The Great Evasion

SYNOPSIS: Unable to to pass corporate tax breaks through Congress, the administration is now encouraging companies to evade taxes by incorporating themselves in foreign tax havens

Last week Stanley Works, a Connecticut tool company, postponed its plan to evade taxes by incorporating itself in Bermuda. The decision reflected pressure from the White House, which denounced the move as unpatriotic in a time of national emergency.

I am, of course, making that last part up. The shareholders' vote approving Stanley's move was challenged by Connecticut officials; also, the company has been put in the spotlight by David Cay Johnston, The New York Times's invaluable tax reporter. But the Bush administration, always quick to question the patriotism of anyone who gets in its way, has said nothing at all about Stanley Works, and little about the growing number of U.S. corporations declaring themselves foreign for tax purposes.

To be fair, the administration didn't create the loophole Stanley wants to exploit. And it's not enough just to denounce corporations that exploit tax loopholes; the real answer is to deny them the opportunity. Still, the administration's silence is peculiar. What's going on?

The closest we have to an official statement on the issue of companies moving offshore comes from the Treasury Department's chief of tax enforcement: "We may need to rethink some of our international tax rules that were written 30 years ago when our economy was very different and that now may be impeding the ability of U.S. companies to compete internationally."

Unfortunately, that statement misrepresents the issue. For one thing, U.S. companies don't necessarily pay higher taxes than their foreign counterparts; Germany's corporate tax rate is significantly higher than ours, France's rate is about the same, and Britain's is only marginally lower. Anyway, the Treasury statement makes it sound as if we're losing revenue because U.S.-based companies are moving their headquarters to lower-cost locations, or because they are losing market share to foreign rivals. Neither proposition is true. In fact, we're losing revenue because profitable U.S. companies are using fancy footwork to avoid paying taxes.

By incorporating itself in Bermuda, a U.S.-based corporation can without moving its headquarters or anything else shelter its overseas profits from taxation. Better yet, the company can then establish "legal residence" in a low-tax jurisdiction like Barbados, and arrange things so that its U.S. operations are mysteriously unprofitable, while the mail drop in Barbados earns money hand over fist. In other words, this isn't about competition; it's about tax evasion.

The natural answer would seem to be to crack down on the evaders to find a way to tax companies on the profits they really earn in the U.S., and prevent them from using creative accounting to make the profits appear somewhere else. It's hard, but not impossible.

But here's the key point: Administration officials don't want to help collect the corporate profits tax. Unable to push major corporate tax breaks through Congress, the administration has used whatever leeway it has to offer such breaks without legislation. The Hill, a nonpartisan publication covering Congressional affairs, recently reported on "a series of little-noticed executive orders . . . that will provide corporations with billions of dollars in tax relief without the consent of Congress."

And now the silence on Stanley becomes comprehensible. The administration doesn't want to say outright that it's in favor of tax evasion; but it also doesn't really want to collect the taxes. Better to say nothing at all.

The trouble is that hinting, even by silence, that it's O.K. not to pay taxes is a dangerous game, because it can quickly grow into a major revenue loss. Accountants and tax planners have taken the hint; they now believe that it's safe to push the envelope. Tax receipts this year are falling far short of expectations, even taking the recession into account; my bet is that it will turn out that newly aggressive tax avoidance by corporations (and wealthy individuals) is an important part of the story. And it will get worse next year.

Furthermore, what does it say to the nation when companies that are proud to stay American are punished, while companies that are willing to fly a flag of convenience are rewarded?

If the administration wants to eliminate the corporate profits tax, let's have a real, open debate starting with an explanation of how the lost revenue will be replaced in a time of severe budget deficits. Meanwhile, let's crack down on tax evasion.

Originally published in The New York Times, 5.14.02