Stateless Income

This paper and its companion, The Lessons of Stateless Income, together comprehensively analyze the tax consequences and policy implications of the phenomenon of “stateless income.” Stateless income comprises income derived for tax purposes by a multinational group from business activities in a country other than the domicile of the group’s ultimate parent company, but which is subject to tax only in a jurisdiction that is not the location of the customers or the factors of production through which the income was derived, and is not the domicile of the group’s parent company. Google Inc.’s “Double Irish Dutch Sandwich” structure is one example of stateless income tax planning in operation. This paper focuses on the consequences to current tax policies of stateless income tax planning. The companion paper extends the analysis along two margins, by considering the implications of stateless income tax planning for the reliability of standard efficiency benchmarks relating to foreign direct investment, and by considering in detail the phenomenon’s implications for the design of future U.S. tax policy in this area, whether couched as the adoption of a territorial tax regime or a genuine worldwide tax consolidation system. This paper first demonstrates that the current U.S. tax rules governing income from foreign direct investments often are misapprehended: in practice the U.S. tax rules do not operate as a “worldwide” system of taxation, but rather as an ersatz variant on territorial systems, with hidden benefits and costs when compared to standard territorial regimes. This claim holds whether one analyzes these rules as a cash tax matter, or through the lens of financial accounting standards. This paper rejects as inconsistent with the data any suggestion that current law disadvantages U.S. multinational firms in respect of the effective foreign tax rates they suffer, when compared with their territorial-based competitors. This paper’s fundamental thesis is that the pervasive presence of stateless income tax planning changes everything. Stateless income privileges multinational firms over domestic ones by offering the former the prospect of capturing “tax rents” — low-risk inframarginal returns derived by moving income from high-tax foreign countries to low-tax ones. Other important implications of stateless income include the dissolution of any coherence to the concept of geographic source, the systematic bias towards offshore rather than domestic investment, the more surprising bias in favor of investment in high-tax foreign countries to provide the raw feedstock for the generation of low-tax foreign income in other countries, the erosion of the U.S. domestic tax base through debt-financed tax arbitrage, many instances of deadweight loss, and — essentially uniquely to the United States — the exacerbation of the lock-out phenomenon, under which the price that U.S. firms pay to enjoy the benefits of dramatically low foreign tax rates is the accumulation of extraordinary amounts of earnings (about $1.4 trillion, by the most recent estimates) and cash outside the United States. Stateless income tax planning as applied in practice to current U.S. law’s ersatz territorial tax system means that the lock-out effect now operates in fact as a kind of lock-in effect: firms retain more overseas earnings than they profitably can redeploy, to the great frustration of their shareholders, who would prefer that the cash be distributed to them. This tension between shareholders and management likely lies at the heart of current demands by U.S.-based multinational firms that the United States adopt a territorial tax system. The firms themselves are not greatly disadvantaged by the current U.S. tax system, but shareholders are. The ultimate reward of successful stateless income tax planning from this perspective should be massive stock repurchases, but instead shareholders are tantalized by glimpses of enormous cash hoards just out of their reach

The Right Tax at the Right Time

The companion paper to this (Capital Taxation in an Age of Inequality) argues that a moderate flat rate (proportional) income tax on capital, measured and collected annually, has attractive theoretical and political economy properties that can be harnessed in actual tax instrument design. This Article continues the analysis by specifying in detail how such a tax might be designed. The idea of the Dual Business Enterprise Income Tax, or Dual BEIT, is to offer business enterprises a neutral profits tax environment in which to operate. To do so, normal returns to capital are exempt from tax by means of an annual capital account allowance, termed the Cost of Capital Allowance (COCA). In turn, investors in firms include in income each year the same COCA rate, applied to their respective tax bases in their investments. The result is a single tax on capital income (rents plus normal returns), where the tax on normal returns is imposed directly on the least mobile class of taxpayers. Labor income continues to be taxed at progressive tax rates. This Article develops in detail the design of the Dual BEIT, at a level of specificity that permits readers to judge the real-world plausibility of the proposal. In doing so, the Article focuses particularly closely on three design issues. First, because labor is taxed at progressive rates and the top rate exceeds the capital income tax rate, the Dual BEIT must specify a labor-capital income tax centrifuge to tease apart labor from capital income when the two are intertwined in respect of the owner-entrepreneur of a closely held firm. Second, the Article considers the theory and practice behind the choice of the COCA rate: that is, the Article inquires into just what should be meant by a “normal” return to capital. Third, the Article specifies an international tax regime that should be attractive to firm managers yet robust to stateless income gaming. Throughout, the emphasis is on developing pragmatic technical solutions that are implementable without profound transition issues, that are administrable, and that fairly balance theoretical desiderata against political economy realities. Note: This Article was prepared prior to the consideration by Congress in late 2017 of the Tax Cuts and Jobs Act (TCJA). The Article therefore does not address any of the provisions of that legislation. In general, however, the TCJA can be summarized as a useful example of capital income tax reform done exceedingly badly

Taxing across borders: tracking personal wealth and corporate profits

This article attempts to estimate the magnitude of corporate tax avoidance and personal tax evasion through offshore tax havens. US corporations book 20 percent of their profits in tax havens, a tenfold increase since the 1980; their effective tax rate has declined from 30 to 20 percent over the last 15 years, and about two-thirds of this decline can be attributed to increased international tax avoidance. Globally, 8 percent of the world's personal financial wealth is held offshore, costing more than $200 billion to governments every year. Despite ambitious policy initiatives, profit shifting to tax havens and offshore wealth are rising. I discuss the recent proposals made to address these issues, and I argue that the main objective should be to create a world financial registry