Tuesday, August 19, 2014

Low Effective Corporate Tax Rates Masked The True Cost of High Marginal Corporate Tax Rates

As USC Gould School of Law Professor Edward Kleinbard discusses in his paper and as Andrew Ross Sorkin discusses in his DealB%%k Blog post, "Tax Burden in U.S. Not as Heavy as It Looks, Report Says" by Andrew Ross Sorkin, there are tax planning ways to lower the high US corporate marginal tax rate and create a low effective US corporate tax rate on repatriated earnings.

Kleinbard and Sorkin ignore the costs, effort and diversion of resources necessary to achieve the results of low effective tax rates through sophisticated tax and financial planning.

Imagine a world without a corporate tax. A chief financial officer of a corporation with a large overseas holding of cash from foreign profits wants to put the money into a US bank to pay for new plants and equipment in the US. The cfo contacts the foreign bank directly or contacts an overseas subordinate and has the funds electronically transferred to the US account.

Now, imagine a world as it currently is with the US tax code. The cfo must involve tax lawyers, tax accountants and others to insure that the transfer of funds from overseas to the US do not trigger any unexpected and unwanted US corporate taxes. Kleinbard seems to minimize the effort, cost and loss of future borrowing capacity (see excerpt of paper below) of a repatriation tax avoidance scheme that involves the corporation borrowing funds and other devices. What if every time (or just once a year maybe a larger sum) you wanted to write a check or use your debit card to buy something, you had to negotiate for a loan from a bank? Convenient? What if you wanted to borrow funds to buy a house but your outstanding previous bank loan used up part of your available credit and you are denied the loan or are approved for a lower amount? Corporations negotiate loans, and their covenants and have limits on their borrowing capacity.

A high comparative corporate marginal tax rate motivates CEOs and CFOs to engage in sophisticated tax and financial planning. It results in the hiring of extra lawyers, accountants and financial planners and strategists. It increases the risk of IRS tax audits, SEC charges, future back tax payments and tax illegalities. It increases the barriers that must be overcome to move available corporate funds into the US. The comparatively high US marginal corporate tax rate is equivalent to forcing someone to go over a mountain when there is quicker tunnel passage through the mountain. Yes, going over a mountain will get you to the same place as going through the tunnel, but it will increase the effort, time, cost and risk to accomplish something that can be done much more easily.

From "'Competitiveness' Has Nothing to Do with it" by Edward D. Kleinbard, USC Gould School of Law, August 5, 2014:
U.S. firms incur costs to operate their stateless income tax machinery, which is wasteful, but at the same time enjoy an essentially unfettered tax planning environment in which to strip income from high-tax foreign jurisdictions to very low-taxed ones. And this sits on top of transfer pricing, selective leverage of group members, and other devices used to move income that economically is earned in the United States to foreign affiliates.
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It is true of course that the federal corporate tax rate – nominally, 35 percent – is too high relative to world norms, and that the ersatz territorial system requires firms to waste money in tax planning and structuring, but effective marginal tax rates and overall effective tax rates reach the level of the U.S. headline rate only when firms studiously ignore the feast of tax planning opportunities laid out before them on the groaning board of corporate tax expenditures.
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large multinational firms often can access their offshore earnings without incurring a tax cost, simply by borrowing in the United States and using the earnings on the offshore cash to pay the interest costs. (The interest earned on a firm’s offshore cash hoard is includible in the U.S. parent’s income as subpart F income, and therefore can be repatriated free of any additional tax cost.) The U.S. parent’s income inclusion on its offshore cash offsets the tax deduction for the interest expense on the firm’s U.S. borrowing, and the firm is left in the same economic position as if it had simply repatriated the cash tax-free (plus or minus a spread for differences in interest rates between the two streams.)

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