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Is Indirectness a virtue on tax havens?

I've been taking a closer look at Obama's tax-haven plan, and I would make a general observation.

First, it is a classic "neo-liberal" regulation, and I don't necessarily mean that in the derogatory sense we usually use that term on this blog. Rather, it tries to indirectly solve a problem by interfering in markets as little as possible. So, rather than telling U.S. corporations what to do and how to do it, and then use the power of the state to punish those who disobey, the Obama proposal attempts to create incentives for private actors to voluntarily comply.

A few examples:

  • Rather than prohibit deferral by U.S. corporations of repatriation/taxation on their foreign-source income, the Obama plan creates an incentive to repatriate income by not allowing companies to deduct expenses supporting their overseas investments from their U.S. tax returns until they repatriate income.
  • Rather than require foreign financial institutions to share information with the U.S. government on U.S. corporations' foreign banking accounts, or prohibit U.S. corporations from doing banking with foreign banks that don't share information with the IRS, the Obama plan would require U.S. banks that service U.S. corporations that also utilize overseas banks that are not "qualified intermediaries" to withhold 20-30 percent of payments to these corporations until certain disclosures happen.

Some of these provisions are kind of clever in a Policy 201 kind of way. The problem is that their very indirectness would still allow substantial evasion of taxes and money laundering.

For instance, the Obama plan would allow U.S. citizens to avoid disclosing foreign bank accounts that have less than $200,000. It's not clear that tax evaders couldn't just create twenty $199,999 bank accounts and avoid disclosure.

Moreover, the corporate tax rate is statutorily 35 percent. Say a corporation CitiMorgan now faces an effective tax rate of 3 percent on global profits of $1 billion, because they park 90 percent of their profits in Panama overseas accounts ($900 million) and 10% onshore ($100 million). This means that, rather than pay their full $350 million in taxes, CitiMorgan pays $30 million. This is a savings of $320 million.

Under the worst case scenario for the tax-evading CitiMorgan under the Obama plan, CitiMorgan faces the 20-30 percent penalty on their onshore account (30% of the $100 million in the onshore account is $30 million). (For simplicity, let's argue that CitiMorgan does not have any Panamanian expenses it would deduct from its U.S. taxes, so wouldn't face the other penalties envisioned under the Obama plan.) Under this scenario, CitiMorgan can choose between doing all banking onshore and paying $350 million in taxes, or banking offshore and paying a 3 percent effective tax rate and a penalty of $30 million for not going through a qualified intermediary, and thus paying $60 million ($30 million effective rate + $30 million penalty). In this scenario, it would still be profitable to dodge U.S. taxes in Panama, even whilst paying a penalty.

In short, it would seem that the government should either outright prohibit corporate tax evasion by jailing those who do not comply, or, if it prefers to take the indirect approach, raise penalties to the point where there can be no savings through offshore tax evasion.

I am not a tax expert, and I may be totally off on my interpretation here, even as back-of-the-envelope as it is. If I am, let me know. But, it seems like corporations will fight ANY reform proposal, so why not actually ask for what we want, i.e. an end to a double standard for corporations and middle class families in tax payments?

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