Territorial: The Hidden Danger Beneath the Tax Rate Debate

By Jacob Wills

Our tax system is fundamental to our democracy, delineating who pays the costs of a functioning civilization. But the system is broken, leaving an undeniable imbalance between the working and middle-classes and the wealthy and multinational companies. It would seem to follow then that the focus of tax reform should be around correcting this imbalance by targeting those that have gamed the system and flagrantly avoided taxation. Yet, the priority for Congress and the administration seems to be to exacerbate tax avoidance with greater incentives for shifting profits offshore.

There is currently $2.6 trillion booked offshore — untaxed — by multinational companies. This is the result of a gaping loophole for multinationals known as deferral, where a company can delay paying taxes until the profits are “repatriated” to the U.S. The administration has frequently cited this number as a reason our tax code needs “reform,” and, on that point, there is broad agreement. Our tax system undoubtedly needs reform, though, their solution—to simply not tax offshore profits—misses the point.

Their proposal would create what is known as a ‘territorial’ tax system, where profits booked offshore by multinational companies would be permanently exempt from U.S. taxes. Proponents, including Trump, argue that this is about competiveness for American companies, saying it would “level the playing field.” The reality is that a territorial tax system would favor multinational corporations over solely-domestic American companies, because multinational companies would never pay taxes on huge swaths of their income regardless of the official “rate.”

The idea that it would promote investment and create jobs is a falsehood. The tax distortions would incentivize companies to move profits and jobs offshore. Recent findings on the best corporate tax avoiders paint a clear picture of what that would look like. An investigation by the Institute for Policy Studies into 92 companies, who were profitable every year between 2008 and 2015 and paid less than 20% in tax, found that the reduced taxes did not lead to job growth. In fact, these companies registered median job growth of negative 1 percent during the same period that overall private sector jobs grew by 6 percent. More than half of the 92 companies eliminated a combined 483,000 jobs.

Under a territorial system, companies would have an even greater incentive to use accounting gimmicks to shift profits offshore. Currently, deferral delays but does not eliminate the responsibility to pay taxes. That fact reduces the incentive to move everything offshore. Eliminating all future tax responsibility would further incentivize companies to move as many profits offshore as possible. It’s a solution more focused on increasing loopholes in the tax code than on stopping the gaming. The shift would no doubt make the problem worse at a cost to taxpayers — either through cuts to Social Security, Medicare, and Medicaid or other services, a shift of the tax burden to the poor and middle class, or an increase in the deficit — further fueling heated austerity debates.

The debate has mostly focused on the rate and proposals to cut it to 15% or 20%, but the rates are meaningless if the overall structure continues to allow companies to shift profits to jurisdictions with a zero percent rate. It’s foolish to think that companies now paying single digit tax rates will suddenly pay 15 to 20% if we exempt offshore profits from tax.

For decades, the wealthy and multinational companies have invested heavily in tax avoidance regimes while the working and middle class households have increasingly picked up the slack. Claiming to solve this problem with a special exemption from taxes does nothing but reward and encourage tax avoiders. Or as Jordan Weissmann recently described it, it’s like “trying to fight shoplifting by making it legal.”

Jacob Wills is a Communications Associate with the FACT Coalition.