On Tax Cuts, Loopholes and Avoidance: Working for Tax Justice

An Interview with Robert McIntyre

Robert McIntyre is director of Citizens for Tax Justice, a nonpartisan research and advocacy group that fights for tax fairness at the federal, state and local levels. Since he began his career in tax reform in 1976, McIntyre has written hundreds of articles on tax policy issues, in publications like the Washington Post, the New York Times and academic journals. He appears frequently on television and radio programs, and often testifies before Congress. CTJ’s highly publicized reports in the mid-1980s on corporate tax avoidance are credited with providing the spark for the Tax Reform Act of 1986, which closed many loopholes. This interview was conducted prior to final Congressional approval of the Bush tax plan.

Multinational Monitor: What are the major elements of the Bush tax plan?

Robert McIntyre: There are tax cuts for the rich and there are small tax cuts for other taxpayers, though not all of them. Although it will probably be less in the final bill, under the Bush plan the highest income tax rate would drop from 39.6 percent to 33 percent. Other rates would drop less than the top rate, but some. They would double the credit that families get for their children from $500 to $1,000 per child, albeit not until the second half of this decade. They would do a little to alleviate so-called “marriage penalty,” whereby some couples pay more if married. And they would repeal the federal wealth tax — the estate and gift tax that is a tax exclusively on the very wealthy.

MM: How large are those different pieces?

McIntyre: About half of the cost comes from the rate cuts. About a quarter is the estate tax and the other quarter is very small income tax changes. The total as Bush proposed it was something in excess of $1.6 trillion over 10 years.

It was only that small because it is supposed to be phased in gradually.

The U.S. House of Representatives passed something very similar to what Bush proposed. Then the House and Senate passed a budget agreement which forces them to scale back by about a quarter, so they’re figuring out how to do that. My guess is that they’ll do it by manipulating the phase-in rules rather than changing the underlying size of the program once it is fully in place.

MM: The phase-in issue means that if you were to look at it over a longer time frame the total would appear to be more per year?

McIntyre: Let’s suppose we had to scale back the cost of the cuts by 10 percent over 10 years. You could just start a year later. That would be a simple way to reach your goal, and you’d still have the same tax cut that you wanted all along, just starting a year later.

MM: If $1.6 trillion is an undercount, what’s a better estimate of the actual cost of the tax cut plan?

McIntyre: As originally put forward, everybody who looked at it said, “Wait a minute, you’ve got all these trap doors in here that are not going to stay around, and you’re pushing tens of millions of people into the alternative minimum tax.” (The alternative minimum tax was designed for wealthy people who circumvented the regular system and paid little or nothing. Under the alternative minimum tax, wealthy taxpayers must pay the greater of their regularly calculated tax or a total calculated without some loopholes and using a lower rate.) That would mean these people would have to fill out their tax forms twice and get really annoyed, and politically that’s not going to happen. If they adjust the alternative minimum tax to avoid this, it will cost another $300 billion over 10 years.

They’ve also assumed that a lot of supposedly temporary current tax breaks will expire, but Congress has extended these breaks in the past, so you have to count that.

Pretty soon the estimates add up to about $2.5 trillion over 10 years, once you include added interest on the national debt from cutting taxes rather than reducing debt. Then in the subsequent 10 years, the cost would be about three times larger, because all the pieces would already be phased in.

MM: In the aggregate, how would the cuts be distributed?

McIntyre: That’s part of the bad news. About 45 percent of what Bush originally proposed and the House passed would go to at best the top 1 percent of the population. Very little of it would go to the bottom half.

MM: What exactly is Bush proposing to do with the estate tax?

McIntyre: He wants to repeal it entirely. He originally wanted to phase it out over about six years. The House blanched at the cost of that and phased it out over 11 years, very slowly so that most of the effect was just outside their 10-year budget window. That enabled them to say that it cost less than $200 billion over 10 years, leaving out the eleventh year, when it cost $100 billion in one year alone. That’s against the rules in the Senate, so they’re trying to figure out what to do about it. But it’s very expensive to repeal it.

MM: Do you think that at the end of the day it will be repealed?

McIntyre: I don’t know. Most of the Senate Republicans still want to repeal it, but it costs an awful lot of money and doesn’t benefit that many people.

MM: How many people would be affected by it?

McIntyre: About 2 percent of the decedents every year leave a taxable estate –– approximately 48,000 people.

MM: What do you think should be done with the estate tax?

McIntyre: It’s a good tax. It raises a lot of money, and comes from the right people. It makes people who haven’t paid tax on their incomes throughout their lives finally make some payment to the tax collector. I can’t think of a better tax, so I wouldn’t do any serious damage to it.

If we really think we’re worried about the handful of car dealerships and other kinds of small businesses that the heirs want to run, then fine, have a special rule that if you keep the business in the family, then you don’t have to pay the tax, or pay a much lower rate. But that would cost very little, because typically you have more than one heir involved. One may want to be a car dealer but the other doesn’t, so they end up selling the dealership to someone else regardless of the estate tax.

MM: What is the marriage penalty?

McIntyre: It’s really nothing but a tiny bonus put in during the 1960s at the behest of the lobby for single people. Looked at that way, it amounts to almost nothing. But looked at as how much less married couples would pay if they decided to get divorced, it can be a pretty big deal. But it’s only just an issue of relative taxation. You could fix it easily by raising taxes a tiny bit on singles and cutting them a tiny bit on married couples.

Unfortunately, it’s been conflated with the idea of big tax cuts for upper income couples. I did a radio program with Grover Norquist [tax-cutting advocate with Americans for Tax Reform] a year ago. I said, “Grover, you and I both know we could fix the marriage penalty in a way that was revenue neutral, no cost. Would you support that if it wasn’t connected to a big tax cut for upper income people?” He said, “Of course I wouldn’t.”

MM: How much of the present tax burden in United States is borne by corporations?

McIntyre: It’s about 10 or 11 percent right now. Back in the 1960s it was about a quarter of all federal taxes.

Corporations pay a lot less as a share of their profits, as a share of total tax burden, as a share of almost anything, than they used to. There are a lot of reasons for that, but the biggest reason is that they’ve figured out ways around the tax laws, mostly by moving their income offshore into places where it isn’t taxed.

Probably the biggest single structural problem we have with income tax right now is trying to crack down on all these corporate tax shelters, almost all of which involve international taxation. So it’s all the multinationals.

MM: How many large corporations avoid paying taxes altogether?

McIntyre: We did a study last fall looking at 250 of the biggest, and about a tenth of them in any given year will pay nothing. Some of these pay less than zero; they get tax rebates from the U.S. Treasury Department. The checks are going in the wrong direction.

MM: How do foreign subsidiaries of multinationals operating in the United States compare to domestic companies?

McIntyre: In theory, our tax system is trying to get corporations to pay taxes on money that they make in the United States, whether they’re U.S.-owned or foreign-owned. Unfortunately, we’ve made it too easy for companies to pretend that they didn’t make the money in the U.S., that instead they made it somewhere else –– somewhere where it isn’t taxed. Multinational companies in general are good at this, whether they are U.S.- or foreign-owned.

If you compare foreign-owned companies to all of our companies, most of which are not multinationals, the foreign companies look worse. On the other hand, if you just compare them to U.S. multinationals, they look a lot alike.

MM: A 35 percent tax rate applies to corporate earnings in the United States. What is the effective tax rate?

McIntyre: For the companies we looked at last fall, the average was about 21 percent for 1998 returns. It was actually falling. It fell by a few points from 1996.

There were a lot of reasons for it, including legal loopholes and illegal tax sheltering gains, where profits you would have thought were from the U.S. were somehow moved to Germany, the Cayman Islands, Liechtenstein or some other place that for one reason or another doesn’t tax them. Corporations do that in a variety of ways, but mostly through paper transactions. For example, if you borrowed money from your foreign subsidiary and pay a lot of interest. Voilà, the income has moved to someplace where it isn’t taxed.

The schemes have gotten worse and worse. If you send it straight to Liechtenstein, there are rules that prevent that from working. So the companies send it to Germany and from there to

Liechtenstein. That works. It shouldn’t, but they were getting away with it, at least for a while.

The Clinton administration tried to crack down, but the Republican Congress was resistant. Now that we have a new administration that is more lenient towards the companies, it is very worrisome that they are going to open the floodgates. Anyone who thought that last year’s election wasn’t important when it came to tax policy was crazy.

MM: Is the maneuvering of interest payments to offshore subsidiaries the number one tax dodge for multinationals now?

McIntyre: Yes. It’s too easy to do. We thought we had rules to stop it, but the companies allege they’ve found ways around it and the Congress has stopped the Treasury Department from cracking down on it.

Amazingly, the right-wing crazies have set up a new lobbying group to promote tax cheating!

The OECD [Organization for Economic Cooperation and Development, a grouping of the rich countries] put out a fairly benign paper asking the tax haven countries to stop hiding the income of drug smugglers and corporate tax evaders. Every leading right-wing group in the country was aghast. Now they’re lobbying like crazy to promote tax cheating.

It would be hilarious, except that now they’ve got a voice in the White House. They’re lobbying to keep the income secret, keep the OECD from penalizing any country that encourages tax evasion. They’re lobbying to make it possible for rich people to use their “God-given right” to avoid paying taxes to the country that they live in.

MM: What is transfer pricing and how serious a problem is it in corporate tax avoidance?

McIntyre: It’s another way to move profits around. It’s a little harder to do than pure financial transactions, but it’s also harder to police.

When companies do business with themselves — that is, with their own foreign subsidiaries — they have to book each of the transactions for tax purposes.

If I transfer raw materials from my Chilean subsidiary to my branch in Texas, I have to buy the raw materials, on paper, from myself. I’ll have on paper my expenses of what it cost my U.S. branch and what profits I made in Chile. It can work in either direction. I may sell things to my Chilean subsidiary. All those transactions have to be reconciled, and since no real transaction happened, the companies have to make up a price for it.

Legions of accountants and economists work on transfer pricing.

Since their clients would like to pay as little as possible in taxes, they somehow or other always come up with transfer prices that minimize the taxable profits that companies make in the United States.

The IRS has tried to police this, but they’re outgunned. So companies avoid a fair amount of taxes through favorable transfer pricing arrangements. It’s probably an unpoliceable system.

We would probably do better to use some kind of a formula based on the location and number of employees, location of production and where sales are, rather than trying to police a number of transactions that never actually occurred.

MM: Are there any decent estimates of the cost of transfer pricing to the Treasury?

McIntyre: Some people have tried to put a real number on it, but it’s hard to know for sure. It probably costs something in excess of $30 billion per year, and could be as high as $50 billion per year.

MM: What are some of the most important targeted tax breaks or loopholes written into the code for corporations?

McIntyre: If you get narrow enough, they’re less important. But some industry-specific ones are left. The independent oil producers, for example, get some breaks.

The big deal items are more broadly available.

For instance, companies write off their equipment much more quickly than it wears out.

There are some explicit international loopholes, many of them fairly recent, that companies have lobbied through the Congress.

The auto industry, which in many ways is really a financing industry these days, wants to treat a big share of its profits as off-shore. They have plenty of ears that want to listen to them in the Congress, and Congress has been passing legislation allowing them to do that.

MM: How do stock options work as a tax avoidance mechanism?

McIntyre: The laws are pretty clear that the current treatment is allowed, even though it may not make any sense. When a company’s stock goes up in value, as it has for a lot of companies recently, they often pay their employees with an option to purchase the company’s stock at a favorable price. When the employees exercise the options, the companies get to take a tax deduction, even though it didn’t cost them anything other than dilution of other stockholders’ shares.

When the companies report their profits, they don’t count stock options as an expense, because it didn’t cost them anything. But when they report their profits to the IRS, they claim a gigantic tax deduction for their employees’ exercising options.

For some of the companies in the high-tech industries, for example Microsoft and Cisco in 1999, it was enough to take them off the tax rolls entirely, even though they made billions of dollars.

According to a study we did, by 1998 stock options were lowering the corporate tax rate by 5 percentage points. So it’s a big deal.

MM: You have highlighted recently how GE has cut its tax by buying tax breaks. How has that occurred?

McIntyre: GE has a huge leasing operation where it will stand in as the owner of assets for businesses that for one reason or another can’t use the tax breaks for these assets –– interest deductions, depreciation write-offs, etc. Businesses will contract with GE, who will be the nominal owner of the assets, to take all the tax breaks. Then GE makes cash payments to the business that, in effect, sold the breaks.

GE is really good at this; they do billions of dollars of it, and it cuts GE’s taxes on the profits from the rest of their business.

MM: Why is the alternative minimum tax for corporations not working to overcome all these avoidance mechanisms?

McIntyre: It might have, but in 1993 under Clinton and the Democrats and then particularly in 1997 under the Republican Congress and Clinton, the corporate minimum tax was gutted. They took out most of the things that made it work. It’s kind of shocking that they got away with it, but they did and, as a result, it doesn’t have much impact anymore.

MM: Would you rank that as a priority for corporate tax reform?

McIntyre: I’d rather close the loopholes directly, but it would be a good backup step. The purpose of the minimum tax was to be a backdoor way to go after some of the loopholes that Congress was unwilling to actually repeal.

If we had to go through the backdoor, it was better than not getting in the house at all. But it would be better if Congress could take on the tax breaks directly. It would also give us a simpler system.

Of course, the goal on the “taxpayers’ side,” as the corporations like to call themselves, is to make it as complicated as possible. As one of my friends used to say, “Tax compliance is cheap and straightforward; it’s tax avoidance that’s complicated and expensive.”

MM: It’s been pretty widely reported that there’s been a deal cut between the Bush administration and the corporate lobby, with the corporate lobby agreeing to hold off on demands for new tax innovations until the big tax cut goes through. What happens afterwards?

McIntyre: I guess we’ll see if there’s any money left over.

This administration has no compunctions about bringing back budget deficits, having no money to pay for government programs, saying the heck with prescription drugs, or leaving Social Security and Medicare in the lurch. None of those things apparently bothers them, so they’ll be happy to propose more tax cuts. On the other hand, I don’t know whether they’ll be able to get them through the Congress next year if there’s no money available.

MM: Are there any particular items you expect to see the corporate lobby bringing up?

McIntyre: The ones that they’re most optimistic about having a chance of getting are more international loopholes.

In addition, the software industry is pushing for a huge tax break for people who buy software, but it’s so expensive that I don’t know how Congress could possibly afford it. But they do have some heavy hitters pushing it. Apparently Grover Norquist has been hired to promote it and so has Ernie Christian, who has always been a promoter of wacky tax schemes since he was in the Treasury Department back in the 1970s. But it could cost $300 billion over 10 years.

Some would like to cut the corporate rate, and whatever Bush’s individual rates come down to, they might make an argument for that. That’s pretty expensive too.

The companies will have a laundry list. The ones that Congress is most amenable to are probably the international loopholes, in part because the Members don’t understand them. For instance, some of the loopholes that they passed in recent years, including the auto industry loophole, are scheduled to expire. Under current law, they are supposedly temporary –– a method to make them seem less costly than they actually are.

Bush is also going to propose some tax breaks for the extractive industries –– mainly oil, but probably coal, too –– as part of his energy policy. Those might get considered later this year, but they might get pushed off until next year because of the cost.

I’m sure there will be a lot of others.