Everyone admits that our current tax system is broken and many "reform" proposals are being considered. But, our current tax code is too fragile to support most of the current "reform" proposals that powerful interests want to layer on it. Instead, we need to strengthen and simplify the tax code to provide a broad tax base before carving out another loophole, like territorial taxation, to "reform" the tax code. We need to reform the tax code so that it doesn't continue to increase the disparity in wealth between the very rich and the rest of us. We also need to remember that the more complicated the proposal, the more likely it is that some lobbyist is proposing another unjustifiable tax expenditure (aka tax subsidy, tax loophole) to benefit his wealthy client. In fact, any business that doesn't seek a tax subsidy is a fool because the rate of return is far higher than it could get in the market. According to a recent study, multinational companies had a 22,000 percent return on tax expenditures they lobbied for, although small in comparison to the 77,500 percent return earned so far on the $116 million the prescription drug industry spent lobbying for legislation to prevent Medicare from bargaining on drug prices.
While the Chairman of the House Ways and Means Committee, Dave Camp, has tried to make the process of tax reform more transparent by publishing various proposals the committee is considering, most of the input is coming from highly paid lobbyists in closed door meetings with the members and staff. Although the media will sometimes cover some tax issues like Senator Levin's recent hearing on Apple's ability to shift its profits offshore and avoid paying taxes on $102.2 billion, most of the backdoor lobbying goes unreported even by Tax Analysts, which does the best job of covering current tax issues, because its all done behind doors closed to reporters.
Apple's CEO Tim Cook's statement to the Senate Permanent Investigations Subcommittee is a good example of the Alice in Wonderland thinking that passes for a serious proposal. His proposal for "reform" is to adopt a territorial system with some minimum payment of taxes on "foreign" income. He thought 15 percent was about right for multinationals to pay, less than half the rate that domestic corporations are supposed to pay. This would perpetuate the current system that encourages the export of jobs and profits offshore, albeit at a slightly lower rate. Although Apple has over $102.2 billion of profits offshore, it decided to borrow $17 billion to pay dividends because doing so was "tax advantaged." Does that give you an indication of how our tax policies have skewed the market?
Clearly, we must do something to reform our foreign tax system, which is based on transfer pricing, despite the fact that every IRS Commissioner has testified the IRS cannot police transfer pricing. Although the multinationals and their associations, like the Business Roundtable and the Chamber of Commerce, have mounted a massive, but stealthy, campaign to enact a territorial system and the Ways and Means Committee have published four variations it is considering, any territorial system would only exacerbate our economic problems because it would continue to subsidize the export of jobs and income and injure domestic companies that have to compete against the multinationals. We need a level playing field, not one tilted towards the multinationals. And, we should not forget that there are no such things as "American" or "foreign" multinationals. They are all multinationals who will invest wherever in the world they think offers the best rate of return. Apple is clearly an American company, but, according to the company, it earns most of its income abroad where it is either not taxed or subject to insignificant tax rates. In short, according to Apple, most of its income is stateless income.
There are two simple solutions to untaxed "foreign" income created by our current tax code: treat multinational corporations located in the United States just like domestic corporations. No more deferral of income. No more check the box. No more special sourcing rules. That would certainly level the playing field and bring in far more revenue.
The second solution to untaxed "foreign" income is to adopt unitary accounting and apportion corporate income based on a formula. The simplest way would be to apportion taxable income by sales. Under this formula, if a company has 10 percent of its worldwide sales in the US, it would pay US taxes on 10 percent of its profits. The other commonly used formula measures, in addition to sales, the amount of property and personnel located in that country and weights them to determine what proportion of world wide income is subject to taxes in that country. In either case, we would need much better sourcing rules to eliminate intra-corporate sales and renegotiation of many of our tax treaties.
The US effectively forced other countries to adopt transfer pricing as the method of determining taxable income when we essentially controlled world markets. But the situation has now changed. Given the increasing globalization of business and the increasing importance of intangibles which have no physical location and are almost impossible to value for tax purposes, the OECD has recognized that something must be done to stop the erosion of its tax base by multinationals shifting profits to no or low tax countries. Although the Treasury is actively opposing any reforms (except for improving policing of transfer pricing, which the IRS has already admitted it cannot police) the OECD has already initiated a serious look at unitary accounting and apportionment as a way to stop multinational profit shifting to avoid paying taxes.
Treasury, which usually supports the multinationals, is opposing such reforms allegedly because there would be difficulties in changing the international system of taxation. It is true that we would have to renegotiate treaties requiring the use of transfer pricing, but that shouldn't be too hard considering the increasing concerns of the OECD and BRICS countries about stateless income that is never taxed anywhere and the erosion of their tax bases.
Reforming our tax code is even more essential to eliminate the shift of income from the middle class to the very wealthy. As Professor G. William Domhoff has pointed out.
In the United States, wealth is highly concentrated in a relatively few hands. As of 2010, the top 1 percent of households (the upper class) owned 35.4 percent of all privately held wealth, and the next 19 percent (the managerial, professional, and small business stratum) had 53.5 percent which means that just 20 percent of the people owned a remarkable 89 percent, leaving only 11 percent of the wealth for the bottom 80 percent (wage and salary workers). In terms of financial wealth (total net worth minus the value of one's home), the top 1 percent of households had an even greater share at 42.1 percent. In terms of types of financial wealth, the top one percent of households have 35 percent of all privately held stock, 64.4 percent of financial securities, and 62.4 percent of business equity. The top 10 percent have 81 percent to 94 percent of stocks, bonds, trust funds and business equity, and almost 80 percent of non-home real estate.
Or to put it in a different perspective, from 2009 to 2011, "Top 1 percent income gains grew by 11.2 percent while bottom 99 percent incomes shrunk by 0.4 percent. Hence the top 1 percent captured 121 percent of the income gains in the first two years of the recovery."
Yet, individual income and payroll taxes on the middle and lower classes have increased over the last 60 years while estate and corporate income taxes have declined substantially as a percentage of receipts. The only logical conclusion is that government tax policies have been instrumental in the shift of income from the middle and lower classes to the rich. This conclusion has been supported by almost all of the non-industry supported research, including the Congressional Budget Office which recently reported that over 50 percent of the 10 largest tax breaks went to the richest 20 percent of Americans and 17 percent went to just the top 1 percent, while the middle quintile only got 13 percent and the bottom quintile only got 8 percent.
Besides taxing the almost $2 trillion of stateless income offshore, there are other alternatives to make our tax and economic system more efficient. Although the Republicans talk about cutting tax expenditures and did cut some in the 1986 Tax Reform Act, they ought to get serious and cut all the corporate tax expenditures which now cost the taxpayers just about the same amount as the corporations pay in taxes. We could also eliminate the cost and distortions of tax accounting and just tax the profits that these corporations report to their shareholders. That would go a long way towards eliminating the deficit and would get the government out of the business of picking winners and losers. Both Republican goals, if you believe their spokesmen.
Eliminating all tax expenditures would allow reporters and the public to learn what new tax expenditures the lobbyists were pushing once there was a clean slate, particularly, if coupled with a requirement like Oklahoma's that requires a cost estimate for every proposed tax expenditure. Although the lobbyists would scream, they'd really love it because it would guarantee they would earn enough to pay for their grandchildren's education.
We should also eliminate many of the tax expenditures that benefit individuals like the mortgage interest deduction and the exclusion of employer provided health insurance from income. Democrats will scream, but the fact is that they only benefit the top 20 percent of taxpayers who file itemized tax returns. We should also note that housing prices in Canada, which doesn't allow mortgage interest deductions, are about the same as in the U.S. In fact, despite claims of "job destroying taxes," most economic research has concluded that substantially raising tax rates on the wealthy would not hurt our economy, but help it.
People complain about the "double" taxation of dividends. Perhaps, we should explore requiring the corporations to pay taxes at the highest personal rate and then when they issue dividends they should contain a non transferable credit of that proportionate amount. The same rule could be applied to partnerships, Sub S corporations and other pass through entities that don't pay corporate taxes. This would eliminate the disparity between corporations and pass through entities and would result in more revenue since the IRS is far more competent in collecting payroll taxes which are similar in nature to this proposal. It would also go far towards eliminating the benefits of holding profits in offshore tax shelters.
We should also tax income from investments at the same rate we tax income from labor. Since between 81 percent to 94 percent of income from stocks, bonds, trust funds and business equity goes to the top 10 percent of the population that would help close the gap between the rich and the middle class.
What we should not do is adopt proposals pushed by many so-called liberal economists for a value added tax (VAT) which would only increase the tax burden on lower- and middle-income taxpayers, increase the disparity between them and the very rich and impose a disproportionate burden on the elderly who spend a greater portion of their income than those who are younger.
Unfortunately, none of the real tax reform proposals are likely to be enacted so long as money talks on the Hill and the public doesn't hear what is going on. As Anthony Downs pointed out in his classic book, An Economic Theory of Democracy, politicians deal in votes. They will do whatever they think will get them the most votes. So long as the public is not aware of what is going on, they will vote with the rich and powerful to maximize the amount of money they can raise to run increasingly expensive campaigns. This is not true for a few issues about which their voters are aware. In those cases, money isn't as persuasive and they will vote however they think they can maximize their votes.
In short, so long as the returns on lobbying are so great, we will see our economic system weakened even more because the middle and lower income classes which, despite a significant decline in its wealth, will be paying an increasing amount of taxes. This significantly diminishes their ability to buy things and keep the economy growing. Unless the media can explain to their readers and viewers what is really at stake, we are doomed to muddle along a nation divided until the next economic crisis energizes the voters to throw the bums out.