Caterpillar Inc., the maker of those bright yellow bulldozers, earthmovers, and rock scrapers that have built roads, dams, bridges, and mines all over the planet, is an iconic American manufacturing company, headquartered since 1930 in the quintessential heartland city of Peoria, Illinois. Caterpillar’s mighty machines were present at the creation of Boulder Dam and the Golden Gate Bridge, the interstate highway system and the Superdome; they have diverted the Nile for the Aswan project and leveled the tundra for the Trans-Siberian Highway. Unlike many of its American counterparts, Caterpillar has largely resisted the temptation to move planning or production overseas. The design of its construction machinery, power generators, and industrial-strength engines is still largely carried out on the drawing boards of Peoria. Most of its products can still bear the proud notice “Made in U.S.A.” In 2014, the company reported global sales of $56 billion and generated $3.7 billion in profit. Caterpillar Inc. ranks among the top fifty manufacturing companies in the world, and its stock has been included for decades in the Dow Jones Industrial Average.
Caterpillar’s prices can be hefty. If you’re in the market, say, for a medium-sized all-wheel-drive road grader, the Caterpillar 140M2 Motor Grader will set you back some $515,000. Yet these machines sell like mad, because they are rugged enough to work anywhere on earth and they last for decades, even if used every day. In fact, that legendary longevity is the real key to Caterpillar’s ongoing financial success. After making a reasonable, but not huge, profit on the initial sale of a machine, the company cashes in big-time by selling spare parts for that same machine for the next twenty, thirty, or forty years. It’s the heavy-equipment equivalent of selling the razor cheap and making the big money selling blades. An internal report to the company’s board in 2012 said that the sale of spare parts acts like “an annuity continuing long after original equipment sales, and generating . . . profits.”1 Because no construction company wants to see a $500,000 machine sitting idle because of a broken crankshaft, Caterpillar aims to replace any part for any machine anywhere in the world within twenty-four hours.
Accordingly, the spare-parts trade is a crucial element of Caterpillar’s overall business and a key contributor to the company’s profits. And those profits, of course, are subject to the 35% U.S. corporate income tax rate. Thanks to exemptions, allowances, and credits, Caterpillar has never had to pay income tax at the nominal 35% rate. Still, its actual rate of corporate income tax, the company says, runs about 29%—higher than what its competitors in lower-tax countries have to pay. In return, of course, the Peoria-based firm gets all the benefits of being an American company: the world’s richest home market, the patent system and courts to enforce it, the rule of law, a well-educated workforce, extensive transit infrastructure, embassies and consulates in every nation to help it deal with foreign clients, and so on.
As François Hollande learned, though, a heavy rate of tax generally leads to heavy-duty efforts to avoid paying the tax. Sure enough, early in this century, Caterpillar Inc. was searching hard for ways to cut its tax payments. Into the breach stepped PricewaterhouseCoopers (or PwC), the giant accounting and consulting firm that had audited Caterpillar’s books for decades. PwC offered major American firms a service it called GTOP, or the Global Tax Optimization Program. The “tax optimization” it had in mind was, in fact, tax reduction; that is, PwC promised to look around the world to find places and ploys that could give a traditionally American firm a much lower rate of tax. For Caterpillar, the auditors quickly decided that the lucrative spare-parts business was the best place to launch a cross-border tax-avoidance scheme.
Until this “tax optimization” program came along, Caterpillar had run its parts business on a fairly simple formula. It designed the parts in Peoria and then contracted with manufacturers—almost all of them in the United States—to build them. Caterpillar bought the parts from the manufacturer, stored them in warehouses (the largest is in Morton, Illinois), and then shipped them to its dealers, around the country and around the world, to sell to the end customer. The profit on those sales accrued to Caterpillar in the United States and was taxed at the U.S. corporate rate.
But PricewaterhouseCoopers, through the GTOP service, designed a different mechanism (different on paper at least). Under PwC’s guidance, Caterpillar created a subsidiary in Geneva, Switzerland, called Caterpillar SARL (“SARL” is a Swiss legal term for a corporation). CSARL was then designated—on paper—as the official spare-parts supplier for all Caterpillar customers overseas. The mechanics of design and manufacture didn’t change; almost all Caterpillar parts were still designed, built, and warehoused in the United States, and Caterpillar employees in America still dispatched them to the dealers. But now CSARL, the Swiss subsidiary, became—on paper—the official buyer and seller of those parts. When the parts were sold, the profits on these sales were assigned to the Swiss company and taxed by the Swiss government at a top rate of 6%.
It was an aggressive tax-avoidance mechanism—the kind of thing that IRS auditors might question when reviewing the company’s corporate tax return. So Caterpillar felt the need to get some legal-sounding imprimatur for its new arrangement. Accordingly, the brass in Peoria decided to ask licensed auditors to judge the legality of the profit-shifting ploy. For this purpose, the company called on its regular auditing firm, PricewaterhouseCoopers—the same firm that had designed the whole Swiss-subsidiary-gets-the-profits scheme in the first place. The PwC auditors concluded, conveniently, that the organizational structure recommended by the PwC tax planners was perfectly legitimate. The auditors also declared, conveniently, that there was no conflict of interest in PwC’s auditing PwC’s proposals.
This left Caterpillar’s spare-parts business with an organization chart wildly out of balance. Responding to questions from a congressional committee, the company said it designed no parts in Switzerland. It manufactured no parts in Switzerland. It stored no parts in Switzerland. Caterpillar had ten warehouses in the United States storing some 1.5 billion spare parts but not a single warehouse in Switzerland. The company had forty-nine hundred employees running the parts business in the United States and sixty-six in Switzerland.
And yet Caterpillar reported to the IRS that 85% of all the profits it made on international sales of spare parts were earned by the Swiss subsidiary and thus not taxable in the United States.
Shifting the parts business (on paper) to Switzerland was not simple and was not cheap. The arrangement consumed months of lawyer time. Caterpillar paid the PricewaterhouseCoopers tax planners $55 million in consulting fees to create the Swiss detour for its spare-parts profit and a few million more for the auditors’ determination that there was no conflict in asking PwC to audit a PwC plan. But those millions were small change for Caterpillar, compared with the huge sums the firm was able to keep away from the IRS. The Swiss bypass shifted about $8 billion in profits from the U.S. parts operation in Peoria to CSARL in Geneva in the first fifteen years of the twenty-first century. If its effective corporate income tax rate in the United States was 29%, that meant Caterpillar cut its U.S. tax payments by $2.3 billion.2
Not a bad return on a $55 million investment. And that rate of return explains why so many American companies have followed the route plowed by Caterpillar. However high the consultants’ fees, and however absurd the resulting organizational chart may look, corporate taxpayers are willing to do what it takes to escape the 35% corporate income tax.
The federal tax on corporate earnings is older than the tax on personal income. The federal corporate income tax was first collected in 1909, four years before the first Form 1040 was sent to a small number of wealthy taxpayers. For some eight decades, the corporate tax rate in the United States was roughly the same as that in other major industrialized countries, so moving to a foreign country would make little difference in the tax a corporation had to pay. Beginning in the 1980s, though, major countries began to cut their corporate income tax rates sharply. The new century brought even lower rates. Between 1997 and 2014, thirty-one of the thirty-four members of the OECD—the club of the world’s richest nations—reduced the rate of corporate income tax. The United States did not follow this trend. By 2016, as a result, the base U.S. tax on corporate income was the highest of any major democracy. America’s corporate income tax ranges from 15% to 35%, depending on the company’s size, but in practice almost all major corporations are in the top bracket, 35%. The French, those nonpareil soakers of the rich, have a slightly lower base rate, but they’ve added a pair of “temporary” surtaxes that make their corporate rate higher than America’s. A few poorer countries, including Argentina and Chad, also tax corporate profits at 35%. But other rich countries, including all of our major economic competitors, have lower corporate rates.
Here’s a sample of corporate income tax rates in 2015.3 The chart on the next page lists the top statutory rate in various countries. Some countries, however, will cut specific deals with individual corporations to give them an even lower rate. That’s why Caterpillar’s Swiss subsidiary in the spare-parts trade had to pay only 6% in Swiss taxes and why Apple, as we’ll see shortly, struck an even better deal with the tax authorities in Ireland.
|
Country |
Rate |
|
Australia |
30% |
|
Austria |
25% |
|
Belgium |
33% |
|
Canada |
15% |
|
France |
33.3% |
|
Germany |
15% |
|
Ireland |
12.5% |
|
Israel |
26.5% |
|
Japan |
23.9% |
|
Mexico |
30% |
|
Netherlands |
25% |
|
Norway |
27% |
|
South Korea |
22% |
|
Sweden |
22% |
|
Switzerland |
8.5% |
|
U.K. |
20% |
|
United States |
35% |
Beyond the high rate, the United States stands apart from most other industrialized democracies in that it imposes the corporate tax rate on a worldwide basis; that is, if a company incorporated in the United States makes a product in Ireland and sells it there, the profit from that sale is subject to the U.S. corporate income tax. The firm won’t be taxed at the full 35% rate, because it can subtract the amount it paid in foreign tax from the U.S. tax bill, but some U.S. tax is owed on that foreign-earned income. Other rich countries, for the most part, impose the corporate tax on a “territorial” basis; that means a German company has to pay tax in Germany only on profits earned within Germany’s borders. Just a few other major nations—for example, Chile, Greece, Israel, and Mexico—impose a tax on money their firms earn overseas.
But the money an American company earns overseas is not subject to the U.S. corporate tax until it is “repatriated”—that is, until the company takes the money out of a foreign bank or security and transfers it to the United States to pay salaries or dividends or to invest in buildings or machinery. Because of the worldwide basis of American taxation, the money is subject to the corporate income tax when it comes home. The result—rather predictable, if you think about it—is that American corporations routinely choose to leave large amounts of foreign earnings overseas. They deposit the money in a Swiss or Spanish bank; they invest it in German or Japanese corporate bonds; they buy Irish or Italian companies. This practice is so common today that the standard estimates say U.S. companies have more than $2.3 trillion stashed overseas. This huge accumulation of cash outside our borders is a key reason for the recent surge in a tax-dodging process called inversion.
It’s important to note that the 35% rate on corporate profits is the “nominal” rate—that is, the figure set forth in the tax law. It’s safe to say that no American corporation pays the full 35% in taxes. Any company with a chief financial officer who is not sound asleep all day long can take advantage of the myriad giveaways in the Internal Revenue Code to reduce its tax burden. As a result, the “effective” tax rate paid by U.S. corporations—that is, the percentage of profits that is actually paid in taxes—is well below the nominal 35% level. But estimates differ sharply about just how far below.
The most comprehensive unbiased study of effective tax rates paid by U.S. firms was issued by the Government Accountability Office (GAO)—essentially, the accounting arm of Congress—in 2013.4 Looking at profits, and taxes paid, in the years 2008–10, the GAO said large U.S. companies actually paid 12.6% of their profits in federal tax. Many companies had to pay state and local income taxes, and some paid income tax to foreign countries on their overseas earnings. But even when all those taxes were added up, the effective rate of tax paid by large U.S. corporations was only 16.9%. The GAO said that companies were able to cut their tax bills far below the statutory rate because of “exemptions, deferrals, tax credits, and other forms of incentives” in the law and because they have successfully transferred much of their profit to foreign countries, as Caterpillar did. Big companies were so successful in the game of tax avoidance that “nearly 55 percent of all large U.S.-controlled corporations reported no federal tax liability in at least one year between 1998 and 2005,” the GAO found.
For the business community, which had been fighting for years to reduce the corporate income tax rate, that report from a respected, nonpartisan observer was a serious political blow. While corporate America was complaining about the world’s highest corporate tax rate, the GAO study said U.S. companies actually paid tax at about one-third of the nominal rate and at lower rates than big companies pay in many other countries. Critics of the tax preferences for corporations piled on. “Some U.S. multinational corporations like to complain about the U.S. 35% statutory tax rate,” said Senator Carl Levin, a Michigan Democrat. “What they don’t like to admit is that hardly any of them pay anything close to it . . . due in large part to the unjustified loopholes and gimmicks that riddle our tax code.”
In response, corporate America unleashed its own studies, designed to show that the GAO was simply wrong. An analyst at PricewaterhouseCoopers issued a report saying that the total tax burden (including taxes paid to foreign countries) on all U.S. corporations “exceeded 35% for the 2004–2010 period.” The Tax Foundation, a respected economic think tank funded by large corporations, disagreed with both the GAO and the PwC studies; its report said U.S. corporations in 2011 paid tax at an effective rate of 29.8%.5
Whatever the actual rate paid, it’s clear that America’s corporate income tax is high enough to motivate corporations to go to enormous lengths to avoid it. “U.S. multinational firms have established themselves as world leaders in global tax avoidance strategies,” notes Professor Edward D. Kleinbard, who teaches tax law at the University of Southern California. Indeed, Apple, with the help of tax-law geniuses, managed to shift its profits (on paper) to a legal concoction where it paid no corporate tax at all.
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APPLE, OF COURSE, IS A famously innovative company, and its lawyers and accountants have been searching for tax reduction stratagems for decades. But the effort picked up significantly in the twenty-first century, as the iPod, the iPad, and, since 2007, the iPhone turned into major generators of profit—profit that would be taxable at the 35% corporate income tax rate. To duck that tax bill, Apple struck deals with the government of Ireland. “Apple, Inc., a U.S. corporation, has used a variety of offshore structures, arrangements, and transactions to shift billions of dollars in profits away from the United States and into Ireland, where Apple has negotiated a special corporate tax rate of less than 2%,” a congressional investigation found.6
But even a 2% rate was more tax than Apple wanted to pay. So the company bookkeepers set up a subsidiary company, Apple Operations International. This legal entity was incorporated in Ireland but managed and controlled from the company headquarters in Cupertino, California. This “company” had no employees and no address; it had a three-member board of directors, which held its meetings in Cupertino. The home office then created a subsidiary of this Irish subsidiary, Apple Operations Europe, and a separate subsidiary of that subsidiary, Apple Sales International. Those two lower-level subsidiaries of Apple Operations International were also incorporated in Ireland but controlled and managed in Cupertino. Then Apple Inc., the American company, designated its network of Irish subsidiaries to be the official seller of Apple products everywhere outside the United States. These products were developed, designed, and programmed in the United States, and manufactured largely in China, but the right to sell them was transferred (on paper) to the Irish subsidiaries. Sales were excellent; in just four years, from 2009 to 2012, Apple Operations International had income of $74 billion.
The tax bill on this income? Zero. Apple Inc., the sole owner of the Irish subsidiaries, paid no U.S. tax on these earnings. The three companies incorporated in Ireland paid no Irish tax on these earnings. This happy outcome (for the stockholders) was the result of a clever organizational dance around the tax laws of both countries. As the company’s tax lawyers had discerned, a company operating in Ireland is subject to Irish tax only if it is “managed and controlled” in Ireland. But under American law, a company is subject to U.S. corporate tax liability only if it is incorporated in the United States. Because those three companies were not managed in Ireland and not incorporated in the United States, they owed no corporate tax to either country. Apple had created $74 billion worth of what the economists call “stateless income.” Of course the company still depended on the police, courts, fire departments, roads, infrastructure, educational system, and other government services provided by both the United States and Ireland; it just decided not to pay for those services, at least not on the tens of billions of dollars earned by its Irish subsidiaries.
When confronted about these tactics by angry U.S. senators from both parties—“It is completely outrageous,” said John McCain, the Arizona Republican, “that Apple has not only dodged full payment of U.S. taxes, but it has managed to evade paying taxes around the world through its convoluted and pernicious strategies”—Apple executives responded with indignation of their own.
“We pay all the taxes we owe, every single dollar,” declared Tim Cook, Apple’s CEO, who noted that Apple paid significant sums in U.S. taxes on its sales in the United States—more than $16 million in corporate income tax every day of the year. “We do not depend on tax gimmicks. . . . We do not stash money on some Caribbean island.” The problem, Cook said, was that 35% corporate tax rate, which would make it “very expensive” to record those international sales in the United States or to bring home the billions of dollars Apple had assigned to its foreign subsidiaries. The best solution would be for the United States to “eliminate all corporate tax expenditures, lower corporate income tax rates, and implement a reasonable tax on foreign earnings that allows the free flow of capital back to the United States.” In short, Tim Cook gave Congress the same message that Gérard Depardieu had given to François Hollande: if you set tax rates high, taxpayers will fall back on “convoluted and pernicious strategies” to avoid them—including taking their money to a different country.
Although Cook did not mention it to the senators, Apple Inc. had actually found a roundabout way to bring home some of the billions it held overseas without paying U.S. tax on the earnings. In 2013, Apple borrowed billions of dollars—that is, it sold corporate bonds—in the United States. It used the interest it earned on the money deposited overseas to pay the interest on the bonds. This maneuver, fully legal, meant that Apple could use the money it held overseas to provide cash at no cost in the United States—without a penny to the tax man.
For all Senator McCain’s ire, Apple’s subsidiary-of-a-subsidiary-of-a-subsidiary structure—the scheme that placed $74 billion beyond the reach of the tax authorities—was actually not as convoluted as another tax-dodging contraption, the intricate mechanism known as a “Double Irish with a Dutch Sandwich.” This one works nicely to shield profits from the tax man for companies that have a good deal of intellectual property, like search engines, software, cancer drugs, or computer operating systems. The “Double Irish” has been used by the likes of Apple and Microsoft, but it’s generally agreed, among aficionados of tax avoidance, that the paradigm case of this particular apparatus is Google’s international tax shifting, which is complicated to the point of being difficult to pin down precisely.
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GOOGLE CREATED A COMPANY called Google Bermuda Unlimited, based in Hamilton, Bermuda. That island nation is famous among tourists for its pink beaches and swaying palms, but it is favored by corporate treasurers for another national asset: a corporate tax rate of 0%. Google’s Bermuda subsidiary is the official corporate owner of a separate subsidiary called Google Ireland Holdings. This one is also based in Bermuda, but the name is appropriate because Google Ireland Holdings is the designated corporate owner of yet another Google subsidiary known as Google Ireland Limited, based in Dublin.
Once this corporate structure was established, Google’s headquarters in the United States assigned the rights to its intellectual property—its search and advertising technology, the golden goose of Google profits—to the “Ireland Holdings” subsidiary in Bermuda. Then it designated the “Ireland Limited” subsidiary in Dublin as the official seller of all Google advertising in Europe, the Middle East, and Africa. This business brought in huge earnings for “Ireland Limited,” the Dublin subsidiary. That would have created large profits for the Dublin subsidiary, which would be taxable in Ireland (at the 12.5% corporate tax rate there). But the Dublin subsidiary paid a “license fee” to the holder of the intellectual property—that is, to the Bermuda subsidiary. The license fees were so large that the Dublin company ended up paying out more than 99% of its earnings to its sister company in zero-tax Bermuda. The result was no taxable income in the United States. Almost no taxable income in Ireland. And lots of corporate income in Bermuda, where there’s no tax on corporate income.
It gets worse. There was a problem with the intricate plan outlined in the previous paragraph. The Irish tax code limits how much profit can be transferred out of Ireland to another country; because Google intended to shift virtually all the profits from Ireland to Bermuda, that limit could have stifled the whole complex transfer scheme. But there was an escape route: Ireland has treaties with certain countries (but not Bermuda) that permit such transfers on a tax-free basis. One of those countries is the Netherlands. So the profit earned on Google’s advertising in much of the world was collected by Google Ireland Limited, in Dublin, and then transferred to Google Netherlands Holdings BV, a shell company (no employees) in the Netherlands (“BV” is the Dutch equivalent of “Inc.”). From there, the money was shifted (on paper) to the Bermuda subsidiary. In essence, the two “Google Ireland” subsidiaries form a sandwich around the Dutch subsidiary. This exercise in three-part harmony means that billions of dollars of earnings built on intellectual property developed in the United States come to Google tax-free. Bloomberg Businessweek estimated that the sandwich cut Google’s U.S. tax bill by $3.1 billion over a four-year period.7
Caterpillar, Apple, and Google are not the only U.S. companies that have devised ornate structures to duck U.S. tax on their international sales. Among others, Microsoft has used a similar stratagem, assigning the profits from its foreign sales to subsidiaries in Singapore and (no surprise) Ireland. But Microsoft took this game one step further; it found a way to duck U.S. taxes on its sales inside the United States. To do that, Microsoft set up a wholly owned subsidiary company in Puerto Rico called MOPR (that is, Microsoft Operations Puerto Rico). Puerto Rico is, of course, a U.S. territory, but the IRS treats it as a foreign country for corporate tax purposes.
Microsoft headquarters in the United States then assigned to the Puerto Rico operation the North American rights to the company’s intellectual property in software, operating systems, search engines, and Web-based products. Whenever a Microsoft product that uses this intellectual property (which is to say, all Microsoft products) was sold in the United States, about half of the profit from the sale was attributed (on paper) to the Puerto Rican subsidiary. This meant that a subsidiary with a staff that comprised less than 1% of Microsoft employees was credited with earning half of the company’s profit in the United States. Microsoft has negotiated a deal with the cash-starved Puerto Rican government to pay income tax at a rate of about 2% on these profits.
“This structure is not designed to satisfy any specific manufacturing or business need,” concluded a congressional study of the Microsoft tax-avoidance mechanism. “Rather, it is designed to minimize tax on sales of products sold in the United States. . . . By routing its manufacturing through a tiny factory in Puerto Rico, Microsoft saved over $4.5 billion in taxes on goods sold in the United States” over a three-year period.8
Despite these industrious efforts to escape American taxes, Caterpillar, Apple, Google, and Microsoft still declare themselves to be American corporations. Apple’s CEO, Tim Cook, was adamant on this point that day when the senators were grilling him about “stateless income.” “I am often asked,” Cook said, “if Apple still considers itself an American company. My answer has always been an emphatic ‘Yes.’ We are proud to be an American company and equally proud of our contribution to the U.S. economy.”
But the lure of tax avoidance is so strong that other American companies have been perfectly willing to renounce legal ties to their home country and move overseas (on paper at least) in pursuit of a lower rate of corporate income tax. This is done through a process called an inversion. It’s a merger arrangement in which the U.S. enterprise buys (or sometimes is bought by) a foreign company and then moves its legal domicile to the new partner’s home country. Because it is no longer an American corporation—even though the management and much of the workforce stay home in the United States—it no longer has to pay that 35% tax on overseas profits. The term “inversion” is used because many of these deals involve a big American company merging with a much smaller foreign firm. The deal inverts the stature of the two, because the smaller foreign company becomes the owner, on paper, of the much larger and richer American “subsidiary.”
Since 2010—when a group of lawyers at the Skadden, Arps firm worked out the legalities of this maneuver—dozens of U.S. companies have become former U.S. companies by means of inversion.9 Burger King, an iconic American burger, fries, and milk shake franchise founded in Florida in the 1950s, is one item on this varied corporate menu. The fast-food giant pulled off a Whopper of an inversion deal in 2014—and became a Canadian company in the process—when it acquired Tim Hortons, a coffee-and-doughnut restaurant chain north of the border. Burger King, with 13,667 outlets in more than fifty countries, was much bigger than its new partner, Hortons, which had about 4,600 restaurants, almost all of them in Canada. Yet the company resulting from this deal, dubbed Restaurant Brands International, incorporated in Canada. Burger King was still managed from the same corporate office in Miami; it still celebrated the Fourth of July and Presidents’ Day with big promotions across the United States; on paper, though, it became Canadian, which meant its profits were now to be taxed at the Canadian corporate income tax rate, 15%, as opposed to the 35% rate back home. Burger King’s tax break was offset somewhat, though, because the province of Ontario charged another 11.5% in corporate tax.
The more important tax benefit seemed to be that the multibillion-dollar sums Burger King had been holding overseas could now be brought home to the United States, in various ways, without paying the U.S. income tax on that money. As a Canadian company, Burger King no longer had to pay U.S. tax when it brought foreign profits home. This is a standard, fundamental tax-avoidance aspect of inversion but not the most important one. The more valuable tax maneuver that American firms can and do employ after an inversion is a process called earnings skimming. For this one, the now-foreign company lends large sums to the parts of the firm remaining in the United States. The U.S. branch uses the borrowed money to pay its bills and makes an interest payment on the loan to the overseas “headquarters.” Because this is considered a business loan, the interest can be deducted (“skimmed”) from taxable earnings in the United States. In essence, a company borrows from itself, pays interest to itself, and gets a big deduction on its U.S. tax bill—for a transaction that may exist only on paper. Individuals can’t use this trick to cut their tax bills, but it’s legal for corporate taxpayers that are incorporated in a foreign country.
By early 2016, the inversion innovation had become so popular that the New York Times compared the surge in tax-avoiding corporations to the flood of immigrants pouring into Europe from the war-torn Middle East. “A Tidal Wave of Corporate Migrants Seeking (Tax) Shelter” read the clever Times headline. Almost any company in almost any industry was said to be considering a move to renounce the United States and move its titular headquarters offshore to duck taxes. Even firms that had profited from federal spending programs, government bailouts, or other significant benefits funded by U.S. taxpayers were willing to flee the country, and its 35% corporate tax, following the siren call of inversion.
Johnson Controls, for example, was a venerable American manufacturing concern—its founder, Warren Johnson, invented the thermostat in 1883—that became a major supplier (of passenger seats, batteries, and so on) to the auto industry. But in the Great Recession of 2008–9, with the Detroit automobile makers on the brink of bankruptcy, parts suppliers like Johnson Controls were in dire trouble. Johnson’s president, Keith Wandell, went to Washington to plead for federal bailout money for his customers. “We respectfully urge . . . Congress as a whole to provide the financial support the automakers need at this critical time,” he said. Sure enough, Washington came up with some $80 billion in emergency funding for domestic automakers—money that proved a lifeline not only to General Motors and Chrysler but also to their major suppliers, like Johnson Controls. (Johnson Controls later noted that it had asked Congress for bailout money only for the companies it supplied, not for itself.) In addition to this federal support, the company had received tens of millions of dollars of tax breaks from states where it had plants.
How did Johnson Controls demonstrate its gratitude for this timely help from American governments? In 2016, the company announced that it was selling itself to a firm incorporated in Ireland, Tyco International, and would no longer be a U.S. corporation. The firm estimated this move would cut its corporate income tax payments to the U.S. government by about $150 million per year. Tyco, incidentally, was itself a veteran of tax-avoidance inversion tactics, having moved its corporate domicile (on paper at least) from the United States to Bermuda to Switzerland to Ireland over a period of roughly twenty years.
Pfizer, the giant drug firm that makes such staples of the American medicine cabinet as Viagra and Preparation H, concedes in its reports to stockholders that its bottom line is heavily dependent on U.S. government programs financed by taxes. “Any significant spending reductions affecting Medicare, Medicaid, or other publicly funded or subsidized health programs . . . could have an adverse effect on our results,” Pfizer noted in 2014. But this did not stop Pfizer from charging ahead with the biggest attempted inversion ever, in 2016, when it paid $155 billion for an Irish drug company called Allergan and announced plans (later scrapped) to move its corporate domicile to Ireland.
For the most part, the companies following the inversion route say that their move to a foreign jurisdiction is dictated by sound business considerations, not by tax concerns. That’s exactly what Rick Gonzalez, the chief executive of an Illinois-based pharmaceutical firm called AbbVie, said when he announced that the U.S. firm intended to buy a drug company called Shire, which was headquartered on the island of Jersey, in the English Channel. AbbVie would then incorporate in Jersey and avoid much U.S. corporate tax. Gonzalez said, though, that this tax saving was not the reason for the planned merger; the company was moving to that island in the channel in order to provide better service to its customers. But then, before the purchase of Shire could be completed, the U.S. Treasury changed some of the rules surrounding inversions, and suddenly the tax benefits for AbbVie looked much smaller. AbbVie abruptly called off its proposed merger with Shire. Gonzalez issued an angry statement saying the Treasury had “interpreted longstanding tax principle in a uniquely selective manner designed specifically to destroy the financial benefits of these types of transactions.” With that, AbbVie pretty much gave the game away. If the move to the isle of Jersey was not undertaken for tax reasons, why would a tax ruling “destroy the financial benefits” of the deal?10
Sometimes, the political or public relations cost of an attempted inversion turns out to be greater than the potential tax savings. The drugstore giant Walgreens found that out when it bought a stake in the European drugstore chain Alliance Boots and then proposed to move its legal domicile from Deerfield, Illinois, to Bern, Switzerland, where Alliance Boots was headquartered. The company was denounced by people who argued, fairly, that a famous American drugstore heavily dependent on taxpayer-funded Medicare prescription sales ought to be an American taxpayer. The Chicago Tribune came up with the term “Walgreed”; the business columnist Al Lewis called the plan an example of “the looting of America. . . . Yes, your corner drugstore would like to take your co-pay, bill your Medicare policy, and then pay its taxes in Switzerland,” Lewis wrote. Under withering attacks from politicians, the press, and its customers, Walgreens had second thoughts and announced that it would retain its corporate presence in the United States.
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ALL OF THE FIRMS cited here, and countless others, have been attacked by critics ranging from Bernie Sanders to Barack Obama to Donald Trump. They have been called “corporate traitors” and “Benedict Arnold companies” for shifting their tax burden out of the United States. They’ve been called outlaws and criminals for setting up such intricate structures to get around the tax code. In response to this calumny, the corporations reply that they are engaged in perfectly legal activity. They “minimize” their tax bills; they “avoid” paying taxes; but they do not “evade” taxes, because that would be against the law.
The distinction here is set forth in the definitive text Tax Law Design and Drafting, edited by the acknowledged master of the subject, Victor Thuronyi of the International Monetary Fund. (Dr. Thuronyi’s magisterial study is priced at $560, so please stop complaining about the price you paid for this book.) That heavyweight piece of analysis defines tax “evasion” as a “clear violation of the tax laws, such as fabricating false accounts.” Tax “avoidance,” in contrast, is “behavior by the taxpayer that is aimed at reducing tax liability but that does not constitute a criminal offense.” Avoidance can involve “abusing gaps or loopholes in the law” but falls short of “breaching specific statutory duties.” And tax “minimization” is defined as “behavior that is legally effective in reducing tax liability,” such as paying your January bills in December so as to get the deduction in the current tax year.
But of course these distinctions are not always so clear in practice. This has led to the cynical observation that “the rich avoid, the poor evade”; that is, rich taxpayers can afford to pay lawyers who will find a complicated but legal way to duck (that is, “avoid”) taxes, while poorer people just cheat (that is, “evade”). Franklin Delano Roosevelt, no friend of those in the upper brackets, observed in 1935 that “tax avoidance means that you hire a $25,000-fee lawyer, and he changes the word ‘evasion’ into the word ‘avoidance.’”
Defenders of tax avoidance tend to fall back on some favorite judicial utterances that seem to support the notion that a taxpayer is not obliged to pay one cent more than the minimum he can get away with under the law. In Britain, the champion of this position was Lord Clyde, the lord justice general, who famously declared in 1929 that “no man in this country is under the smallest obligation . . . to enable the Inland Revenue to put the largest possible shovel in his stores.” In the United States, the preferred citation comes from the best-named magistrate in U.S. history, the federal circuit court judge Learned Hand. In one of the most widely cited opinions in the history of tax law, Judge Hand declared that “anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” In the same opinion, Hand even seemed to authorize both “avoiding” and “evading” taxes. “A transaction, otherwise within an exception of the tax law,” he wrote, “does not lose its immunity because it is actuated by a desire to avoid, or, if one choose, to evade, taxation.”
Learned Hand’s mellifluous defense of tax avoidance is cherished by the lawyers and consultants who design “convoluted and pernicious strategies.” What these lawyers and consultants generally don’t mention is that in that case—it was Helvering v. Gregory, issued in 1934—Judge Hand also said that there are limits to how far you can go to avoid, or evade, taxes. In the Helvering case that tax lawyers love to quote, Learned Hand actually ruled in favor of the IRS and ordered the avoider to pay up.11
The case involved a wealthy Brooklyn socialite, Mrs. Evelyn Gregory, who was the sole owner of a company called United Mortgage Corporation. That firm, in turn, owned about $133,000 worth of stock in a separate company, the Monitor Securities Corporation. In 1928, Mrs. Gregory decided to sell the shares of Monitor Securities (it turned out to be a smart decision, because Monitor’s shares lost virtually all their value in the 1929 market crash). Under the tax code, her profit on those shares would have been treated as ordinary income, and thus would be taxed at the top income tax rate. But if she could arrange the deal so that her profit was a “capital gain,” she could cut the tax bill in half. To make this arrangement, Mrs. Gregory’s lawyers created a shell corporation—no employees, no board of directors—in Delaware. That newly formed corporation received (on paper) the shares in Monitor, sold them, and distributed the proceeds to Mrs. Gregory. She put the money in the bank and dissolved the Delaware corporation six days after it was formed. She then told the IRS that her earnings on the Monitor shares were “capital gains.” On this basis, Mrs. Gregory paid the tax on her profit at the lower rate. The IRS went to court, arguing that she should have paid at the higher rate for ordinary income.
In his oft-quoted opinion, Hand first lays out the principle quoted above: nobody has to pay a cent more in tax than the minimum required by law. But then he goes on to examine the dubious transactions—the empty corporate shell that existed for all of six days—Mrs. Gregory engaged in to take advantage of the lower tax rate. And he concludes that the whole complex operation was a “sham,” designed only to evade taxes: “The transactions were no part of the conduct of the business of either or both companies; so viewed they were a sham.” Because there was no legitimate business purpose for routing the shares the way she did, Mrs. Gregory had to pay the full amount the IRS demanded. “It is plain,” Judge Hand decides, “that the taxpayer may not avoid her just taxes.” A year later, the Supreme Court affirmed Hand’s ruling; Mrs. Gregory’s “sham” did not work.
It doesn’t seem like too great of a stretch to suggest that some of the machinations employed by Google, Apple, and others to avoid (“or, if one choose, to evade”) taxes might also fall into the “sham” category. For the most part, though, these companies have faced little or no trouble from the IRS. If some corporate treasurer can find a tax lawyer to design an intricate international arrangement that moves U.S. profits overseas and then cuts the tax bill, the IRS tends to stand aside and let it happen. This is partly because the corporations hire sophisticated tax accountants and law firms to make sure that maneuvers like the “Dutch Sandwich” fall within the precise parameters of the tax code.
But it’s also because the IRS, facing budget cuts year after year from a hostile Congress, just doesn’t have the firepower to take on rich, well-lawyered tax avoiders. The commissioner of the IRS, John Koskinen, essentially admitted that this is the case. “When Congress cuts our budget,” the commissioner told me, “they say we have to do more with less. But the fact is, we’re doing less with less because we don’t have the resources to enforce the law the way we would want to.” In the year 2015, the IRS reported that it performed fewer corporate audits than in any year since 2002, and the revenue generated from audits also hit a ten-year low.
There was considerable public consternation, in Congress and on the nation’s editorial pages, about the surge of tax-ducking inversions that began in mid-2014. While members of Congress from both parties were lamenting this trend, nobody suggested that a gridlocked Congress might actually agree to do something about it. Accordingly, the secretary of the Treasury, Jacob Lew, stepped up three times—in the fall of 2014, and again in late 2015, and yet again in 2016—with new regulations designed to make inversions more difficult to pull off. Lew himself conceded that his proposals were weak reeds at best, but he said his actions went as far as he could go without congressional action. Tax accountants generally agreed that Lew’s new rules would not stop the inversion craze among corporate treasurers. After Lew’s second round of regulating, a Wall Street Journal headline neatly captured the business view: “‘Inversion’ Rule Changes Appear Minor.” The only institution that punished U.S. companies for committing inversion was Fortune magazine, which refuses to list a company incorporated overseas in the famous Fortune 500 rankings. Fortune kicked out about ten companies, including Pfizer, which had ranked at No. 51 before it became an Irish corporation in order to cut its tax bill.
One company that did get in trouble with the IRS, and with criminal prosecutors, over its tax-avoidance efforts was Caterpillar Inc. After Caterpillar paid PricewaterhouseCoopers for figuring out the Swiss-subsidiary profit shift, it saved some $200 million each year in U.S. taxes for more than a decade. Things were going fine until the company ran into a buzz saw by the name of Carl Levin—and that convoluted tax diversion plan began to crumble.
Carl Levin, a Democratic U.S. senator from Michigan, served in Congress so long that he became chairman of an entity called the Permanent Subcommittee on Investigations. This is an obscure but powerful unit with a generous budget and a sizable staff that can probe, essentially, anything its chairman wants to probe. Levin chose to investigate tax avoidance by multinational U.S. corporations. This won the senator mixed reviews. The New York Times called him “a gift” to ordinary U.S. taxpayers; the Wall Street Journal called the same senator “a one-man wrecking crew of American job creation.” Regardless, Levin pursued his tax probes with a passion. Thus it was, on an April morning in 2014, that the permanent subcommittee held a cantankerous hearing on the subject of “Caterpillar’s offshore tax strategy.”
Levin and his investigative staff laid out the history, in which some $8 billion of profits on spare-parts sales were transferred to a country that never designed, built, or warehoused a single spare part. Caterpillar executives responded, saying the profit shift to Switzerland was a “prudent, lawful business activity,” carried out strictly for business purposes without consideration of the tax benefits. “We do not invent artificial business structures,” said the company’s vice president for financial services. Unfortunately for Caterpillar, the committee staff had obtained documents from PricewaterhouseCoopers that explicitly declared that the point of the Swiss transfer was to cut taxes. The smoking gun was an e-mail from a PwC tax partner that warned Caterpillar about the risks of its plan. “We are going to have to create a story,” the tax man noted. “Get ready to do some dancing.” As if that weren’t bad enough, another PwC tax expert sent back a flip e-mail of his own: “What the heck. We’ll all be retired when this comes up on audit.”12
At the end of the hearing, Levin called on the IRS to investigate the Caterpillar maneuvers. Roughly a year later, Caterpillar announced that the IRS had dunned it for some $1 billion in back taxes and penalties for just one three-year period, from 2007 to 2009, because of improper shifting of profits to the Swiss subsidiary. The IRS was also probing the company’s tax returns for other years. Meanwhile, federal prosecutors in Illinois subpoenaed corporate documents to determine whether the profit shifting violated federal law. And the Securities and Exchange Commission launched its own probe of Caterpillar’s tax-avoidance efforts. To add insult to all these legal injuries, the Wall Street Journal reported that this flurry of investigations “threatens to become a serious embarrassment for Caterpillar, which has long projected a squeaky-clean Midwestern image.”13
But such federal probes of tax-dodging efforts were hardly common. Most American companies that created an intricate avoidance apparatus were basically left untouched by the underfunded IRS and other U.S. agencies. The real heat over profit shifting, earnings skimming, and sweetheart deals with national tax agencies came from two international organizations, the OECD and the European Union. After years of study, the OECD in 2015 issued an “action plan” called BEPS—the Base Erosion and Profit Shifting Project—that gives countries various tools to prevent their companies from fleeing the nest to find a lower tax rate somewhere else.
Meanwhile, EU authorities had repeatedly expressed concern and anger about corporate tax-avoidance shenanigans, but their power to act was minimal, because it is a basic principle in Europe that the EU cannot dictate any country’s tax rules or rates. If Switzerland wanted to offer a French company a special 2% tax rate, the EU commissioners in Brussels could only look on.
In 2014, though, the EU began pursuing tax dodgers under a new legal theory: the “state aid” rules. These regulations say that European governments cannot give their home-country companies special benefits that would give them an economic advantage over foreign competitors. For example, if France let some lumber company take timber from the national forests at no charge, that would be an unfair advantage over a German company that had to pay for its trees and would thus violate the “state aid” regulations. So the tax police in Brussels started citing certain countries—mainly Ireland, the Netherlands, Luxembourg, and Switzerland—for giving special low tax rates to certain companies; the regulators said those tax breaks amounted to “state aid” for the favored firms. And this had some impact. A few companies—Apple, Starbucks, and Fiat—were eventually required to pay back taxes to European countries that were found to have taxed them too lightly. In 2016, the EU ordered Apple to pay more than $14 billion in back taxes to Ireland—an order that was immediately challenged by Apple and the Irish government. The national tax authorities in several countries dropped some of the gimmicks they had used to lure foreign corporations; thanks to the European Union crackdown, the notorious “Double Irish” is no longer a viable path toward tax avoidance. Of course, the tax lawyers immediately started designing new ways for companies to duck taxation.
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THE U.S. CORPORATE INCOME TAX is not working. We have a higher corporate tax rate than almost any other country, and we apply it to income earned anywhere in the world. And yet corporate income tax revenues have fallen so sharply that they now make up a fairly small share of the federal government’s annual tax revenues. In the 1960s, the corporate tax brought in about 33% of U.S. tax revenues. Today, the same tax provides less than 9% of revenues; that means individual taxpayers have to take up the slack and pay more. Which we do. In the 1960s, the individual income tax and the Social Security tax constituted about 50% of all federal tax revenues; today their share of the nation’s total tax burden is more than 80%. Corporate tax revenues are plummeting partly because Congress has larded the corporate income tax with costly preferences and giveaways for corporations, and partly because American multinationals have become so successful at shifting income overseas. Hundreds of millions of dollars—money that might have gone to raising wages, or creating new medicines, or building factories—have been paid to tax lawyers for the creation of elaborate evasion schemes. The result is a complicated, unpopular, and stiff corporate income tax that actually doesn’t do much taxing. “Both the high U.S. tax rate and the worldwide system of taxation have more bark than bite,” notes the tax scholar Kimberly Clausing of Reed College.
What should we do? The solution proposed by politicians in both parties and by many (but not all) economists is to reduce that 35% rate. A lower rate would bring the United States more into sync with other wealthy countries. Reducing the corporate rate has been an international trend for the past three decades. Virtually all the other rich countries have done so, which is why it seems so attractive to American corporations to move their taxable income, or even their legal existence, overseas. If we were to follow the BBLR principle, we could almost certainly lower the rate of corporate tax without a loss of revenue.
The Government Accountability Office added up the cost of some eighty major business tax preferences and reported a tax loss for the year 2011 at $181 billion, which is not much less than the total revenue the corporate income tax brings in each year. Eliminating most of those deductions, exemptions, credits, and allowances would broaden the base significantly, so the rates could be lower. And many of these loopholes are indefensible. Why should a company be allowed to lend itself money, pay itself interest, and then take a tax deduction for the interest it paid to itself? No individual taxpayer could get away with that scam. But Congress lets corporations use that “earnings skimming” gambit every day of the year.
The most common proposals for cutting the corporate income tax rate call for a new rate in the range of 25%. President Barack Obama suggested cutting the rate to 28%, a proposal that was pronounced dead on arrival as soon as it reached Capitol Hill. The presidential candidate Donald Trump went further, of course, proposing a 15% corporate tax rate. A study by the Tax Analysis Center concluded that if all deductions, credits, and so on for business were eliminated, the IRS could collect the same revenue with a rate of 9% that it brings in now with the 35% rate. A rate that low, most likely, would take away the incentive to hire tax consultants and shift profits overseas.
The problem here is that if the United States cuts its rate, other countries might well respond by cutting their rates even lower. How low can you go? Congress might cut the U.S. corporate income tax rate to 12.5% to be competitive with Ireland. But then Switzerland, with its 8.5% rate, would still be a lure for chief financial officers looking to reduce the tax bill—not to mention Bermuda, New Zealand, and other countries where the corporate income tax rate is zero. And if the United States did agree to a large cut in the rate, other countries might well cut their tax rates even more sharply. This is a race to the bottom that nobody can really win.
How low does the tax rate have to go to stop corporations from devising intricate mechanisms to avoid paying? Great Britain, which reduced its corporate tax rate half a dozen times in the twenty-first century, now taxes profits at 20%. But that didn’t stop Starbucks from creating an intricate multinational network to avoid tax in Britain. Starbucks had more than eight hundred outlets in Britain in the second decade of the twenty-first century, and the company repeatedly told financial analysts that the U.K. business was “profitable.” But when it came time to pay the U.K. “company tax” on its income in Britain, those reported profits disappeared. Starbucks told the tax authorities that it had actually lost money for fourteen of the fifteen years between 1998 and 2013 and thus paid no U.K. tax.
Here’s how: The Starbucks stores in the U.K. had to make royalty payments to Starbucks subsidiaries in other countries. Every time Starbucks sold a cup of coffee in Britain, it paid a royalty to a Swiss company called Starbucks Trading, which owned the rights to all coffee beans the company sold in Europe. There was a second royalty payment due to a Dutch company, Starbucks Coffee EMEA BV, which held the rights to all the “intellectual property” in a cup of coffee (presumably meaning the recipe for a Frappuccino or the trademarked logo on the paper cup).14 And those royalty payments to other subsidiaries of the same company totaled more than Starbucks had earned in Britain. The upshot: no profit to report in Britain and thus no British tax. This neat arrangement caused such an uproar in the U.K. when it was reported (by Reuters, in October 2012) that Brits all over the country mounted a noisy, angry boycott of Starbucks. The protest campaign was so effective that Starbucks finally agreed to pay £20 million in U.K. tax—more than $30 million—in an effort to get its customers back.
Another approach to corporate tax reform would be to induce companies to bring home some of the money they have stashed away overseas. The amount at stake here is staggering: an estimated $2.3 trillion “permanently invested” outside the United States. Much of this money is actually held in bank accounts or investment funds within the United States, but on paper it is officially overseas and thus not subject to U.S. corporate tax. If all these profits were repatriated, and the full 35% tax were paid, the government would take in a revenue windfall of about $700 billion; that’s enough to fund the entire defense budget, including the Middle East and Afghanistan, for a little more than a year. If all these profits were repatriated and corporations paid a tax of 15% on these earnings—roughly the effective rate they’re paying now—the tax revenue would come to $300 billion, which would totally cover the government’s combined annual spending for education, environmental protection, agriculture, housing, homeland security, national parks, and NASA.
To induce corporations to bring some of that money home—so that the government gets some tax revenue and the companies can have cash they could use to create new jobs or build new factories—many have proposed a tax holiday, in which the funds can be repatriated with a smaller tax bite. President Obama suggested a onetime cut to 19% for taxing profits brought home from overseas.
As a matter of fact, we tried the tax-holiday approach in 2004. After intense lobbying from American multinationals eager to bring their money back home, Congress passed a law optimistically titled the American Jobs Creation Act. One section of that law, known as the Homeland Investment Act, said that corporations could repatriate foreign-held profits and pay tax on them at a onetime rate of 5.25%—that is, about one-seventh of what they would have paid at the full corporate income tax rate. Wary of what corporate titans might do with this money, Congress specifically said that the repatriated funds could not be used to increase dividends to stockholders or to juice up executive pay. Instead, the money brought home was supposed to fund job creation, research, and capital investment here in the United States.
The government subsequently estimated that some $300 billion came home to the United States because of this break, generating about $16 billion in tax revenues. But the money didn’t go where Congress had hoped it would.
“Repatriations did not lead to an increase in investment, employment or R&D—even for the firms that lobbied for the tax holiday stating these intentions,” concluded a report from the National Bureau of Economic Research. “Instead, a $1 increase in repatriations was associated with an increase of approximately $1 in payouts to shareholders.”15 Beyond that, the tax holiday probably had the perverse effect of inducing corporations to keep more money overseas. “The provision also sends firms a strange message,” noted Professor Clausing of Reed College; “they have an incentive to leave income abroad in the hope of similar holidays in the future.”16 Clausing concluded that the American Jobs Creation Act lived up to its name in one respect: “creating jobs for accountants and lawyers.”
As the mountain of corporate cash piled up overseas grows higher and higher, some experts predict that American corporations will bite the bullet and pay the full rate of tax in order to get some of their money back home. “American corporations have been so proficient at shifting their earnings overseas . . . that today they’re hoist by their own petard,” notes Martin Sullivan, the highly regarded chief economist at the Washington firm Tax Analysts. “It’s great to keep your profits out of the U.S. tax net, but as those piles of cash grow, you are missing more and more opportunities to employ that cash in the U.S. At some point, saving tax is not worth it.”
From this point of view, Congress should hang tough—keep the corporate rate high, refuse to authorize another tax holiday—and sooner or later corporate America will bring its money home and pay the tax. Indeed, this has seemed to be the case in recent years. Economists estimate that some $300 billion was repatriated, at full tax rates, in 2015—about the same amount that came home following the 2004 tax holiday. When General Electric, under pressure from stockholders, decided in 2015 to repatriate $36 billion that had been held overseas for years, the Wall Street Journal reported that “GE’s decision suggests more companies may be reaching a tipping point.”17
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LARGE QUANTITIES OF MONEY and effort—resources that might have been used for something productive—have been poured into “convoluted and pernicious strategies.” Accordingly, some tax experts recommend that we eliminate the corporate income tax completely. Professor Laurence J. Kotlikoff of Boston University makes the case as follows:
Many economists . . . suspect that our corporate income tax is economically self-defeating—hurting workers, not capitalists, and collecting precious little revenue to boot. . . . The rich, including . . . stockholders, can take their money and run. . . . To avoid our federal corporate tax, they can, and often do, move their operations and jobs abroad. Apple . . . paid only 8.2 percent of its worldwide profits in United States corporate income taxes, thanks to piling up most of its profits and locating far too many of its operations overseas.18
Those who agree on eliminating the corporate tax tend to disagree on what should be done to make up for the lost revenue. On the left, economists like Robert Reich of the University of California, Berkeley, say corporate profits should still be taxed but not until the corporate earnings have been distributed to stockholders. Then the government can make the stockholder pay a higher rate of tax on the dividends or on the increase in the value of the stock. The shortfall from lost corporate tax revenue would then be offset by the higher revenues from taxing the stockholders’ dividend and capital gain income. Conservative economists like N. Gregory Mankiw of Harvard argue that we should stop trying to tax corporate earnings in any form and make up the revenue through “a broad-based tax on consumption.”
Whatever changes we eventually make, almost every observer agrees that the current corporate income tax is not working. The corporate income tax, once a key source of funding for the U.S. government, has become just another minor revenue source. There are already many of those.