The real tax avoidance scandal centers on dividends and capital gains

April 3, 2011

Just in case you missed it, the New York Times recently ran a blockbuster story reporting that General Electric — with $14.2 billion in worldwide operating profits in 2010 — owed no U.S. corporate taxes for the year. Gulp. The story must have given heartburn to some in the White House, because Barack Obama has named GE CEO Jeffrey Immelt to head the President’s Council on Jobs and Competitiveness. Well, GE seems plenty competitive in tax avoidance. The question is: Can we do anything about it?

The answer is “yes,” but the right response is counterintuitive. It’s not to raise taxes on multinational companies but to lower them. To offset that tax loss and cut budget deficits, we should then increase individuals’ taxes on corporate dividends and capital gains (profits from sales of stock or property). They enjoy a ridiculously low top rate of 15 percent — a giveaway to the rich that makes no sense as economic policy. The wealthiest 1 percent of Americans receives two-thirds of capital gains and dividends.

Before getting into details, a few observations on the Times’ story. It merged — and muddled — two separate problems.

First, GE’s U.S. taxes. No one has accused the company of anything illegal. It reported a pretax profit of $5.1 billion on its U.S. operations for 2010 but said previous losses eliminated U.S. tax liability. Those losses stemmed from the financial crisis and were incurred by GE Capital, a subsidiary that makes loans. It is also worth noting that, despite its present success, GE hasn’t fully recovered from the crisis. In 2010, global profits were 44 percent lower than in 2007.

Next, GE’s tax avoidance. GE annually files tax returns in 250 global jurisdictions; its tax department employs 975. Like many multinationals, it aggressively strives to steer foreign profits into countries with low taxes; as long as these profits stay abroad, they are not taxed by the United States. (There’s a distinction between tax “avoidance” and tax “evasion.” Avoidance means reducing taxes legally; evasion is illegal nonpayment.)

Note that GE’s status as a multinational didn’t eliminate its 2010 U.S. taxes; that resulted from the financial crisis. But GE’s multinational status does pose a public policy issue. How to deal with these footloose firms?

Love or hate them, multinationals are here to stay. By 2008, IBM, Caterpillar and all other U.S. multinationals had invested $3.2 trillion abroad; meanwhile, Toyota, Siemens and other foreign companies had invested $2.2 trillion here. Waging war against multinationals is senseless. As Dartmouth economist Matthew Slaughter notes, they represent a huge source of well-paid jobs and advanced technology. Indeed, countries compete for them by cutting corporate tax rates. Ireland’s is a puny 12.5 percent.

We’ve ignored this competition. Our top corporate tax rate of 35 percent is one of the highest, though some tax breaks reduce the effective rate. Europe’s average rate is closer to 25 percent. Meanwhile, successive presidents and Congresses cut the capital gains rate from 28 percent under President Ronald Reagan to 20 percent and then 15 percent — a rate also enjoyed unjustifiably by hedge fund managers. In 2003, Congress cut the rate on dividends, once taxed as ordinary income, to 15 percent.

That’s all backward, say economists Rosanne Altshuler, Benjamin Harris and Eric Toder in a paper from the nonpartisan Tax Policy Center. We should lower the tax on corporations. That would make the United States more attractive to American and foreign multinationals. We should then raise taxes on the people who receive the benefits of profits. The economists suggest cutting the corporate rate to 26 percent and increasing the capital gains rate to 28 percent; dividends would be taxed as ordinary income. Eliminating unwarranted business tax breaks would generate extra revenue.

If done properly, this switch would create jobs, reduce the budget deficit and diminish tax avoidance. The idea that raising rates on capital gains and dividends would harm the economy is contradicted by experience. After all, the Tax Reform Act of 1986 — proposed by Reagan with bipartisan support — raised the capital gains rate to 28 percent, and the economy did fine. Indeed, ending the low 15 percent rate for hedge funds would remove a tax subsidy that favors paper investing over real production.

The scandal is not that GE is paying no U.S. taxes for 2010; that will be temporary. The scandal is that we’re not facing the realities of globalized business. Liberals would penalize U.S. multinationals by raising their taxes; conservatives champion dubious tax cuts for the rich. Whatever their partisan appeal, these policies do little for the economy. It’s true that many factors influence where companies expand: wage rates, local markets, government regulations, exchange rates. But if we take away one factor — taxes — we’re crippling our ability to compete for global business.

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