It is with dismay that we read about the complex tax package Congress passed in December. It is hard to believe, but true, that Congress made permanent, for example, an unjustified tax loophole for corporations (the active financing exception) that lets corporations pay no taxes on income “earned” in foreign countries provided they keep that income offshore. That means that either money doesn’t come back to the U.S to support jobs or our economy or that money is returned to the U.S. untaxed through various complex devices that disguise its origin. Either way it’s a $78 billion loss to the U.S. economy that could pay for pre-K for all low and moderate-income children in the country for 10 years.
Congress also extended for five more years another unjustified corporate tax loophole, called the CFC Look-Through Rule, that allows a totally artificial device to be used to defer taxes on income to some unspecified future date.
A public opinion poll in 2014 asked Americans how best to strengthen our economy. The No. 1 response was: “Ask the wealthy and corporations to pay their fair share.” That response even beats out making the U.S. first in education or investing in infrastructure or investing in U.S. technology.
The poll result reflects the immense power of tax fairness as an issue and its relationship to the No. 1 domestic issue of our time: the growing income and wealth disparities that threaten the economic future of our nation and are so inconsistent with the dominant spirit of America that our boats all rise and fall together.
As chairman of the U.S. Senate Permanent Subcommittee on Investigations (PSI), I (Sen. Carl LevinCarl LevinFor the sake of American taxpayers, companies must pay their fair share What the Iran-Contra investigation can teach us about Russia probe Senate about to enter 'nuclear option' death spiral MORE) was frequently involved in investigating and trying to remedy the ethical wrongdoing and fiscal damage of tax dodging. The committee held hearings on the ways in which some of our most profitable corporations and wealthiest individuals avoided paying taxes through the use of unjustified tax loopholes — loopholes that have no economic purpose and whose only purpose is tax avoidance.
Eliminating unjustified tax loopholes is estimated to raise $265 billion over 10 years. Here are five such loopholes that Congress could have and should have eliminated:
1. Currently U.S. multinationals have accumulated over $2 trillion in otherwise taxable profits in low tax jurisdictions offshore. As documented by PSI hearings on Apple, Microsoft and Caterpillar, most of these profits relate to intellectual property that was developed by U.S. companies in the United States, but then the companies transferred the rights to use that property — and the resulting profits — to their own shell companies in offshore tax havens. Congress should eliminate the ability to avoid tax on such profits.
2. Currently, U.S. multinationals like Pfizer are engaging in “inversion” transactions in which, despite no change in their operations, they claim to become residents of offshore tax havens. Congress could eliminate this loophole by treating corporations managed and controlled from the United States as U.S. tax residents.
3. Currently, U.S. corporations can claim a bigger deduction for stock option exercises on their tax returns than the corresponding expense represented publicly on their corporate books. The result is artificially high tax deductions costing the U.S. Treasury tens of billions of dollars. Congress should require corporations to take stock option tax deductions in amounts no greater than the stock option expense shown on their books.
4. Since 1981, profits from certain derivatives (including commodity futures) have benefited from a favorable “blended tax rate.” Capital gains from selling these derivatives are taxed at a lower long-term capital gains rate, even if the derivatives are held for seconds. Congress can eliminate this loophole and the commodity speculation and high frequency trading that are encouraged by it.
5. Currently hedge fund managers pay the lower long-term capital gains rate on their income from providing management services that are normally taxed at the higher regular income tax rate. Congress should eliminate this “carried interest” loophole.
Unjustified tax loopholes whose sole purpose is tax avoidance are sharply distinguishable from tax credits and deductions that have an economic purpose. For instance, the mortgage interest deduction makes it easier to buy a house; the charitable deduction creates an incentive to donate to charity; accelerated depreciation creates an incentive to buy new equipment. One may not agree with such deductions or credits, but they at least serve an economic or broad public purpose.
But the unjustified tax loopholes we’ve identified here and others like them have no such justification. They should be eliminated even if we had no deficit, because they unfairly shift the tax burden to others.
So-called “tax reform” will be at the center of the national election debate this year. If members of Congress propose closing unjustified tax loopholes used by some of the most profitable corporations and wealthiest individuals — as Sen. Sheldon WhitehouseSheldon WhitehouseHollywood, DC come together for First Amendment-themed VIP party Overnight Energy: Trump set to sign offshore drilling order Trump's FDA nominee clears key Senate committee MORE (D-R.I.) and Rep. Lloyd Doggett (D-Texas) are doing in this Congress — most Americans will approve, since they correctly feel the wealthiest among us have done exceedingly well in the past few decades while working families have been left out from the economy’s growth.
Closing unjustified tax loopholes is not a tax increase; rather, it’s tax collection from those currently avoiding, without a legitimate public policy purpose, paying taxes. Most people who do not want to raise tax rates still favor closing loopholes that let a special few unfairly escape paying their taxes. Moreover, the revenue that would be produced could be appropriately used for education, infrastructure, defense and deficit reduction. A recent poll showed that 83 percent of those polled, including 79 percent of Republicans, want to see revenue from loophole closing used for investment and deficit reduction, not rate reductions.
Focusing on closing unjustified loopholes provides a popular and meaningful option of talking about taxes in a way that connects to average Americans without being pulled into a likely fruitless partisan debate over broad tax reform. Unfortunately, in this latest tax package, Congress went the wrong way.
Levin (D-Mich.) served in the Senate from 1979 to 2015. He is the distinguished legislator in residence and chairman of the Levin Center at Wayne State University Law School in Detroit. Avi-Yonah is the Irwin I. Cohn professor of law and director of the Graduate Tax Program at the University of Michigan.