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Finance

Frothy coffee: Letting off steam

The U.K. Parliament recently held hearings concerning the amount of tax paid in the U.K. by the subsidiaries of international companies. They called on Starbucks, Google and Amazon to testify. Over a period of three years, Amazon U.K. paid £2.3 million on sales of £7.1 billion. In 2011, Google U.K. paid £6 million on sales of £7.1 billion. Starbucks has paid £8.5 million in taxes in 14 years, during which time their sales were £3 billion – a tax rate of less than 1 percent.

Starbucks explained that they used some of the methods described here last month. Starbucks U.K. pays a royalty to Starbucks Netherland for the use of the trademark and business methods. That transfers profits to the Netherlands where royalty income is not taxed. Starbucks U.K. “buys” its coffee from Starbucks Switzerland at a price 20 percent above market, which transfers profits to Switzerland where the taxes are much more lenient. After the hearings, Starbucks agreed voluntarily to pay the U.K. an extra £20 million in taxes.

Negotiations in this country to avoid the fiscal cliff have involved a lot of discussions about tax rates for the top 2 percent of taxpayers and whether lower taxes on higher incomes results in job creation. There has been far less talk about corporate tax rates and closing corporate loopholes.

Why can the U.K. address these issues head on with U.S. companies while our politicians are silent? One reason is that the U.K. political system is far less influenced by lobbyists and corporate contributions to political campaigns, and so they are less inhibited.

The theoretical debate about whether lower tax rates will create jobs is just that – a debate. But in the case of corporate tax rates, we have real-life empirical evidence to test the theory. Eight years ago, Congress was concerned about U.S. corporations parking profit offshore in order to avoid U.S. taxes. So they passed the “American Jobs Creation Act of 2004” (AJCA). It allowed U.S. companies to repatriate income from outside the U.S. at an effective tax rate of 5.25 percent instead of the top 35 percent corporate rate. But there was a condition.

Congress specified that in order to qualify for the reduced taxation, the repatriated funds must be reinvested in the U.S. “for the funding of worker hiring and training, infrastructure, research, and development.”

In response to the AJCA, corporations returned $312 billion to the U.S. and received an estimated $3.3 billion in tax relief. In October 2011, the Congressional Research Service published a report that measured the effect of the AJCA. The report surveyed major multinational companies from 2002 through 2007. The main findings were:

  1. After taking advantage of the lower tax rate and repatriating over $150 billion, the top 15 repatriating companies reduced their overall U.S. workforce by nearly 21,000 jobs and showed slight decreases in U.S. research and development expenditures.
  2. Despite a prohibition on using repatriated funds for stock repurchases, between 60 and 90 percent of the repatriated cash from all 840 repatriating companies was associated with payouts to stockholders.
  3. Despite another prohibition on using repatriated funds for executive compensation, the annual compensation for the top five executives at the top 15 repatriating companies increased 27 percent in 2005, and another 30 percent in 2006.
  4. The top 15 firms accounted for over 50 percent of the repatriated funds and included Pfizer, Merck, Hewlett-Packard, Johnson & Johnson, IBM, Schering-Plough, DuPont, Bristol-Myers Squibb, Eli Lilly, Intel, and Oracle.
  5. Most of the repatriated funds came from tax haven jurisdictions. For seven companies (including Microsoft and Oracle), over 90 percent of the funds came from tax havens. Coca-Cola repatriated over $7 billion from a Cayman Island subsidiary that had no employees. Intel repatriated almost $5 billion from a Cayman subsidiary that had no office. Oracle repatriated over $3 billion from an Irish subsidiary with no office.

To be fair, one of the top 15 repatriating firms did create over 100,000 jobs between 2003 and 2010. The only problem is they were in India. It was so proud of the achievement that it filed a patent application in 2006 for computerized “Method for Identifying Human-Resource Work Content to Outsource Offshore.” In 2007, it filed another patent application describing a “Workforce Sourcing Optimizer” that claimed to be able to help clients achieve “50 percent of resources in China by 2010.” When the patent applications were made public in 2009, they were hastily withdrawn.

The study by the Congressional Research Service shows that the AJCA was an abject failure. Using accounting gimmicks to park funds in offshore tax havens will continue unless Congress acts to close the loopholes. The Congressional study also makes one question whether lowering corporate tax rates will generate U.S. jobs unless accompanying legislation is passed with a lot more teeth than the AJCA.

Another clue as to why the U.K. Parliament may be more willing to close these loopholes than we are may be found in the President’s Council on Jobs and Competitiveness. The chair of that council is the CEO of a company that paid no U.S. taxes from 2008 to 2010, despite profits exceeding $10 billion for the period. In 2010, the company spent $41.8 million in lobbying and political contributions. The company has 14 tax haven subsidiaries in Bermuda, Singapore and Luxembourg. By the end of 2010, they had $94 billion in unrepatriated profits. I am sure the chair gives the president sound and unbiased advice about closing these tax loopholes.

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