House tax plan does not stop the gaming

Gary Kalman | 5/11/2017, 6 a.m.

For all the concerns raised by economists and others about the House tax plan, it is generally assumed that the proposal will reduce the gaming of the tax system by multinational corporations. Among the more active debates: Will the currency adjust perfectly or will retail prices rise? Is the plan legal under our trade agreements? Do foreign investments take a dive?

While all those questions are hotly debated, consensus is that the current gaming will end. “Not to worry,” we are told, “that’s covered.” In a recent article, Marty Sullivan, chief economist at the nonpartisan Tax Analysts, was quoted saying that “the basic, fundamental structure of it seems much more resilient to gaming — by far.”

So, it is curious that earlier this year, General Electric, Pfizer and others that have been called out for aggressive tax avoidance publicly aligned with a coalition of companies to push the House tax plan. Between 2001 and 2015, Verizon paid an average of 12.4 percent in federal income taxes, as opposed to the 35 percent statutory rate, on steadily increasing profits. In five of those years — all profitable — the company paid no federal income tax. General Electric, for more than a decade, paid negative 1.6 percent on $58 billion in profits. Yet, the senior management of these companies clearly believe they will do better under the proposal.

How do you reconcile these competing assumptions? I didn’t understand, so I asked. After several conversations with economists, the answer is in the definition of “gaming.” The House plan, if implemented, would end the incentive to invert or book profits offshore. That is true. Instead, it would shift the gaming from location of profits to location of sales.

The few economists looking closer at this problem have written about how Microsoft or Apple could potentially locate servers in tax havens. Any downloads of software, music or movies could count as foreign sales and therefore generate no tax liability. That would increase the impact of tax avoidance as those companies currently do owe taxes on profits they book offshore — to be paid when they repatriate those profits to the U.S. parent. By switching from a system in which companies pay on all their profits to a so-called “territorial” system, the House plan would permanently exempt future taxes on all revenues booked offshore, opening the door to rampant abuse.

There is also the potential for exporters to merge with importers to share excess tax credits. This would reduce or eliminate tax liability for the importer on whom the plan relies to pay the lion’s share of the taxes. When asked about this, one economist responded, “that is not gaming.” True, mergers are a legitimate business practice but, in this instance, it is still a practice driven not by product or service quality, not by delivery or manufacturing efficiency, but by the tax code.

While there are numerous incentives in the tax code to affect corporate behavior, this one has no other purpose than tax avoidance. One entrepreneur who started an outdoor recreation company (an importer of materials and equipment) said he would consider buying a wheat exporting company to offset his tax liability. Not much synergy between rafting supplies and wheat, but the tax credits would be attractive.