/abstract=1791783), but one must make concessions when trying to say something substantive in 750 words.

As to tax rates, it is a mistake to add state tax rates when looking at the effective tax rates borne by US firms in respect of their international income, because foreign income generally is not taxed by the states. (It is of course fair to include state burdens in looking at domestic effective rates.) The first of the two long papers discusses this at more length.

Finally, unless one is commenting for the purpose of confessing crimes, I do not understand or accept the idea of e-noms de plume. If you think your comment is worth others reading, it's worth your acknowledging ownership of it.

Ed Kleinbard

Posted by: Edward Kleinbard | Apr 1, 2011 11:13:49 AM

Ed (if may call you that), do you have any idea how many threats are made against reasonable commenters whose opinions or information upset activists? Even you attacked them for their wanting to remain anonymous. We should just discuss ideas and not the people who offer them.

Posted by: Woody | Apr 1, 2011 11:48:52 AM

Dear Professor Kleinbard

Re using noms de plume. It is not possible that you do not understand why people post anonymous comments on the web. Using it as a way to denigrate another's comments is pure "poisoning the well."

One of the commenters on Powerlineblog was an attorney for a large DC law firm, "was" being the operative word. Because of the internal firm response to a blog he had posted under his own name, he was forced, on threat of losing his partnership, to quit one of the most successful blogs.

You, sir, occupy a tenured position. I do not. As an attorney, my clients are not forced to retain me. I, therfore, think twice and avoid unnecessary public comments that "could" offend any of my current and future clients. I find it difficult to believe that you could not imagine or "understand" this.

As back to the 40% rate - I did not read the kerfuffle over GE as concerning the foreign tax they paid but the US tax they paid. You seem to acknowledge this position as the amount of the tax reserve when such income is repatriated would include state tax.

Rather than quibble about the 40% tax rate, I would reiterate that that is the rate imposed on the US actvities of taxpayers. Such a rate provides a tax incentive for businesses to operate outside the US whenever possible

Posted by: Ed D | Apr 1, 2011 12:00:59 PM

", I do not understand or accept the idea of e-noms de plume. "

How nice and dandy that a multi-millionaire, tenured law professor is willing to preach to us about how important it is to use one's real name. Not all of us have a pile of money and permanent job security to fall back on, Mr. Kleinbard.

Where were your candid comments about the tax system when you were a partner at CGSH? Oh wait, let me guess, you didn't think you could slam your clients for worldwide tax planning when they were paying you for your giant billable hour fee. Show a little sympathy and let some people comment on this board without your holier-than-thou criticism.

I never saw you post comments on TaxProf when you were in practice. (I readily admit that you were rude to many of your clients and co-counsel during meetings and conference calls, because I was there for some of them, but that's different from commenting on a widely read blog).

Posted by: makeitright | Apr 2, 2011 1:15:04 AM