The Center's work on 'Taxes and the Economy' Issues


Tax Incentives for Retirement Savings Need Reform

September 29, 2014 at 2:18 pm

“We need to hear facts and serious policy proposals, not political slogans” like “upside-down tax incentives,” the Senate Finance Committee’s top Republican, Orrin Hatch, said at a recent committee hearing on retirement savings.  But tax incentives for retirement plans like 401(k)s and individual retirement accounts (IRAs)are indeed “upside down,” providing the largest subsidies to high-income taxpayers while benefiting low-income households the least (see chart).  As we’ve written, tax incentives for retirement savings are expensive, inefficient, and inequitable, making them ripe for reform.

New studies, including one highlighted at the September 16 Senate hearing, show how some very high-income taxpayers are accumulating enormousbalances using tax-preferred accounts — well beyond the accounts’ intended purposes.  Roughly 9,000 taxpayers have IRAs with balances that top $5 million, a Government Accountability Office (GAO) study found.  Despite contribution limits to tax-advantaged retirement accounts, such balances are possible because some executives buy shares of stock for their IRAs at extremely low valuations — sometimes less than a penny each.  Those balances then swell when the stocks are valued at market price — and the gain is tax-free.  Senate Finance Committee Chairman Ron Wyden (D-OR) termed this abuse of IRAs an unintentional “tax shelter for millionaires.”

The GAO study complements research published in the Journal of Retirement, which estimated that about 85,000 households each held over $3 million in certain tax-preferred plans, including IRAs.

Retirement savings tax incentives are among the largest federal category of “tax expenditures,” in terms of federal revenue losses.  While lavishing large tax benefits on very wealthy filers, they do little to encourage new saving among a broad segment of lower- and middle-income Americans.

The need for reform is clear.

President Takes Important First Step Against Corporate “Inversions”

September 23, 2014 at 5:16 pm

In an important first step to stem “inversions,” in which a larger U.S. multinational merges with a smaller foreign firm to avoid U.S. taxes, the Treasury announced new rules that not only effectively remove one way that taxpayers subsidize such deals, but also tighten existing limits on them.  The President should (and likely will) look for further steps the Administration can take, and Congress should do its part to protect the corporate tax base from this brazen tax avoidance.

Here’s some background.  Corporations do not pay taxes on foreign earnings until they bring them back to the United States.  Many firms are looking for ways to access their foreign-held profits while avoiding U.S. taxes — the same taxes that domestic firms pay on their profits.  A corporate inversion is one way to achieve this goal, which is why firms such as Medtronic, AbbVie, Pfizer, and Mylan have all sought or announced plans to invert.

The Treasury’s new rules aim to discourage firms from pursuing such tax avoidance inversions.  One new rule prevents inverted firms from using so-called “hopscotch” loans to access a foreign subsidiary’s prior earnings and avoid U.S. tax.  These loans, which a subsidiary in a foreign tax haven makes to the new foreign parent (thereby “hopscotching” over the former, U.S.-based parent in order to avoid U.S. tax), will now count as U.S. property and thus be taxable.

The Treasury is also closing some loopholes in existing anti-inversion regulations, such as tightening the rule that a U.S. firm combining with a foreign firm continue to be taxed as a U.S. firm if it owns 80 percent or more of the combined company.  The Treasury rule aims to ensure that this 80 percent threshold is a real one.

The President and several key members of Congress have called for legislation to lower this threshold even further.  They want to set the threshold at 50 percent, meaning that a U.S. firm could not invert without losing control of the new firm.  That would act as a strong deterrent against inversions.

The President and Congress should also pursue how to crack down on “earnings stripping,” which allows companies to use debt to siphon profits out of the United States.  A further option would be to require companies that invert to pay the taxes they owe before they “leave” the country.  The President and Congress should take these next steps to combat the inversion epidemic.

Debating Corporate “Inversions”

September 19, 2014 at 3:32 pm

At a Heritage Foundation panel discussion this week, CBPP Senior Tax Policy Analyst Chye-Ching Huang debunked myths surrounding the recent wave of corporate “inversions,” in which U.S.-based firms move their headquarters overseas for tax purposes, and explained why policymakers should take strong action against them, explaining:

People think that there is a simple story that is driving inversions . . . that there are companies that are changing their tax headquarters to escape the highest statutory rate in the OECD [Organisation for Economic Co-operation and Development].  But that simple story is not what is happening. . . . The problem is really about U.S. multinationals and other multinationals gaming the tax system in the U.S. and all throughout the OECD so that they can claim that all of their profits are in tax havens.

Other panelists included CNBC Senior Economics Contributor Larry Kudlow, Heritage Chief Economist Stephen Moore, and Walter J. Gavin, Retired Vice Chairman of Emerson Electric.

As we’ve explained (see here and here for examples), the effective tax rate that U.S. multinationals face on their worldwide income is well below the 35 percent top U.S. statutory rate.  A big reason why is that multinationals report vast amounts of their income as coming from tax havens where they pay little or no tax.  Adopting a foreign headquarters could make it easier for multinationals to claim that their profits are made offshore and to use tax havens to avoid taxes anywhere.

House Republicans’ Wrong-Headed Approach to Tax Extenders

September 17, 2014 at 1:00 pm

House Republicans are putting before the House this week a campaign-oriented bill of wide-ranging measures that have previously passed the House, including repealing portions of the Affordable Care Act and scaling back Dodd-Frank regulations.  The bill, which won’t advance beyond the House due to obvious Senate and White House opposition, also includes business tax provisions that lawmakers will likely consider again during Congress’ post-election lame duck session this fall.  For that reason alone, the legislation warrants some attention.

The House bill would make permanent certain “tax extenders” — so named because Congress routinely extends them for a year or two at a time — as well as bonus depreciation, which lets businesses take larger upfront tax deductions for certain purchases, such as machinery and equipment, and that historically has been a temporary measure to help revive a weak economy.  Congress should reject the House approach to these provisions because it is not fiscally responsible, is poorly designed from an economic standpoint, and is antithetical to tax reform.  Moreover, it reflects seriously misplaced priorities, putting the permanent extension of these business provisions ahead of more pressing provisions for hard-working families.

  • Its $500 billion price tag is fiscally irresponsible.  Policymakers have enacted significant deficit-reduction measures since 2010, with the vast majority coming from spending cuts.  The one revenue contribution stems from the 2012 “fiscal cliff” bill — i.e., the American Taxpayer Relief Act — that raised $770 billion in revenue from high-income taxpayers (from 2015 to 2024).  The tax extenders and bonus depreciation provisions in the House bill would reduce revenue by $500 billion over the decade, effectively giving back two-thirds of the revenue contribution to deficit reduction (see chart).  (The total cost of the House bill is about $575 billion, because of other revenue-losing provisions.)

  • It’s poorly designed from an economic standpoint because it makes bonus depreciation permanent.  Making bonus depreciation permanent accounts for more than half of the $500 billion cost of the business tax provisions.  But bonus depreciation was specifically designed not to be permanent because its temporary nature is what drives its (albeit limited) effectiveness during recessions.  Its modest economic boost comes entirely from inducing firms to accelerate some of their purchases into the period when the tax break is in effect and the economy is weak.  Making it permanent would negate this modest incentive effect.  That’s why the Bush Administration and Congress allowed it to expire after the 2001 recession ended and why this Congress should let it expire now.
  • It moves away from tax reform.  The fundamental nature of tax reform is to “broaden the base” by scaling back tax subsidies and to use the freed-up funds to lower tax rates, reduce budget deficits, or both.  For example, House Ways and Means Chairman Dave Camp (R-MI) earlier this year advanced a comprehensive plan that eliminated tax subsidies for certain business investments, including the repeal of bonus depreciation.  These changes were central to his base-broadening provisions.  But the package that House Republicans are now bringing before the House goes in the opposite direction.  Its provision to make bonus depreciation permanent narrows the tax base and, thereby, moves away from tax reform.

If, during the lame duck session, policymakers consider making any tax extenders permanent, they should focus first on making permanent important provisions of the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC) that are due to expire at the end of 2017.  Failure to make the EITC and CTC provisions permanent would have a significant impact on low- and moderate-income families, pushing 17 million people (including 8 million children) into — or deeper into — poverty.

Kleinbard: “Competitiveness” Argument for Moving Firms’ Headquarters Overseas Is a Canard

August 12, 2014 at 10:10 am

The claim that many U.S. companies are moving their headquarters overseas because U.S. corporate tax rates make them uncompetitive is “largely fact-free,” USC law professor and former Joint Tax Committee staff director Edward Kleinbard concludes in a new paper.

While many firms and their lobbyists highlight the 35 percent top U.S. corporate rate, that’s not what companies actually pay, Kleinbard explains.  The effective tax rate that U.S. multinationals face on their worldwide income — that is, the share of this income that they pay in taxes — is well below this statutory rate.  A big reason is that multinationals report vast amounts of their income as coming from tax havens where they pay little or no tax, even if they have few staff and do little business there.

Kleinbard also explains that the 2004 repatriation tax holiday, which allowed multinationals to bring profits held overseas back to the United States at a temporary, vastly reduced tax rate, gave them a big incentive to stockpile billions more in tax havens and await another tax holiday.  These large stashes of profits in tax havens are an important reason — Kleinbard thinks the key reason — why many companies are considering moving their headquarters overseas.  By “inverting,” these companies can basically declare their own, permanent tax holiday and avoid ever paying U.S. taxes on foreign-held profits.  And once inverted, they can use legal avoidance schemes to effectively get those profits to their U.S. shareholders.

In other words, multinationals are already using tax havens to achieve zero or extremely low tax rates.  Firms considering inversions are searching not for a “competitive” tax rate but a zero tax rate by ensuring that those profits remain “stateless” — that is, taxed nowhere at all. (Echoing a famous line from Mae West, Kleinbard’s paper is titled “‘Competitiveness’ Has Nothing to Do With It.”)

Kleinbard’s solution has three parts:

  1. Make it harder for a U.S. multinational to invert.
  2. Prevent companies that do invert from effectively distributing their “foreign profits” to U.S. shareholders without paying U.S. tax.
  3. Make it harder for all U.S. multinationals to claim that U.S.-earned profits were actually earned in tax havens and low-tax countries.