It is a well known fact that taxation is the lifeline of a nation. The US taxation system creates the mechanism for collecting funds that can be used to sustain and improve basic services (Barber 10). Roads, schools, hospitals, are built and law enforcement agencies are maintained through the efforts of the Internal Revenue Service.
Employees, professionals, and businessmen must pay taxes so that Americans can sustain a certain way of life. Nevertheless, it is common knowledge that a significant amount of taxes are collected from corporations (Schmitt 15). But it can be argued that many multinational corporations have found a way to reduce the amount of taxes they are supposed to pay the government through the use of tax havens.
Multinational corporations through the help of financial advisers are able to exploit legal loopholes so that they can shift profits and move funds from the parent company to subsidiaries located in countries designated by tax authorities as tax havens. It is detrimental to the US economy if corporations are allowed to evade taxes. However, there are incentives on both sides to continually use tax havens and this will be discussed in the following report.
Pass the Burden
Corporations are entities that in recent years have become as powerful as local governments. The money and political clout of many multinational corporations allowed them to increase their profits while drastically reducing their operational expenses.
A closer look at some of the world’s top multinational corporations will reveal a common trend that can be reduced to three statements:
- the world’s money, technology, and markets are controlled and managed by gigantic global corporations;
- corporations are free to act solely on the basis of profitability without regard to national or local consequences; and
- there are no loyalties to place and community (Korten 133).
As a consequence economists and concerned citizens have observed a disturbing development with regards to corporate greed, because for many corporate leaders, sustainability is a problem of the next generation. As a result the following observations had been a focal point of discussion in many sectors. The following information has long-term consequences that have to be addressed sooner than later:
IN 1957, corporations in the United States provided 45 percent of local property tax revenues. By 1987, their share had dropped to about 16 percent. A 1994 study by the Progressive Policy Institute of the Democratic Leadership Conference identified what it considered to be unjustified subsidies and tax benefits extended to corporations in the United States amounting to $11 billion over five years … the largest corporations are paying less taxes and receiving more subsidies (Korten 133).
One way to reduce the amount of taxes normally paid by a US-based corporation is to transfer operations abroad. In the case of many giant firms the cost of transfer is cheap because they simply crossed the border that separated the US mainland from South America.
In most cases it requires a few hours of travel time for corporate leaders to move from company headquarters to their maquiladora plants in Mexico. Compared to the amount of taxes they have to pay if they stayed in the United States, corporations benefited from tax exemptions as investors in a foreign land (Korten 132). However, this is nothing compared to other strategies employed by multinational companies to increase their profitability and at the same time lower the amount that they have to pay in terms of taxes.
It is a common refrain among strategists and analysts to share the burden, so that the greater the number of stakeholders carrying the burden the lower the risks involved. But corporations have found a way to share the burden to others without giving anything in return.
According to economists, “about half of corporate taxes fall on investors in reduced dividends and share prices, and the other half falls on labor in reduced wages and increased prices” (Gloor 1). This is made possible by a legal loophole wherein corporations are only required to pay dividends after taxes had been deducted from the profits.
Furthermore, the taxes that the government levies on products and services simply increase the price that consumers have to pay. The taxes that are supposed to be paid by employers and employees in the form of income tax is to be shared by both employer and employees, but in reality it is the employees that are paying for that particular amount.
However, this is just the beginning because multinational corporations are aware of other schemes that can significantly increase their profitability and of which is the use of tax havens outside the United States.
Tax Havens
According to the Congressional Research Service there is no precise definition of a tax haven although common features of a country that can be considered as a tax haven are listed as follows:
- enables a company to pay low or zero taxes;
- lack of effective exchange of information;
- lack of transparency; and
- no requirement of substantial activity (Gravelle 2).
A major loophole in the US taxation system that enables the proliferation of tax havens is the rule that a multinational corporation’s income will not be taxed if this was earned through the activities of a foreign subsidiary. The only time that the US government can tax this income is if the profit is repatriated back to the parent company in the United States. Thus, a corporation can simply replicate itself in another country wherein the local government finds it advantageous to become a tax haven.
The aforementioned loophole is made more effective by two features of a tax haven. First of all, most tax havens do not impose taxes. This feature is especially true in a country wherein most of the residents are poor. Thus, government officials find it impractical to collect income tax. In most cases tax havens impose low rates of tax as a form of incentive to attract investors (Gordon 15). The second important feature of tax havens is secrecy.
The high level of secrecy is based on common law and can therefore be considered as a legal loophole. According to legal experts, common law secrecy is derived from “the finding of an implied contract between a banker and his customer that the banker will treat all of his customer’s affairs as confidential” (Gordon 15). It is therefore convenient to use tax havens as an effective means of tax avoidance.
A euphemism for secrecy is privacy and this is also a byproduct of a legal loophole that allowed tax havens to copy the famous Swiss numbered bank accounts and profit from this endeavor. In a Swiss numbered account “the identity of the account holder is only known to one or two bank officials” (Sharman 25).
It is very convenient and at the same time offers the highest form of protection from antagonists desiring access to this valuable information. The system is made more effective by a law that ensures heavy prison terms for bank officials and financial professionals who will divulge this type of information to third parties. In addition, tax haven countries usually do not collect taxes and therefore it is not a crime not to pay taxes.
Thus, authorities residing in tax havens do not have any legal obligation to cooperate with investigators regarding tax evasion cases (Sharman 25). There is therefore a great deal of incentive to move funds to banking institutions that offer a form of tax shelter outside the United States.
The United States government taxes “all income earned in its borders as well as imposing a residual tax on income earned abroad by U.S. persons” (Gravelle 7). However, a multinational company can shift profits from the US to a country known as a low-tax jurisdiction. As a result this particular firm can significantly reduce the taxes that it has to pay to the Federal Government but its operational efficiency remains intact. Therefore, firms can greatly benefit from the artificial shifting of profits.
According to the US PIRG Education Fund, in the course of a decade, “an estimated $1 trillion in revenues is lost due to the use of tax havens and the government must make up for this shortfall” (Tichon 2). This is a two-edged sword hurting the economy in two ways.
The significant losses in revenue means that the government cannot provide adequate services such as education, healthcare, and much needed infrastructures. At the same time the government will be forced to increase taxation in order to lessen the budget deficit. It is therefore to the best interest of the people for tax havens to be abolished completely. But upon close examination it is not beneficial to the US government and for the US economy to go after erring multinational corporations using tax havens.
Impossible Task
It is the moral responsibility and the legal right of the IRS to go after tax evaders. The avoidance of taxation cannot be justified especially if ordinary citizens are forced to pay taxes under penalty of stiff fines or imprisonment.
If one considers the disparity of income of individuals or small businessmen in comparison to the millions or even billions of dollars of revenue enjoyed by multinational companies then it is easy to be outraged by the use of tax havens. It is of critical importance to identify multinational corporations that utilize this scheme as well as tax havens that encouraged this kind of practice. However, it was found out that the total eradication of tax havens is detrimental to the overall US economy.
In a globalized economy US based firms are faced with mounting pressure to lower cost and increase profitability. It is therefore the responsibility of the US government to help these firms succeed.
The following reasons explains why there is ambivalence when it comes to the creation of strong policy that will discourage the use of tax havens and these are listed as follows:
- the need to maintain the competitive position of US businesses that are investing abroad or exporting overseas;
- the need to maintain tax equity as between investment in the US and investment overseas;
- the need to provide fair rules for taxing foreign investment;
- the need for efficiency; and
- the need to consider foreign policy (Gordon 42).
It is important to point out that US businesses must be given an incentive to develop operations abroad. Naturally, these firms will choose to build in a region that offers low tax rates.
The US government cannot radically alter current laws to dismantle tax havens because doing so can reduce the competitiveness of US firms exporting products to countries that can also be considered as tax havens. A rigid implementation of rules can make it impractical to continue doing business outside the US. It is also important to avoid double taxation.
It is also imperative that the US government must encourage foreign investment and if these foreign corporations enjoy a certain type of tax deferment scheme, then the US government cannot impose a double standard by insisting that other nations cannot use the same strategies to entice foreign investors. There is also a great incentive to maintain a high level of administrative efficiency.
Conclusion
It is important to eliminate tax avoidance such as the practice of using tax havens as a way to significantly reduce the taxes that a corporation must remit to the US government. The proliferation of tax havens is made possible by the exploitation of legal loopholes.
These legal loopholes on the other hand are a direct result of the need to maintain competitiveness in a highly globalized economy. Therefore, the US government can intensity its drive to reduce lost revenue through tax avoidance but it is impossible to totally eradicate the use of tax havens. The United States have to respect the sovereignty and independence of other countries.
At the same time the elimination of the protocols that enable the existence of tax havens also means the removal of the competitive advantage of US firms that benefit from the low tax rates offered in these countries. Thus, US firms will be at a disadvantage because companies in Europe and Asia use the same strategy. It is also impossible to break the client confidentially agreement utilized by account holders and therefore they are shielded from tax investigations.
Works Cited
Barber, Hoyt. Tax Havens Today: The Benefits and Pitfalls of Banking and Investing Offshore. New Jersey: John Wiley & Sons, 2007.
Gloor, Peter. Fundamental Tax Reform and the Case for a Net-Worth Tax. Fair Share Taxes, 2009. Web.
Gravelle, Jane. Tax Havens: International Tax Avoidance and Evasion. Congressional Research Service, 2009. Web.
Gordon, Richard. Tax Havens and their Use by United States Taxpayers: An Overview. New York: Books for Business, 2002.
Korten, David. When Corporations Rule the World. CT: Kumarian Press, 2001.
Schmitt, Jesse. Legal Off Shore Tax Havens. FL: Atlantic Publishing Group, 2008.
Sharman, Jason. Havens in a Storm: The Struggle for Global Tax Regulation. New York: Cornell University Press, 2006.
Tichon, Nicole. Tax Shell Game: The Taxpayer Cost of Offshore Corporate Tax Havens. The US PIRG Education Fund. 2009. Web.