By David Morse, CPA Tax Policy Associate Director
President Trump struck against the Koch Brothers and their network last week in a tweet stating:
“They want to protect their companies outside the U.S. from being taxed, I’m for America First & the American Worker – a puppet for no one. Two nice guys with bad ideas. Make America Great Again! “ –Donald Trump, Twitter, July 31, 2018
The president’s trade policies and Koch opposition may have induced a reaction. But the President delved into the results of last December’s tax cuts, asserting that he is for “America First and Worker First.” By contrast, he said the Kochs “want to protect their companies outside the US from being taxed.” The Koch network has even indicated they have a priority concern for overseas workers. However, it is more likely that they are concerned with their ability to continue to enjoy tax avoidance.
Laura Ingraham said on Facebook that “One could also make the argument that selling out American workers, and offering up our industries and our marketplace to the gods of globalism is also pretty destructive.” ,Laura Ingraham Fox News, July 30, 2018.
If the President wants to seriously embrace the mantle of “America First” tax reform and Pro-“American Worker” tax policies, he should tell Chairman Kevin Brady (R-TX) of the House Ways and Means Committee to move towards a tax program that that prevents the Koch Brothers and other companies from avoiding taxes and laying off US workers and when moving overseas.
When Chairman Brady released a proposed Tax Cuts 2.0 plan two weeks ago, experts hoped for improvements and technical changes to make the Tax Cut and Jobs Act work better. However, the proposals were somewhat predictable and lackluster. Most notably, there were no changes fully addressing the Kochs’ globalist tax avoidance loopholes.
Before the TCJA, the Koch-financed tax network had been hyper-focused on achieving tax reform that enabled even more companies to profit from offshoring. Koch-Based multinational companies had been good at making their American profits disappear into foreign subsidiaries. But an origin-based territorial tax system was the desired goal of multinationals. Such a system has no constraints on one of the biggest practices of tax avoidance: profit shifting.
Under the current system, an American Koch-subsidiary selling in the US could buy its raw materials, services, and even production from foreign Koch-subsidiaries at a substantial mark-up. In effect, the American subsidiary selling the product to the American consumer would claim less profit in the US. Meanwhile, the foreign-subsidiaries (that never had any contact with the American consumer) would claim most of the profit. This allows a company to keep much of its earnings overseas. An origin-based territorial tax would have removed that limitation and keep profit shifting loophole in place. This type of territorial is fake because it continues to allow companies like the Koch Industries to avoid paying taxes unlike their domestic American competitors.
Unfortunately, the writers of the TCJA simply formulated a new skin for the old worldwide system and curbed some tax avoidance. The Congressional Budget Office (CBO) released a report indicating that only $65 Billion of over $300 Billion of profit shifting will be recaptured. The Koch Brothers’ are now working to repeal the modest anti-tax avoidance provisions, known as BEAT, FDII, and GILTI. But Congressional tax writers indicated that these protections were a natural consequence of a territorial tax. A territorial tax system will always be fake as long it relies on origin-based taxation. Michael Graetz, a Columbia Law School professor and former Treasury official, described GILTI as “a truck built on a car chassis.”
While Congress has recognized that multinational companies (such as those owned by the Kochs) have been avoiding American taxes, they declared victory after solving only around 20 percent of the issue of tax avoidance. Most analysts agree that while a snippet of tax avoidance was clipped off, the incentives for tax-avoidance methods remain sizable. What remains are significant differences in effective tax rates that disadvantage domestic corporations unable to compete with foreign and US multinational corporations. Simply put, domestic corporations can’t transfer-price their way out of facing a tax burden.
The TCJA solutions has additional problems. The bill continued incentivizes for many companies to move or keep production offshore as a mechanism to avoid taxes. Thus, the TCJA actually hurts American businesses and American workers by rewarding companies that move factories and jobs overseas. Koch industries has even more reason to offshore American factories and American jobs. The TCJA also didn’t fully achieve tax equality between domestic and foreign companies.
A truly America First tax system, one that protects production located in America, is still possible if Congress replaces the fake territorial tax with a real one—Destination-Based Sales Factor Apportionment. The principles of the sales factor system are simple. Companies pay taxes on their profits, but only on those profits directly allocated to sales within the US. Legal loopholes and profit shifting get wiped off the tax board by making the location of the customer the determining factor in where the sales are located.
Let’s take the Koch-subsidiaries again. Under Sales Factor Apportionment, the Koch parent company would now be obligated to report sales in the US as compared to global sales of all subsidiaries, and use that fraction to figure out how much global profits are taxable by the US. There would be no profit shifting because the calculation is relatively straightforward. A sale to an American is a US sale, and the profits are American. Moving factories and jobs away or disguising American profits as foreign ones will yield no tax benefit.
Destination-based Sales Factor Apportionment is more fair because it applies to foreign companies the same way it applies to American companies. If you sell in the US, you pay tax on the profits made from US customers. The need for the complexities of GILTI, BEAT, and FDII disappear because the system is built to tax territoriality, and uses a measure that is very hard to game.
These ideas are not new. States have been using them successfully for years. Individual states started with a formula of apportionment using sales, capital, and labor. Over time, a sales emphasis has come to dominate the system. Partially this benefits the businesses, but it also helps the states because faking sales outside of the state is much harder without legal loopholes or illegal tax reporting.
Sales Factor Apportionment would give the president a pro-American alternative to lackluster Tax Cut 2.0 proposals so that when the Koch global business network hires cheap foreign labor and sells to wealthier US consumers, they will pay their fair share of US taxes. It would improve the Tax Cut and Jobs Act by helping smaller domestic business, keeping jobs in the US, and providing fairness across the board.