US corporations are being subsidized by the US government to build factories abroad and to ship jobs formerly held by American workers overseas. In addition they are getting all sorts of tax breaks on profits they make selling products into the US market. These policies were designed during Republican administrations generally although Bill Clinton played a big role in this "globalization" process. There are three main goals of globalization from the corporation's point of view: 1) produce where labor and other inputs to the production process are cheapest; 2) sell into whatever markets are most lucrative (right now the US market represents the largest consumer market in the world); 3) pay as little in taxes to any government anywhere in the world. The Obama administration has tried to change some of these tax policies, but to no avail. The latest example of this is that at first the bill giving aid to first responders of 9/11 was going to be funded by not letting corporations continue to deduct expenses for constructing foreign plants from their tax bill. However, Republican objections and obstructionism forced a "compromise" in which that corporate tax "loophole" was left intact. Obviously, if there are tax advantages to constructing plants abroad in addition to the lure of cheap labor, corporations are being encouraged by US government policy to outsource American jobs. Just the opposite should be true. They should be given tax breaks for constructing plants here and employing American workers. The Obama administration has pledged to fix this situation, but with Republican control of the House there is little chance they will be able to accomplish this goal.
Here's how it works. Although the US corporate income tax rate is 35%, most corporations end up paying only 6-7%. This year, Google, which made $5.5 billion in revenues, only paid an effective tax rate of 2.4%. Corporations set up foreign subsidiaries in low tax countries and then shift profits to those subsidiaries. Therefore, they claim that they didn't make those profits in the US where they sold their merchandise but in those foreign countries where they didn't. It's a corporate shell game. You make your profits where the consumer market is good but taxes are high and then shift those profits to a country where the consumer market is bad but tax rates are low. An additional neat trick is that corporations are able to shift their expenses on their foreign operations to the US. Even though the expenses were incurred in the foreign country where their plant is located, for example, for tax purposes they are shifted to the US where they are deducted from their US tax bill. So they have the best of both worlds. They can shift factories to foreign countries where labor is cheapest, and then turn around and deduct the expenses for outsourcing plants and jobs from their US tax bill.
It's called "transfer pricing:"
For many companies, however, national combined reporting requirements aren’t an issue—they just create subsidiaries in international tax shelters like Ireland and the Cayman Islands. A tool called transfer pricing lets companies make profits in tax havens while allocating expenses to higher-tax countries, writes the OECD Observer.
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Google’s “Double Irish” strategy is one popular transfer pricing scheme. Google created two companies in Ireland to execute this maneuver. One pays royalties to use intellectual property (expenses that reduce income tax in Ireland). A second, located in Bermuda, collects those royalties. The meat in Google’s sandwich is the Netherlands, where profits go on their way from Ireland to Bermuda.
“Irish tax law exempts certain royalties to companies in other EU- member nations,” according to the excellent Bloomberg article that describes Google’s acrobatics. “A brief detour to the Netherlands avoids…Irish withholding tax.”
If you think the federal government would want to sink its teeth into those profits by implementing an international combined reporting requirement, think again. The feds would rather get what they can without changing the law: Google and the IRS negotiated for three years before coming to “an arrangement” that let the company execute its transfer pricing strategy, according to Bloomberg.
Transfer pricing is another reason the states are going broke. By locating plants in states where there are few sales, corporations avoid paying taxes in other states where most of their profits are made. By using this strategy with respect to foreign countries, they put their tax avoidance schemes on steroids. Corporations that transfer income abroad even though a lot of it might have been generated in the US are still on the hook if they repatriate those profits. That is if they bring those profits back into the US. But there is no need to. Most corporations never repatriate that income. They leave it parked outside the country because their interest is in constructing plants and facilties outside the US where labor is cheapest.
Halliburton is a good example of a corporation which makes most of its profits inside the US but exports most of its profits abroad. Recently, it moved its corporate headquarters to Dubai.
For decades, the U.S. tax code has encouraged companies like Halliburton to transfer the location of its subsidiaries from the United States to foreign countries. This is one reason why only thirty-six of Halliburton's 143 subsidiaries are incorporated in the United States and 107 subsidiaries (or 75 percent) are incorporated in 30 different countries.
There are two methods by which Halliburton lowers its tax liability on foreign income: (1) By establishing a "controlled foreign corporation" and (2) By establishing a subsidiary inside a low tax, or no tax, country known as a "tax haven."
Controlled foreign corporations are becoming increasingly valuable to corporations because they allow those corporations to not pay any US income tax on profits generated outside the US. By filing a few papers and incorporating a subsidiary in the country where the profits are made, the subsidiary is no longer considered a "US resident" under the tax code. Instead it is considered a "foreign resident." These profits are only taxed if the profits are repatriated which in most cases they never are.
Here is more on how corporate profits are shifted to countries with low or no tax rates:
Congress reported that Halliburton owns 17 subsidiaries in tax haven countries, including 13 in the Cayman Islands, which has no corporate income tax, two in Liechtenstein and two in Panama.
An analysis by CitizenWorks.org found a far greater number Halliburton tax havens. The nonprofit public interest group found that, while Dick Cheney was CEO of Halliburton (between 1995 and 2000), the number of Halliburton subsidiaries incorporated in offshore tax havens rose from 9 to 44. CitizenWorks.org also found that the Fortune 500 companies with the most offshore tax havens are dominated by energy firms, including El Paso (#1), AES (#2), Aon (#5), Mirant (#7), Halliburton (#8), and Williams (#14).Controlled foreign corporations and tax havens are the result of decades of corporate lobbying in Washington, DC. It has benefited corporate America tremendously. The tax savings to Halliburton, and the corresponding tax loss to individual American taxpayers, are enormous. Halliburton paid only $15 million of their $80 million in total taxes (or 19 percent) to the U.S. government in 2002. The remaining 81 percent of the company's taxes went to foreign governments. Although Halliburton is an "American" corporation on paper, it is actually a foreign corporation that has no allegiance to the United States.
The Obama administration has taken steps to discourage job creation overseas by American corporations and to encourage job creation at home. The likilhood of any of these steps being passed into law is nebulous. If American corporations find that American incorporation becomes too onerous, they can simply incorporate elsewhere like Hallburton did. Nevertheless, here are some of the things Obama is trying to do:
Currently, businesses that invest overseas can take immediate deductions on their U.S. tax returns for expenses supporting their overseas investments but nevertheless "defer" paying U.S. taxes on the profits they make from those investments. As a result, U.S. taxpayer dollars are used to provide a significant tax advantage to companies who invest overseas relative to those who invest and create jobs at home. The Obama Administration would reform the rules surrounding deferral so that--with the exception of research and experimentation expenses--companies cannot receive deductions on their U.S. tax returns supporting their offshore investments until they pay taxes on their offshore profits. This provision would take effect in 2011, raising $60.1 billion from 2011 to 2019.
In the final analysis perhaps the only way to retrieve taxes from corporations using every trick for tax avoidance is a VAT tax. The advantage of a VAT tax is that it is collected at point of sale. So no matter where a corporation chooses to move its corporate headquarters, it will never be able to escape taxation as long as it wants to sell into the American market. This also means that corporate profits aren't subject to manipulation by tax lawyers advising corporations how to get around paying taxes, and corporate lobbyists can't drill loopholes into the tax code. A VAT tax would truly tax profits made from sales in the country where the product was sold instead of allowing profits to be transferred to low tax countries. Also a VAT tax would avoid the transfer of deductible expenses from foreign countries to the US. It would put a stop to the transfer of profits to tax havens and expenses to high corporate tax rate countries like the US.
A VAT tax could also get around the free trade tariff restrictions. Germany imposes a VAT tax on imports to make them equivalent to domestically produced products on which VAT taxes have already been paid. This is only fair, but it also tends to give an advantage to domestically produced products and job creation and maintenance in country. The VAT tax could be charged directly to the corporation whose product is being sold and not to the customer by estimating profits from each sale. Of course, the corporation could raise prices on the product thus effectively transferring the VAT tax to the consumer, but this is not necessarily bad in that it would tend to equalize the advantages of products produced by higher priced American labor. Revenue sharing of the VAT tax between the Federal and state governments would do a lot to alleviate the states' fiscal problems.
In the long run corporations cannot expect to outsource jobs and insource consumer sales indefinitely. The American market cannot sustain 70% of GDP being produced by consumption without American jobs being created to support that consumption. Prudent tax policies will not only encourage domestic job creation but also will recoup much needed tax revenues from corporations who have been escaping from paying their fair share.
