It was a humbling experience for the chief executive of the world’s most valuable company. Hauled before a Senate panel, Apple’s Tim Cook had to explain how an American company whose American engineers had created the iPhone and the iPad was able to avoid paying any taxes on billions of dollars in profits generated by those products — not to United States, not to any country. The only defense the Cook could conjure up for Apple “stateless” income was that it was all perfectly legal.
A few miles away in Arlington, a 55-year-old economist named Marty Sullivan sat on a folding metal chair at a card table in the garage of his modest brick home and watched the hearing unfold on his laptop computer. Sullivan is one of those unheralded members of the permanent Washington establishment who make things work, at least when the politicians let them. And for two decades, from the same home office, Sullivan has been exposing the tax-dodging schemes of multinational corporations in the columns of Tax Notes, a must-read publication for tax lawyers, accountants and policy wonks.
It was Sullivan who shined an early light on how companies had finagled “transfer prices” — the price one division charges another for parts or services — to shift profits to low-tax jurisdictions.
It was Sullivan who had called out the big drug and tech companies for transferring ownership of their patents and trademarks — the source of much of their profits — to subsidiaries in Ireland and other low-tax jurisdictions.
It was Sullivan who highlighted the absurdity of tax havens in which just a handful of multinationals claimed to earn annual profits that were several times the country’s entire GDP.
And it was Sullivan who in 2010 pieced together from public filings that Apple had understated its reported profits to hide the fact that it was paying a tax rate of less than 2 percent on its overseas profits, shining the spotlight on Apple’s tax avoidance schemes.
“We’ve been banging the drum on this stuff for years,” Sullivan said with just the slightest hint of satisfaction as the morning sun filtered into the garage he shares with bicycles, garden tools, an American flag and an old coffee maker. “But it’s finally gone prime time.”
For years, big multinational corporations, waving the banner of competitiveness, have been pushing hard for corporate tax reform. “Reform” means different things to different people, but to multinational corporations, it has meant a sizeable cut in the 35 percent corporate tax rate and an end to all U.S. taxation on profits earned overseas.
Now, however, revelations of elaborate tax dodges by respected companies such as Apple, Google, Microsoft and Starbucks have badly undermined their “reform” push, not just in the United States but around the globe.
At a recent meeting in St. Petersburg, the leaders of the 20 leading industrial nations vowed to push ahead with tough new global standards that would put an end to “stateless” income and limit the ability of firms to avoid taxation by shifting profits to tax havens. After years of competing against one another for corporate investment by offering ever-more-favorable tax regimes, cash-strapped governments have decided to go after the companies rather than each other.
“There’s been a race to the bottom, and the multinationals were winning,” said Eric Toder, co-director of the nonpartisan Tax Policy Center in Washington.
In Washington, meanwhile, a newly appointed House-Senate conference committee has been instructed to come up with a long-term budget plan by mid-December in the hopes of avoiding a replay of this month’s government shutdown. President Obama, along with both Republican and Democratic leaders have expressed hope that some form of corporate tax reform will be included in that budget blueprint.
The chairman of the House Ways and Means Committee, Rep. Dave Camp (R-Mich.), is in the final stages of crafting a “revenue neutral” tax reform proposal that looks to lower the corporate rate by closing the most egregious loopholes while imposing what amounts to a modest minimum tax on overseas profits. The chairman of the Senate Finance Committee, Max Baucus (D-Mont.), promises his own plan by the end of the year that is likely to be even less tax-friendly to overseas operations.
For multinationals, in other words, the political tide seems to have turned. Rather than coming out the winners from corporate tax reform, as they once fantasized, they now face the very real prospect of paying more taxes rather than less— an outcome Apple’s Cook told the Senate his company is prepared to accept.
“For a long time, much of the corporate community was in denial about their tax strategies,” a senior partner in the Washington office of one of the big accounting firms told me recently. “The politics of that have now changed — and a lot of it goes back to the work that Marty Sullivan has done.”
The boy from Jersey City
Like many in Washington, Marty Sullivan grew up somewhere else — Jersey City, N.J. His mom was an elementary school teacher, his dad a reporter for the local newspaper covering Jersey City’s notoriously corrupt government. Marty was the fifth of eight children. Although the family didn’t have much money, he managed to get a good Jesuit education at St. Peter’s Prep. He also got his first exposure to tax avoidance at a Mafia-owned restaurant, where he worked washing dishes and was paid strictly in cash. By the time he was a high school senior, the restaurant manager was telling the somewhat shy but reliable Sullivan that he had the potential to become a busboy some day.
The admissions committee at Harvard thought it saw greater potential.
Freshman year at Harvard is apt to be a bit of a culture shock for a kid from Jersey City. Sullivan’s early test scores in the introductory economics class were so low that a teaching assistant suggested he consider another major. But he stuck it out long enough to catch the attention of Prof. Dale Jorgensen, then one of the country’s leading economists, who eventually invited Sullivan to become a research assistant. Only three years later, he was at Jorgensen’s side as the economist told the Ways and Means Committee that a new tax break for business investment the committee was considering would effectively wipe out corporate taxes.
“That experience really turned my head,” Sullivan recalls.
After earning his PhD at Northwestern and settling into a teaching job at Rutgers, Sullivan got a call from a Treasury official who had read a paper he had written and asked g him to come to Washington. It was 1985, and tax reform had become a top priority for both the Congress and the Reagan White House.
“Suddenly I was sitting in a room with a dozen or so extremely bright people and we were pretty much rewriting the nation’s tax laws,” said Sullivan, who joined the Treasury’s Office of Tax Analysis. “I remember thinking that I really wanted to hang out with these guys.”
“He was able to take complicated ideas and explain them to members [of Congress] in a way that wasn’t talking down,” said Mark Mazur, assistant secretary of the Treasury for tax policy, who worked with Sullivan on the committee and remains part of his extensive network in the tax world.
Two years later, Sullivan moved to the other end of Pennsylvania Avenue to join the elite staff of Congress’s Joint Committee on Taxation.
“Even then, Marty was very independent,” recalls Peter Merrill, another Jorgensen protege at the committee who now heads the economic analysis group at PWC, the giant accounting firm. “Some of us can accommodate a party line that’s laid down by those above us in the hierarchy. Marty has no interest in that.”
In 1992, Sullivan took up a job offer he couldn’t refuse from Arthur Andersen, the leading accounting firm of the day. With two young children and a wife at home, he needed to earn more money. But it wasn’t long before he realized that he wasn’t cut out for a corporate culture.
“Fundamentally, I’m an intellectual,” Sullivan says. “When arguing on behalf of a client, you have to be 100 percent for that client. That doesn’t mean lying, but it doesn’t mean telling the whole story either. I wasn’t really comfortable with that.”
So Sullivan quit his job at Arthur Andersen and became a house husband while his wife, Mary, returned to her job as a government economist. One day a stranger named Tom Field knocked at the door. Field had been a top tax lawyer at the Treasury until the early 1970s but left out of frustration at the undue influence of corporate lobbyists in the making of tax policy. With a number of partners, among them Marty Lobel, legislative assistant to then-Sen. William Proxmire, and Tom Reese, a reform-minded priest fired by the Vatican as editor of a Jesuit magazine, Field launched a nonprofit organization, Tax Analysts, to advocate for reform of the tax code.
It wasn’t long before reporters began calling Field with questions about tax policy. And Field began to write down his answers and distribute them in a mimeographed newsletter. They called it Tax Notes.
“We discovered that Washington tax lawyers and lobbyists and government officials were willing to pay rather generous amount of money for a six-page newsletter,” recalled Lobel, now a private attorney. He continues to serve as Tax Analysts board chairman. “We also discovered that the best way to advocate for tax reform was not to advocate at all, but simply expose what was really going on.”
By the time Field showed up at Sullivan’s door in 1995, Tax Analysts had 100 employees and a growing portfolio of tax newsletters. The pay would be nowhere near what he was earning at Arthur Andersen, but it would allow him to work from home and continue to home-school a daughter with developmental delays. And he was happy to take up Field’s challenge, as Sullivan now characterizes it, “of working round the clock to expose corporations that are getting away with murder.”
“Right from the start, I knew he’d be a star,” says Field, who is now retired.
‘Eye for that golden nugget ’
“The first thing I do when I get Tax Notes is turn to Marty’s column,” said Bill Gale, the Brookings economist and co-director of the Tax Policy Center. A Sullivan column, he says, is always thorough, meticulous, and reliable. It also has the advantage of being readable, as clear and concise as anything about taxes can be.
Sullivan’s focus is the economics of taxation — the effect of a particular tax or tax policy on employment, income, profits or economic growth. But unlike economists who understand taxes at the level of theory or abstraction, explains Alan Auerbach, an economist at the University of California who has known him since their Harvard days, Sullivan digs in to understand how households and firms actually behave and how the law is enforced.
Sullivan is famous for digging into the footnotes of the public disclosures of big corporations to find out what taxes they really pay in each of the places they do business. The companies don’t make it easy, and many of the taxes companies claim to pay are deferred until a later time, or never paid at all.
“Marty has an extraordinary eye for that golden nugget buried in a pile of public information,” says David Cay Johnston, a former reporter for the New York Times who lectures on tax policy at Syracuse University’s law school.
Sullivan is hardly the only one in Washington who has been thinking and writing about corporate tax reform. There are think tanks such as the Tax Policy Center, plus a small coterie of investigative reporters such as Johnson, Jesse Drucker at Bloomberg News, and David Kocieniewski and Charles Duhigg of the New York Times, who won a Pulitzer Prize this year for a series that revealed the inside details of Apple’s international tax strategy.
And surely no one has been beating the drum for corporate tax reform longer or harder than Robert McIntyre at the liberal-leaning Citizens for Tax Justice.
“He’s an unflinching advocate,” Sullivan says admiringly of McIntyre. “I’m a flinching one.”
Indeed, it may be his restraint that sets Sullivan apart. These days, there’s probably no policy area where it’s harder to find objective, unbiased analysis than taxes, which have become the bloody battleground of American politics. In addition to the broad disagreements between Democrats and Republicans about how high taxes should be and how the burden should be distributed on any particular tax issue, there are likely to be dozens of special interest groups making wildly conflicting claims about fairness or economic impact. Sullivan comes as close as anyone comes to be the straight-shooting arbiter of the truth.
“With Marty, it’s hard to pigeonhole him as having any ideology other than a stubborn attachment to common sense,” said Ed Kleinbard, former chief of staff of Congress's Joint Committee on Taxation who teaches tax law at the University of Southern California.
“What I like about Marty is that I have no idea what his politics are,” said Kevin Hassett, a tax expert at the conservative American Enterprise Institute. “He goes wherever the facts and the economics lead him.”
It’s not that Sullivan doesn’t have opinions — he’s got one on just about any aspect of tax policy that you can think of, and lots more that you haven’t. But he’s just as likely to criticize the Obama administration as the tea party or to advocate policies supported by small businesses as those backed by large multinationals.
What you notice reading through a stack of Sullivan columns is how fair and rational they are, devoid of hyperbole and cheap shots, with only the rare flash of sarcasm or irony. He is careful to present the best arguments of those with whom he disagrees, if only to explain why they are wrong. His writing style is spare and confident.
Yet beneath this veneer of logic and restraint are the passion and moral sensibility of a crusader. Sullivan’s radar is finely tuned to pick up any hint of hypocrisy and intellectual dishonesty. And while the economist in him understands and accepts that corporations have a mandate to maximize profits through “tax efficiency,” the kid from Jersey City and St. Peter’s Prep is quietly outraged by government officials who so readily yield to the corporations’ self-serving entreaties.
“What politicians keep forgetting is that you can’t ‘partner’ with the corporate community when it comes to writing the tax laws,” Sullivan explains. “They’re not partners — they are adversaries.”
Tax all firms or none
So what would a reformed corporate tax code look like if Marty Sullivan had his way? What if he was back in that room with a dozen tax geeks trying to hammer out a fair, efficient corporate tax code? It would probably look something like this:
For starters, Sullivan, like most economists, thinks there shouldn’t be a tax on corporate profits. A genuinely fair and neutral tax code, they argue, would tax profits once — when they are passed on to shareholders. With the corporate tax, profits are taxed twice — once when the company records them as profits and again, on individual tax returns, when these profits are passed along to shareholders as dividends or capital gains from selling their shares.
When it comes to this double taxation, however, Sullivan has made peace with the reality that good politics trumps good economics: There are few politicians who would dare to champion the idea that individuals should pay higher taxes so corporations should pay none.
Certainly it would make the corporate tax more defensible, Sullivan is quick to add, if all businesses were required to pay it. But, as it happens, many are exempt: those organized as partnerships, sole proprietorships, closely-held private firms (known as “S corporations”) or limited liability companies and partnerships (LLC’s and LLP’s). Their profits are simply “passed through” to their owners each year and taxed once as individual income.
For many years, these were mostly small enterprises, so exempting them from the corporate tax was both politically popular and not overly costly to the Treasury. As recently as 1980, their profits represented about a quarter of all business income.
But in recent years, the ranks of “pass-throughs” has been swelled by giant law firms, hedge funds, energy and real estate partnerships, venture capital firms, investment banks and giant family-owned companies. Today, the Treasury estimates, as much as 70 percent of net business income escapes the corporate tax.
What this means is that there are companies of the same size with the same profits, in some cases competitors in the same industry, that are paying significantly lower tax rates — on average, 6 percentage points lower — just because they operate under a different legal charter.
Digging through IRS statistics, Sullivan found that there are nearly 20,000 “pass-throughs” in the United States with assets of more than $100 million — hardly anyone’s idea of a small, struggling business. That list included nearly 1,000 large but closely held “S” corporations with average sales of more than $500 million and annual profits in excess of $30 million. None of them pays a dime in corporate tax.
“The unfairness of this is so plain even a 5-year-old can understand it,” Sullivan wrote in a recent column. This disparate tax treatment doesn’t just distort investment and economic activity; by Sullivan’s estimate, it also robs the Treasury of about $40 billion a year. That alone is enough to knock 3 percentage points off the corporate tax rate.
Acknowledging the political power of small business, Sullivan’s fix is fairly simple: subject any business with sales over $50 million to the corporate tax.
World’s highest tax rate?
These days, the business lobby never misses an opportunity to point out that the 35 percent corporate tax rate is the highest in the industrialized world. With state taxes, it’s about 39 percent. For other industrialized countries, the statutory rate averages about 30 percent.
What really matters to business, of course, is not the statutory rate but the effective tax rate — the percent of profits paid in taxes once all the deductions, credits and other complex provisions of the tax code are taken into account. What you don’t hear from the business lobby is that, in terms of the effective rate, the United States is slightly below the average of the big industrial countries, at about 26 percent. According to Sullivan, the claim that our corporate tax rate is crippling the competitiveness of American business is “vastly overstated.”
The real problem, he says, isn’t the level of taxation but the huge variation in effective tax rates paid by different companies in different industries. The Treasury estimates that retailers and wholesalers, for example, pay an average effective federal tax rate of 31 percent, while utilities pay an average of 14 percent. Other industries fall somewhere in between. The variation within industries is even greater. The aim of tax reformers like Sullivan is to eliminate those unfair and investment-distorting variations by eliminating loopholes and preferences, making it possible to reduce the statutory rate without reducing the amount of total taxes collected.
And that’s where the fun begins. For while the business lobby stands united in its call for a lower rate, it remains badly divided over which tax preferences it would give up to achieve it. Various business groups and alliances claim to have a plan. But they refuse to disclose them publicly, lest they expose fissures in the business community and invite a budget-strapped Congress to close the loopholes without lowering the rate.
In his weekly columns, however, Sullivan has put an economically sound reform blueprint on the table.
It would start by dealing not with a loophole but a long-established accounting rule that allows businesses to deduct interest payments in calculating their taxable profits.
The rationale for this rule is straightforward: Interest is a business expense, just like the payroll or the electric bill. But economists think of it differently. All businesses need capital to start and grow, and that capitals comes in two flavors: debt that is borrowed and must be repaid, and equity that is invested by stockholders in exchange for an ownership share. Under today’s tax and accounting rules, money paid as interest on debt is tax-deductible, while money paid to equity shareholders is not.
This asymmetry winds up creating a big incentive for businesses to borrow money for new investments. The Treasury calculates that, under current tax rules, the tax rate on profits from an investment financed solely with shareholder’s equity could be 37 percent, while the rate on profits financed solely by debt could be negative 60 percent. In other words, the government winds up subsidizing debt-financed investment, not taxing it.
For Sullivan, fixing this distortion ought to be the first stop on the road to corporate tax reform. The political problem is that it will disproportionately affect companies and industries that rely on debt — utilities, finance, real estate and manufacturing.
Manufacturing, as it turns out, has also been the big winner from a wide array of tax preferences, in large part because union- and tech-friendly Democrats are often happy to join tax-averse Republicans in supporting such breaks. According to Sullivan, that means that any meaningful reform of the corporate tax will inevitably hit that sector the hardest.
Sullivan has some sympathy with two of the biggest preferences enjoyed by the manufacturing and tech sectors — the tax credit for research spending, and rules that allow businesses to deduct their investments in buildings and equipment at a faster pace. As Sullivan and other economists see it, research has benefits that spill over into the larger economy, justifying some government subsidy. And “accelerated depreciation” doesn’t reduce tax payments so much as delay them.
Sullivan sees no economic justification, however, for a special tax break for firms doing manufacturing and production at home rather than overseas. Over the years, the definition of what constitutes domestic production has become so ridiculously broad (it now includes making hamburger into patties and assembling wine and cheese gift baskets) that it costs the Treasury as much as $20 billion a year in forgone revenue. Getting rid of this one provision would be enough to lower the corporate rate by 1.5 percentage points. To Sullivan’s dismay, President Obama has proposed to increase the tax break while limiting it to “advanced” manufacturing.
Taxing foreign profits
It is the treatment of foreign profits such as Apple’s that is likely to be the most complex and contentious element of the corporate tax reform debate.
Under the current system, American companies pay the corporate tax in whatever foreign countries they do business in — and pay the Treasury any difference between the foreign rate and the higher U.S. rate of 35 percent.
But there’s a wrinkle: Companies can defer their U.S. tax payments until the profits are brought home (“repatriated”). And when this deferral is combined with all the other games companies play, the result, according to Sullivan, is that multinationals have a big incentive to shift jobs, investment and profits overseas.
Sullivan’s solution is fairly simple: Join the rest of the world and embrace a “territorial system” in which profits are taxed solely in the place they are earned. But Sullivan and other reformers would add two caveats: (1) much stronger rules against shifting of revenue, expenses and assets to foreign subsidiaries and (2) a minimum tax on all foreign profits, so that companies derive no benefit from shifting operations or profits to tax havens with little or no corporate tax.
Such a simplified system would put an end to “stateless income” and reduce the incentive to invest overseas or stash profits offshore. But it would also raise a question of how to treat the $1.7 trillion in “deferred” profits on which U.S. taxes have not yet been paid. The business lobby argues that if companies were allowed to bring that money home tax-free, or at a tax rate of 2 or 3 percent, it would create tens of thousands of American jobs. But exactly the same argument was made a decade ago on behalf of an earlier “tax holiday” that brought home $300 billion in corporate profits. A subsequent review showed that little of that money was used for job creation. Instead, as Sullivan has frequently reminded his readers, it was mostly used to pay down debt, pay dividends and buy back stock.
Politics of reform
Perhaps the biggest impediment to corporate tax reform isn’t the lack of consensus within the business community about which tax preferences will go and which will stay. While any genuine reform is likely to create sizeable numbers of winners and losers, from a political standpoint the lobbying by each groups is likely to cancel the other out. And as always happens in such circumstances, the financial sting for the losers could be reduced by phasing things in gradually.
The bigger political problem is that while both Republicans and Democratic leaders claim to support loophole-closing, rate-reducing, job-creating corporate tax reform and simplification, each party insists on linking it to other, more controversial priorities.
This year, House Republicans decreed that there would be no corporate tax reform without a simultaneous reform of the individual income tax code that lowers both the top individual and corporate rates to 25 percent. That would exponentially increase the political complexity of any reform effort by stirring up vehement opposition from special interest groups determined to protect popular deductions for home mortgages, charitable contributions, college tuition and state and local taxes, to name just a few.
The official reason offered by Republican leaders for coupling corporate and individual tax reform was that unless both the corporate and top individual rate were lowered in tandem to the same rate, it would jeopardize “job creating” small businesses that would continue to pay at the higher, individual rate. This argument, of course, ignores the advantage that most small businesses already have because they don’t pay the corporate tax and avoid double taxation.
The real reason, according to business lobbyists and aides on Capitol Hill, is that tea party Republicans are still smarting from the post-election budget deal last December that raised the top individual rate to 39 percent. Determined to roll it back, they see tax reform as the way to do it. That’s a non-starter for Democrats. And it also reflects the new reality of a Republican Party that is much more responsive to the needs of private businesses and wealthy individuals than it is to the interests of big, multinational corporations.
Meanwhile, Obama recently upped the political ante on corporate tax reform by demanding that the one-time surge in corporate tax revenue that would result from repatriation of deferred profits should not be used to permanently lower the corporate tax rate. Instead, he insisted it be used to pay for investments in infrastructure, community colleges and dozens of new manufacturing innovation institutes. By proposing to divert tens of billions of dollars from corporate rate reduction to public investment, the president effectively abandoned “revenue-neutral” tax reform in favor of something that would, in the long run, increase the total amount of taxes paid by businesses — a non-starter for Republicans and their corporate allies.
In a recent column in Tax Notes, Sullivan methodically analyzed a variety of policy options for untangling this political Gordian knot with a “business-only” tax reform that would deal with both corporations and the “pass-throughs.” But Sullivan acknowledged that despite the “feigned comity” and “political pragmatism” that has been on display since the resolution of the budget crisis — and despite the substantial boost that it would bring to the economy in terms of efficiency, productivity, jobs and investment — tax reform remains a long shot.
Alan Viard, a tax economist at the American Enterprise Institute, takes a somewhat more optimistic view: “The thing to remember about tax reform is that it always looks improbable until it happens,” he says.
In “This Town,” his recent best-selling book about the media and political culture in Washington, New York Times reporter Mark Leibovich describes a capital run by a clique of ethically challenged strivers consumed by their ambition for money, fame, status and an invitation to the best parties.
It’s an amusing but ultimately flawed portrait. What is missing from Leibovich’s cynical and rather cartoonish portrait of Washington are people like Marty Sullivan — talented, hard-working professionals who are motivated to do right for the country. They don’t make big money, they don’t get much publicity, and they certainly won’t be found at the annual White House Correspondents dinner.
What they do have is the credibility to separate the truth from the self-serving hokum, the wisdom to fashion a workable compromise and the persistence to hang around long enough to make a difference.
In the real Washington, they are the interesting characters, the genuine celebrities, the real heroes.
Correction: An earlier version of this story misidentified Edward Kleinbard. The story has been corrected.