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Offshore Tax Shelters?

During the last presidential campaign, John Kerry scored populist points castigating “greedy corporations” who avoided paying their “fair share” of taxes by “sheltering” their profits in foreign countries. In an era of corporate downsizing and record budget deficits, that topic resonated with many people and the charges were repeated widely before disappearing under the weight of other criticism more easily tied directly to George W. Bush. But, before they disappeared, The Boston Globe ran a piece by Stephen Glain on the topic in their business section. I sincerely believe there is a lot of questionable — or downright dishonest — stuff going on behind the corporate veil in support of avoiding taxes. But I also believe that a business reporter should consider the possibility that some practices characterized by populist politicians as malfeasance may actually have a rational and legitimate basis in business principles — and that a reporter writing a story on the topic should at least talk to some people in business who are using those practices before writing the story about them.

I sent this directly to Mr. Glain to express my dismay. To his credit, he answered my missive with a promise to consider its implications before reporting on this topic in the future. As far as I know there have been no more such reports.

24 February 2004

I read your article in today’s Globe about companies manipulating cash flows with overseas subsidiaries to shelter income from U.S. taxes. I am sure there are many sleazy reasons why companies might do this but I was disappointed that you never bothered to ask the question of whether there might be legitimate reasons as well — or to ask any actual business managers what reasons they might give.

Here is one (simplistic) scenario you might consider:

    Imagine a hypothetical mid-sized corporation, with a large capital plant and a large workforce, operating over the last 15 years — a span of time incorporating the George Bush (I) recession and the current recession as well as the 90’s boom. Imagine that, during the ten boom years, the company made a profit of $700 million, or $70 million per year on average; in five down years, because they could not just shed their capital and employee expenses in short order when revenues fell, the company lost $275 million, for an average of $55 million per year. Over the 15 year span, its pre-tax profits were $425 million, or $28.3 million per year. At a corporate tax rate of 35%, its taxes were $9.9 million per year, or $148.8 million.

Except, that’s not what would have happened. In the down years, when it lost money, the company would have paid no taxes and received no refunds. In the up years, when it made money, it would have paid $245 million in taxes on its $700 million in profits. Averaged over the fifteen year period and its $425 million dollar profit, the effective tax rate it paid would have been not 35% but almost 58%, because it got no credit from the tax system for the years it was in the hole.

This is true of pretty much any large company that must maintain fixed infrastructure and operating costs throughout a business cycle and will, therefore, have years during the bottom of the cycle when it loses money: the effective tax rate they will pay over a boom/bust business cycle will be significantly higher than the tax rate approved by Congress and published by the IRS.

We presume that Congress set the tax rate at (for instance) 35%, rather than at 58%, because they felt that was a fair and economically sound policy. It doesn’t seem untoward for a company to arrange to smooth out the ups and downs of the business cycle — for instance by stashing money overseas during boom times and recovering it during bust times — to bring their effective tax rate back in line with that set by Congress.

And that is what must happen for a truly American company to take advantage of those “loopholes”. If a company is global, with subsidiaries and business dealings all over the world, what arguably makes it more “American” than otherwise is that its ownership is American and/or that its primary business is in America — that it is American stockholders and American operations who are benefiting from the profits. But they can only do so if the money eventually comes home; leaving it sitting in the overseas subsidiaries indefinitely doesn’t work. And when it comes home — presumably during an economic slowdown so it offsets current losses — it is taxed, but taxed in a way that fairly evaluates the long-term profitability of the company. The only thing “unfair” about that strategy is that it is only available to companies with overseas operations and not to everyone else. But that is the fault of the Congress, not of business.

There is certainly corporate malfeasance going on in American business; and there are certainly efforts to circumvent legitimate tax liabilities that do not pass the ethical smell test even if they pass the legal one. But to fail to explore the fair uses of tax strategies in an article on the front of the business section — to imply that any tax strategy must be, by definition, dodgy, unethical, and un-American — does everyone a disservice.

© Copyright 2004, 2005, Augustus P. Lowell

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