The Hidden Entitlements

3. Tax breaks for multinational corporations

Multinational corporations, whether American- or foreign-owned, are supposed to pay taxes on the profits they earn in the United States. In addition,American companies and individuals aren't supposed to gain tax advantages from moving their operations or investments to low-tax offshore "tax havens." But our tax laws often fail miserably to achieve these goals.

For example, IRS data show that foreign-owned corporations doing business here typically pay far less in U.S. income taxes than do purely American firms with comparable sales and assets. The same loopholes that foreign companies use are also utilized by U.S.-owned multinationals, and even provide incentives for American companies to move plants and jobs overseas.

The problems in our taxation of multinational companies stem mainly from the complicated, often unworkable approach we use to try to determine how much of a corporation's worldwide earnings relate to its U.S. activities,and therefore are subject to U.S. tax. In essence, the IRS must try to scrutinize every movement of goods and services between a multinational company's domestic and foreign operations, and then attempt to assure that a fair, "arm's length" "transfer price" was assigned (on paper) to each real or notional transaction.

But companies have a huge incentive to pretend that their American operations pay too much or charge too little to their foreign operations for goods and services (for tax purposes only), thereby minimizing their U.S. taxable income. In other words, companies try to set their "transfer prices"to shift income away from the United States and shift deductible expenses into the United States. A May 1992 Congressional Budget Office report found that "[i]ncreasingly aggressive transfer pricing by . . . multinational corporations" may be one source of the shortfall in corporate tax payments in recent years compared to what was predicted after the 1986 corporate tax reforms. Variants on the transfer-pricing problem--such as ill-advised"source" rules and statutory misallocations of certain kinds of expenses--expand the tax avoidance opportunities. The official list of tax expenditures in the international area--totaling$95 billion over the next seven years--focuses on congressionally-enacted loopholes in the current "transfer pricing" approach. Thus, the list includes items such as indefinite "deferral" of tax on the profits of controlled foreign subsidiaries, misallocations of interest and research expenses, "source" rules that treat certain kinds of U.S. profits as foreign, and the Puerto Rican "possessions tax credit."7

Fixing these problems in the current system would be a good idea. But even better would be to replace the current, complex "transfer pricing"rules with a much simpler formula approach that taxes international profits based on the share of a company's worldwide sales, assets and payroll in the United States. Exactly how much revenue could be gained by this kind of comprehensive international tax reform is unclear, but some estimates are on the order of $15-20 billion annually.

Not listed in the official tax expenditure budget, but a major tax break nonetheless is the tax exemption for interest earned in the United States by foreigners. Such interest (on loans to American companies and the U.S.government) was exempted from U.S. tax under the Reagan administration in 1984. At the insistence of the proponents of the change, this interest income is not reported to foreigners' home governments, and as a result, tax evasion is said to be the norm. As a result, the United States has become a major international tax haven. There is evidence that not only foreign tax cheats,but also Americans posing as foreigners have been taking advantage of this loophole. Reinstating the tax has been proposed, with a waiver of the tax if a foreign lender supplies the information necessary to report the interest income to the foreign home government.

President Clinton pledged major international tax reforms in his 1992 campaign,but Congress rejected even the rather timid changes he proposed in 1993.The President's 1997 budget proposes $6.3 billion in international tax reforms over the 1997-2002 period, while congressional tax plans call for about a quarter that much. In addition, both sides want to scale back the $3 billion a year tax break for corporations in Puerto Rico by about half a billion dollars a year.

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