Tax Justice Blog

Partners in Crime? New GAO Report Shows that Large Corporate Partnerships Can Operate Without Fear of Audits

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More than a decade ago, a Republican-led Congress held a series of “show trials” designed to paint a picture of the Internal Revenue Service as intrusive, jackbooted thugs. It worked — at least well enough to convince Congress, which has since embarked on a decade-long trend of gradually defunding the IRS’s enforcement capabilities. But a new report from the General Accounting Office  (GAO) is the latest indicator that the pendulum has swung too far toward defanging the IRS’s enforcement capabilities. The GAO report shows that a business form known as “widely held partnerships” is growing dramatically — and that the IRS is able to audit less than 1 percent of the very largest such firms.

Businesses that are partnerships are not subject to the corporate income tax. Instead, the profits are passed along to the partners, who pay personal income taxes on them. Under current rules, this means that when the IRS wants to audit the partnership’s tax filings, it must examine the tax returns of each of the organization’s partners — and levying an adjustment is similarly burdensome for the IRS. The largest such partnerships, including hedge funds and private equity firms, can have hundreds or even thousands of partners. Even an adequately funded IRS might understandably find it difficult to audit even the most blatant partnership tax dodger.

But of course, the IRS is not adequately funded.The agency has lost 10,000 employees since 2010, more than 30 percent of which worked in enforcement areas.

If the prospect of large partnerships being able to bank on the inability of the IRS to audit them sounds like trouble, it is: the revenue stakes are potentially huge. The GAO estimates that the largest partnerships had $69.1 billion in total net income in 2011 alone. Any aggressive tax avoidance practiced by these firms will have a real effect on our nation’s budget deficit.

In a statement on the report, Senator Carl Levin from Michigan said, “Auditing less than 1 percent of large partnership tax returns means the IRS is failing to audit the big money. It means over 99 percent of the hedge funds, private equity funds, master limited partnerships, and publicly traded partnerships in this country, some of which earn tens of billions each year, are audit-free.”

Astonishingly, both President Barack Obama and outgoing House Ways and Means Chair Dave Camp have proposed sensible (partial) solutions to this problem. Both propose to allow the IRS to audit partnerships at the entity level, the same way they audit publicly traded corporations. Sadly, neither has proposed to completely reverse the damaging loss of IRS audit capacity caused by recent budget cuts.

Unfortunately, Camp’s proposal is embedded within a larger tax plan that altogether would result in a massive $1.7 trillion dollar deficit and make the tax code more regressive. Congress should enact the specific reform that would address the problem with partnerships now, on its own.

Norquist-Backed Tax Cut for the Rich Fails in Tennessee

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Grover Norquist’s Americans for Tax Reform, along with the Tax Foundation and Koch brothers-backed Americans for Prosperity all tried to convince Tennessee lawmakers that the state’s wealthiest investors need a tax cut.  Fortunately for Tennesseans, their elected officials rejected that idea this week.

 At issue was the state’s “Hall Tax,” a 6 percent levy on stock dividends, certain capital gains, and interest.  Tennessee does not tax wages, business income, pensions, Social Security, or virtually any other type of income imaginable.  But for anti-tax groups, even the state’s narrow income tax on investors was too much to stomach.

The Tax Foundation put out an alert claiming Tennessee could improve in its (highly questionable) tax climate ranking by repealing the tax, while Grover Norquist traveled to Tennessee to urge repeal and Americans for Prosperity ran a series of radio ads doing the same.

The state’s comptroller got in on the action as well, bizarrely suggesting that the Hall Tax is bad policy because it is not primarily paid by large families or low-income people lacking health insurance.

But ultimately, sensible concerns that repeal would require damaging cuts in state and local public services eventually won out, and the bill’s sponsor dropped his plan.

This is good news for people concerned with the fairness and adequacy of state tax systems.  As our colleagues at the Institute on Taxation and Economic Policy (ITEP) explained in a report picked up by The Tennessean, these cuts in public investments would have come with no corresponding tax benefit for the vast majority of households:

“Nearly two-thirds (63 percent) of the tax cuts would flow to the wealthiest 5 percent of Tennessee taxpayers, while another quarter (23 percent) would actually end up in the federal government’s coffers. Moreover, if localities respond to Hall Tax repeal by raising property taxes, some Tennesseans could actually face higher tax bills under this proposal.”

Tennesseans can breathe a sigh of relief that this top-heavy tax repeal plan didn’t make it into law this year.  But you can bet that Grover et al. will try again soon as they attempt to set in motion a national trend away from progressive income taxes.

NASCAR Tax Breaks Just Another Reason Corporate Tax Is on the Skids

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Back in 2004, as the presidential contest between George W. Bush and John Kerry heated up, so-called NASCAR dads were identified as a potential key constituency in swinging the election results—and the NASCAR dad vote was courted accordingly by both sides. Entirely coincidentally, Congress chose to codify a four-year “NASCAR tax break” into law in 2004 as part of the American Jobs Creation Action of 2004, a corporate-gift-laden package pushed through just before the election. The idea was that corporations building race tracks and related facilities should be able to write off costs of these investments over seven years, a much shorter period than the likely lifespan of the tracks.

Although some members of Congress have attempted to make this tax break permanent since then (most notably former Pennsylvania Sen. Rick Santorum’s Fairness and Permanency Act of 2005) none have succeeded. But Congress has done what, in the eyes of the racing industry, is the next best thing: they’ve made the NASCAR break part of the “tax extenders,” the growing array of temporary, primarily corporate tax breaks that are routinely authorized by Congress for one or two years to obscure their long-term cost.

The International Speedway Corporation, which owns tracks in Daytona, Darlington and Watkins Glen, has benefitted handsomely from Congress’s largesse. In 2013, the company reported $73 million in U.S. profits, didn’t pay a dime in federal income tax but received a rebate of $8 million. In fact, over the past five years, ISC has enjoyed a federal tax rate of just 11 percent on $400 million in US profits.

ISC’s competitor Speedway Motorsports has been even more blessed: the company reports a 6.9 percent federal tax rate over the past five years on $287 million in U.S. profits, and reports zeroing out its federal income tax entirely in two of those years.

To be clear, if the federal corporate income tax is on the skids, the NASCAR tax break plays only a small direct part in this decline. The temporary extension of the tax break envisioned by Sen. Ron Wyden’s “Expiring Provisions Improvement Reform and Efficiency Act of 2014” would never cost more than $18 million a year. But the NASCAR giveaway is perfectly emblematic of the “death by a thousand cuts” that plagues the corporate tax: as long as the racetrack industry continues to enjoy this special privilege, it will be difficult for Congress to repeal tax breaks for other favored businesses. Any movement toward true corporate tax reform needs to start by rooting out even the smallest targeted corporate giveaway. Wyden’s extenders bill fails utterly to achieve this.   

Delayed Action on Cap and Trade Comes at a Cost

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In spite of mounting evidence that greenhouse gas emissions will continue to increase the earth’s temperatures, political polarization in Washington is standing in the way of the United States doing its part to address this global crisis.

A new report from the United Nations’ Intergovernmental Panel on Climate Change paints a sobering picture of the need for the governments to take immediate action to reduce carbon emissions. The report finds that despite ongoing efforts by developed nations to curb these emissions, greenhouse gas emissions "have grown at about twice the rate in the recent decade (2000–2010) than any other decade since 1970.” The report also outlines compelling arguments for enacting policy solutions (such as a carbon tax or a “cap and trade” mechanism) to curb emissions in the very near term, because delays could make it impossible to prevent substantial increases in worldwide temperatures and would likely increase the cost of any mitigation efforts.

But as the New York Times notes in its coverage of the report, these findings are falling on deaf ears in Congress. The Times spends far more ink detailing the political impossibility of a carbon tax than it does discussing the report’s bleak findings. The politics surrounding the carbon tax are, indeed, challenging. Congressional efforts to reform the tax code are widely perceived to have ground to a halt in this election year, and any effort to hike carbon taxes would face additional opposition from lawmakers.

This opposition is, in part, sensible: in general, a national tax on consumption is a bad idea that would make our already unfair tax system even more so. Taxes on consumption are regressive, taking a much larger percentage of income from middle- and low-income families than from the rich. This is because middle- and low-income families must spend most or all of their income on basic necessities, while rich families can put a lot of their income toward savings (which are not touched by a consumption tax).

A tax on carbon emissions, while inherently regressive, could be coupled with features to keep it from burdening middle-income Americans and hitting low-income Americans the hardest. Because any such tax would likely generate substantial new revenues—the Congressional Budget Office (CBO) has found that a carbon tax that starts off at $20 per ton and then rises by 5.6 percent annually could raise as much as $1.2 trillion over ten years—it would be straightforward to design a tax cut, such as a reduction in the federal payroll tax or a targeted tax credit, that would help to offset the impact of the carbon tax on middle- and low-income families. Since our tax system already imposes substantial taxes on low-income families who would be hit hardest by a carbon tax, a low-income offset must be part of any acceptable environmental tax reform.

And there are other compelling arguments in favor of some form of carbon tax. It would create a market incentive to develop low- or zero-carbon emission energy sources and simultaneously create a market disincentive to using carbon emitting energy sources. In other words, while it would raise substantial new revenues, it would reduce the amount of greenhouse gasses released into the atmosphere, as manufacturers, shippers, and consumers shift away from fossil fuels.

Of course, discussions of environmental tax reform should not distract lawmakers from the fundamental challenges facing our existing tax code. As we have argued, both the individual and corporate income taxes are ridden with loopholes that should be repealed as part of revenue-raising federal tax reform. And we’ll shed no tears if Congress starts its 2015 session by requiring General Electric and other big multinationals to pay their fair share of the corporate tax rather than dealing with the thorny carbon tax issue. But the latest UN report is a stark reminder that the potential costs of delay on environmental tax reform will be substantial.

Kansas Lawmakers Compliance With Supreme Court Decision Proves Difficult

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Kansas lawmakers just passed legislation to comply with the recent state Supreme Court ruling mandating increased K-12 funding to poor school districts, but it didn’t come easy.

The Kansas City Star notes that “[l]awmakers discussed taking the money out of the state’s reserve fund, but those dollars are needed just to keep the lights on in state government. They talked about taking from some educational funds to give to others. They considered shaking out pockets looking for spare change. At one point, senators were reduced to eying the $2 million in the problem gambling fund.”

These difficult choices are a direct result of the last two years of radical tax cuts. Governor Sam Brownback’s supply-side promises notwithstanding, his regressive income tax cuts show no sign of paying for themselves anytime soon, which means lawmakers must look under cushions to meet their court-mandated funding obligations.

The current budget is balanced precariously. As the Kansas City Star reminds us, “Right now, the budget is balanced only by dipping into reserve funds. If current revenue and spending trends continue, it will go underwater in 2016. After that, a state that is shortchanging its universities and disabled citizens will have to start cutting more deeply; forecasters estimate $962 million in cuts by the 2019 fiscal year. Kansas already is raiding its highway fund to pay for transportation of school students and even a chunk of the debt service for the recently completed statehouse reconstruction. Part of the teachers’ pension funds are coming from gambling revenues, in apparent violation of state statute.”

Having found $129 million in new money for poor school districts, the legislature clearly felt the need to dispel any illusion on the part of voters that they actually value public schools, and added legislative measures to undermine them. Kansas is now the latest state to enact “neo-vouchers,” corporate tax credits for companies making contributions to private schools. As we’ve explained in the past, this back-door approach to school vouchers erodes corporate tax revenues, takes money away from already-strapped public schools, and limits state policymakers’ oversight of the private schools receiving these state-funded scholarships. In other words, having grudgingly given new revenue to public schools with one hand, they now will be taking it away with the other.

State News Quick Hits: Maine Cracks Down on Tax Havens and More

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Maine legislators are poised to crack down on corporations that use foreign tax havens to hide income from state tax authorities. The legislation, which has now been passed by both the House and Senate but still faces further votes, requires multinationals doing business in Maine to declare income otherwise attributed to more than thirty countries known to be popular tax havens (like the Cayman Islands and Bermuda, not to mention the Bailiwick of Guernsey, which turns out to be an island off the coast of France). Analysts estimate that such a change would increase state revenue by $10 million over the next two years. And U.S. PIRG, among other public interest organizations, has been beating the drum for this sensible reform, which we discussed in our recent report: 90 Reasons We Need State Corporate Tax Reform. Oregon and Montana already have similar laws on their books.

Thanks to a refundable tax credit included in New York’s budget this year, theater companies who launch their productions in upstate New York will enjoy having taxpayers foot the bill for 25 percent of the cost of “their so-called tech periods, the weeks long process in which a production gathers the costumes, tests the sets and choreography and establishes the lighting and musical cues.” Despite the credit’s extreme generosity, we’re still not sure it would have been enough to save Spider-Man.

Tax swap proposals that would trade income rate reductions for sales tax increases have been all the rage in conservative states in recent years. But what if your state doesn’t even have an income tax to begin with? Not wanting to be left out of the tax swap craze, Republican candidate for Texas Comptroller Glenn Hegar has a solution: completely replace property taxes with an increased sales tax. Texas already has a horribly regressive state tax system (PDF), but eliminating the property tax -- which is at least close to proportional in its distribution across income groups -- would only make matters worse. And while it is “easy to hate” the property tax, without it Texas would need to drastically cut services or more than double the sales tax. Such a trade could also mean less autonomy for localities (PDF) and a revamped school financing system.

Grover Norquist and the Koch brothers’ Americans for Prosperity are continuing to push for eliminating income taxes on investors in Tennessee, and there’s a chance they may succeed.  The state’s tax-writing committees will be voting this week on whether or not to gradually repeal Tennessee’s “Hall Tax” on dividends, interest, and some capital gains.  But repeal would be steeply regressive, as our partners at the Institute on Taxation and Economic Policy (ITEP) showed in a report cited by The Tennessean.  And on top of that, a spokesman for Governor Bill Haslam explains that “we’re in the middle of dealing with difficult budget realities … and this legislation would automatically put the issue above other priorities when revenues come back.”

Cuomo Gets His Election-Year, Tax Cut Wish

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New York Governor Andrew Cuomo got his election-year wish: a $2 billion tax cut package that doles out goodies to Wall Street banks and rich homeowners. Cuomo, a Democrat who likely has presidential ambitions, sold the tax cuts under the false promise that they would help New York businesses “thrive.” Tax cuts have become something of an obsession for Cuomo, despite the fact that important public investments have been neglected by five consecutive years of austerity budgets.

Here’s a run-down of the tax changes in the budget deal:

Property tax: A three-year property tax rebate program will cut homeowners’ taxes by $1.5 billion by “freezing” the amount many currently pay. But the cuts won’t be evenly distributed and generally won’t target those most in need of relief. For those living in local jurisdictions that comply with a 2 percent property tax cap and working to consolidate services with neighboring jurisdictions, the state will send homeowners (only those with household income under $500,000 qualify) a check for the amount of any increase in property taxes over the prior year (the checks are conveniently scheduled to be sent out for right before the November elections). For those living in New York City, which is not subject to the tax cap, low-income homeowners and renters will be eligible for a small, refundable property tax circuit breaker credit which will cost $85 million a year. Unfortunately, an expanded circuit breaker tax credit available to homeowners across the state-- one of the best ways to provide targeted property tax reductions-- was dropped from the final bill.

Business taxes: Corporations will get more than $500 million in tax cuts, including a permanent across-the-board corporate income tax rate cut from 7.1 percent to 6.5 percent. Manufacturers will be zeroed out from paying the corporate income tax altogether and will also receive a new property tax credit. Though Cuomo has heralded his business cuts as a boon to manufacturers, they in fact already pay very low rates (Our recent state corporate tax study found that Corning, for example, paid only a 0.3% state tax rate on $3.5 billion in profits over the past five years) and the primary beneficiaries are predominantly Wall Street banks.  The package eliminates the state’s bank tax, subjecting banks instead to the corporate income tax, and also allows them to pay only 8 percent of their income from qualified financial instruments (securities) under the assumption that 92 percent of their income from these sales comes from customers outside of New York.

Estate tax: Though there had been talk of also lowering rates, legislators ultimately agreed to cut the state’s estate tax by increasing the exemption from $1 million to $5.25 million, the threshold currently used at the federal level.

We’ll let others analyze the budget as a whole, which is worth $138 billion and includes important provisions on charter schools, pre-K, and campaign finance. But on the tax front, the bill falls far short of the type of targeted, progressive reform that is so badly needed.

Is the Obama Administration Blocking International Efforts to Address Corporate Tax Avoidance?

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According to the Daily Tax Report (subscription only) a Treasury Department official said publicly on April 8 that the government’s goal in international negotiations over corporate tax dodging is to prevent dramatic change and preserve the “arm’s length” standard that has proven impossible to enforce.

Last summer, the Organization for Economic Co-operation and Development (OECD) released an “Action Plan on Base Erosion and Profit Shifting” in response to public outcry in several nations that multinational corporations are using tax havens to effectively avoid paying taxes in the countries where they do business.

At that time, CTJ criticized the plan as too weak, arguing that:

While the plan does offer strategies that will block some of the corporate tax avoidance that is sapping governments of the funds they need to make public investments, the plan fails to call for the sort of fundamental change that would result in a simplified, workable international tax system.

Most importantly, the OECD does not call on governments to fundamentally abandon the tax systems that have caused these problems — the “deferral” system in the U.S. and the “territorial” system that many other countries have — but only suggests modest changes around the edges. Both of these tax systems require tax enforcement authorities to accept the pretense that a web of “subsidiary corporations” in different countries are truly different companies, even when they are all completely controlled by a CEO in, say New York or Connecticut or London. This leaves tax enforcement authorities with the impossible task of divining which profits are “earned” by a subsidiary company that is nothing more than a post office box in Bermuda, and which profits are earned by the American or European corporation that controls that Bermuda subsidiary.

The rules that are supposed to address this today (but that fail miserably) require multinational corporations to deal with their offshore subsidiaries at “arm’s length.” This means that, for example, a corporation based in New York that transfers a patent to its offshore subsidiary should charge that subsidiary the same price that it would charge to an unrelated company. And if the New York-based corporation pays royalties to the offshore subsidiary for the use of that patent, those royalties should be comparable to what would be paid to an unrelated company.

But when a company like Apple or Microsoft transfers a patent for a completely new invention to one of its offshore subsidiaries, how can the IRS even know what the market value of that patent would be? And tech companies are not the only problem. The IRS apparently found the arm’s length standard unenforceable against Caterpillar when that company transferred the rights to 85 percent of its profits from selling spare parts to a Swiss subsidiary that had almost nothing to do with the actual business.

It turns out that some of the OECD governments are proposing reforms that challenge the arm’s length concept at least to some degree, but the US government is pushing a line that is more favorable to the multinational corporations.

Robert Stack, the Treasury Department deputy assistant secretary for International Affairs in the Office of Policy, is quoted by the Daily Tax Report as saying that the “main challenge for the U.S. is to get this project to work back from blunt instruments and towards policies that are understandable, fair, clear, administrable, and reach the right technical tax results.”

Stack also said that the “United States feels very strongly that the 2014 deliverable should be a clear articulation of intangibles under the arm's-length principle—and should reserve on the evaluation of potential special measures to treat BEPS [base erosion and profit-shifting] that depart from the arm's-length principle.”

The international tax system needs reform that is more fundamental than anything that either the OECD or the US is contemplating. Any system that relies on the artificial boundaries between the dozens (or hundreds) of entities in a multinational group and the ways they price transactions between them is unworkable. The US’s “deferral” system and Europe’s “territorial” system, which both require transfer-pricing rules and the hopeless “arm’s length” standard, should be eliminated. CTJ has proposed its own tax reform plan that would provide fundamental solutions. 

Good and Bad Tax Policy in Maryland

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The estate tax, Earned Income Tax Credit (EITC), and film tax credits were all major topics of debate in Maryland this year.  Now that the state’s legislative session has ended, here’s a quick look at what happened on each of these issues.

Estate tax:  Despite having the highest concentration of millionaires in the country, Maryland lawmakers say they’re very concerned the estate tax may be driving wealthy residents out of the state.  Because of this, both the House and Senate approved a bill benefiting estates worth more than $1 million.  Assuming the governor signs the bill, which seems likely, Maryland’s estate tax exemption will increase from $1 million to more than $5.3 million by the end of the decade.  This is unfortunate since, as we explained in testimony before both of Maryland’s tax-writing committees, an estate tax cut will reduce the adequacy and fairness of the state’s tax system without producing any economic benefit.

Earned Income Tax Credit:  In better news, Maryland lawmakers unanimously agreed to expand the state’s EITC.  Maryland currently allows taxpayers to choose between a refundable EITC equal to 25 percent of the federal credit, or a 50 percent nonrefundable EITC.  Legislation approved on Monday will gradually increase the refundable portion of the credit to 28 percent, which means low-income taxpayers who earn too little to owe personal income taxes will receive a somewhat larger refund to help offset the significant amounts (PDF) of sales and property taxes they pay each year.

Film tax credit:  A couple months ago, the producers of Netflix’s “House of Cards” threatened to leave the state unless lawmakers gave them more taxpayer dollars through the state’s film tax credit program.  Despite trying mightily to comply with their demand, the legislature ultimately failed to reach an agreement on a bill that would have shelled out an extra $3.5 million to the filmmakers.  Less encouraging, however, is that the show could still collect another $15 million in tax credits—on top of the millions it has already received.

"Tax Extenders" Would Mean Even Lower Revenue than the Ryan Plan

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The tax extenders making their way through Congress would cut federal revenue below the level proposed in Rep. Paul Ryan’s budget. This once again demonstrates that anything goes when it comes to providing tax breaks for corporations.

As CTJ explained in its report last week, the Ryan plan includes huge tax cuts for the very rich. But Ryan nonetheless proposes to eliminate unspecified tax breaks to offset the costs and thus collect the same amount of revenue as current law.

The tax extenders, on the other hand, would cut revenue, and increase the deficit, by $700 billion over the coming decade if Congress continues its practice of extending these breaks every couple of years or makes them permanent.

Even organizations not particularly known for progressive positions have pointed out this fact and how it damages the fiscal outlook that lawmakers claim to care about whenever they are discussing domestic spending.

CTJ has explained that the tax breaks that make up the bulk of the “tax extenders” do not provide any economic benefits that would justify the increase in the budget deficit that would result.

We have called the “tax extenders” the biggest budget buster many have never heard of. Fortunately, more and more people are publicly decrying this giveaway to corporations.

Citizens for Tax Justice:
“Four Reasons Why Congress Should Reject the "Tax Extenders" Unless Dramatic Changes Are Made”

Citizens for Tax Justice op-ed in the Hill:
“Tax Extenders: The Biggest Budget Buster You’ve Never Heard Of”

Americans for Tax Fairness:
“35 National Organizations Say Oppose Offshore Corporate Tax Loopholes in Tax-Extenders Legislation”

The Financial Accountability & Corporate Transparency (FACT) Coalition:
“FACT Urges Chairman Wyden: Don’t Let First Major Action Favor Multinationals”

The National Priorities Project:
“Congress May Extend Corporate Tax Breaks But Not Unemployment Benefits”

Offshore Loophole Got Snuck Back in Tax Extenders Bill Behind Closed Doors

New York Times editorial:
“Hypocritical Tax Cuts”

Washington Post editorial:
“Lawmakers Should Offer Up a Fiscally Responsible ‘Tax Extenders’ Bill”