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Legal Loopholes – How are corporations outsmarting the world?


Click here to view my paper!

 

Introduction

If you were a billionaire, how far would you go to maintain your wealth?  For corporations like Amazon, Google, and Starbucks, their immense wealth comes with a considerable amount of tax. However, their endless resources and top lawyers let them strategize cunning ways to avoid tax like we have never seen before. Just barely legal, but definitely a problem, I present to you ‘Corporate Tax Avoidance’. This is the topic that I explored in my paper.

 

 

How did I get interested in this topic?

As I mentioned in my video, I first learned about the problem of avoiding taxes in a short documentary by the Verge titled ‘Billionaires, Explained.’ However, I only found out about corporate tax evasion recently in a movie called ‘The Laundromat.’ This movie tells the story of an old lady who struggles to sue powerful companies whose legal loopholes let them have almost full control over their own money. The movie ends with the ‘Panama Papers’ scandal, largely regarded as “history’s biggest data leak” that exposed two billion dollars hidden offshore. However, I am interested in corporate tax avoidance, which is completely legal, but still has negative effects on our economy.

 

 

The Problem

Maybe the term ‘tax evasion’ sounds familiar to you. Although this is close to ‘tax avoidance’, they are very different. I try to clarify this very interesting distinction in my ‘History of the Problem’ section. Tax avoidance is the legal practice used by people and corporations to lower their taxes legally, and can take on many forms. David A. Weisbach provides an excellent explanation from Tresch 2002, p. 512:

Tax avoidance refers to taxpayers taking advantage of the provision of the tax laws to reduce their tax liability….Avoidance of taxes is legal and its consequences certain. Tax evasion refers to hiding sources of taxable income from the tax authorities to reduce one’s tax liability….Evading taxes is illegal and its consequences are uncertain; they depend on the probability of the taxpayer being caught.”

Our economy has become increasingly global, and with it, the ease of moving large amount of money nearly anywhere around the world. Corporations take advantage of this and transfer their money to countries with lower taxes. This is the crux of the problem. Surprisingly, hundreds of large corporations like Amazon, Starbucks, Bank of America, Verizon, and Apple are paying little or no taxes. Apple was particularly exposed by the Panama Papers scandal in 2016. From the 11.5 million documents that were revealed to the world, Apple was found to have been hiding an offshore stock of cash worth $252 billion. David Pegg, a reporter for The Guardian writes that,

“an estimated $500bn is withheld from public coffers each year by multinational companies.”

In a report by the Congressional Budget Office released in 2018, so-called ‘profit shifting’ (strategically moving your money), costs the U.S. Treasury alone about $80 billion each year. However, this problem does not just exist in the United States. Countries around the world with lower taxes are being used as ‘tax havens,’ and have tried to control the companies exploiting this loophole.

For my paper, I focused on corporations only. Through my research, I found that corporations are able to avoid large parts of their tax because of two main concepts: internal subsidiaries and global mobility.

Creating internal subsidiaries is the strategy of forming smaller companies and moving money between them. By cleverly transferring money between these companies, companies such as Starbucks have been able to avoid paying large amounts of tax.

The second key strategy is global mobility. With the ability to create smaller companies, corporations naturally tend to place these subsidiaries around the world, particularly in places with less income tax. Companies flock to countries like Ireland, the Bahamas, Panama, and other small islands in central America to escape paying taxes.

 

 

A cartoon of companies hiding money in island ‘tax havens’, which are countries with relatively low taxes.

 

 

Techniques like these can prevent governments from getting money that is rightfully theirs. The extreme effect of tax avoidance is evident in this graph:

 

Why you should care

“Taxes are what we pay for a civilized society”

said Oliver Wendell Holmes, a former Supreme Court Justice. The government and our society have grown increasingly dependent on taxes, which puts greater urgency on fixing corporate tax avoidance. Taxes are crucial to support governments and societies as a whole. Although we often hear many American adults complain about the IRS taking away their money, almost all of the money in some form comes back to their communities and loved ones.

In 2020, the US government is projected to divert 60% of its budget into programs such as Social Security, Medicare, and Medicaid. That is 4.7 trillion dollars going to take care of all Americans and especially those who need it the most. In addition to that, another $1.4 trillion goes into building infrastructure (safe roads, bridges, and rail lines), and by extension creating jobs. Besides taxing individuals, the government also taxes the income of corporations. According to the Adam Davidson from the New York Times:

“American businesses currently have $1.9 trillion in cash, just sitting around….If the companies spent their savings, rather than hoarding them, the economy would instantly grow, and we would most likely see more jobs with better pay.”

 

The Solution

Heightened interest and alarm in tax avoidance has only increased over the years, especially with a new discovery in 2016. The ‘Panama Papers’ are a collection of 11.5 million files “obtained by a breach of the computer system of Panamanian law firm Mossack Fonseca”, writes Erol Eda and Leonard Spector, who worked on a report about this scandal. The ‘Panama Papers’ exposed the tax avoidance (and sometimes evasion) schemes of many powerful political figures.

Ever since this event, a number of solutions have been implemented to combat this seemingly ubiquitous threat. Quite notably are the efforts of the US government. In 2017 the U.S. Public Interest Research Group released a report stating that representatives were pushing for the Corporate EXIT Fairness Act and the Stop Tax Haven Abuse Act, which would “close a number of loopholes that let corporations and wealthy individuals book income to offshore tax havens to avoid taxes”, write an article titled “New Bills”. These domestic efforts, combined with the ‘General Anti-Avoidance Rule’ proposed by the United Nations in 2017, makes the elimination of tax avoidance look optimistic. However, after much research, I believe that I have found a more straightforward solution.

The solution that I arrived at is called ‘destination-based tax’, which would ignore the country that the tax haven is in, and focus on where the company’s customers are. It is fairly easy for a company to move money in our global economy, but nearly impossible for it to move its customers.

This system would possibly use bank account numbers to locate customers, as computer IP addresses can be easily manipulated. One might be skeptical of a complete change to how an income tax rate is calculated, but this is not a new concept. Currently, in the United States, almost all of the 50 states use this type of tax. However, what we need is for this measure to be applied to the whole nation. If Apple had to adhere to this policy, it would be paying approximately more than 50 times the tax that it currently is. An even better version would be to evaluate both where a company sells and hires, which would give a more accurate picture of where a company is truly doing business. This would result in the amount of tax Apple pays to be about 38 times more than it is now. This is an enormous amount of money that a ‘destination-based tax’ would fairly and carefully collect.

I will talk more about how this fixes the loopholes in my solution section.

 

 

What does my paper explore about this topic?

Throughout my paper, I tackle the complex distinction between tax avoidance and evasion. I discuss the origin and development of taxes themselves, the findings of the Panama Papers in 2016, and recent changes in US policy. I explain the strategies that companies use to shelter their earnings. I review competing solutions for tax avoidance and chose the one that has been tested and predicted to best tax our huge corporations: the destination-based tax. View my paper here.

 

 

What you can do to help

If you agree with my choice, but am unsure how to help, you can try to stay informed about current news regarding the issue, and even consider lobbying for a national destination-based tax. Hopefully, you have enjoyed diving into this ongoing issue, as you will now be more knowledgeable on this subject while the government tries to tackle these shrewd and detrimental companies in the coming years.

 

I would love to hear what you think about my paper down below in the comments! Also please feel free to ask any questions, as this is a very complex subject.

 

Image Sources

Wilson, James. “Russia’s Role in Tax Avoidance, Tax Evasion and Money Laundering.” Eupoliticalreport, 6 Mar. 2019, www.eupoliticalreport.eu/russias-role-in-tax-avoidance-tax-evasion-and-money-laundering/.

McCarthy, Niall. “Tax Avoidance Costs The U.S. Nearly $200 Billion Every Year [Infographic].” Forbes, Forbes Magazine, 27 Mar. 2017, www.forbes.com/sites/niallmccarthy/2017/03/23/tax-avoidance-costs-the-u-s-nearly-200-billion-every-year-infographic/.

Also, click here to view my paper’s works cited. My paper includes all parenthetical citations.

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COMMENTS: 7
  1. April 23, 2020 by Carl Thiermann

    Riley—I am on board with your research and conclusion: –destination-based taxation is the most promising solution to this global challenge. In addition to your clear explanations of tax avoidance vs. evasion, I thought your personal introduction was excellent. Introducing yourself and explaining your interest in the topic invited me into the discussion and made the research more intriguing.

  2. April 24, 2020 by Daniel

    Riley, this was very good. Your use of charts, visuals, and statistics really helped show how big of an issue this is. I found your solution section very good, and was interested by the idea of a destination-based tax. I was astounded by the estimated annual corporate tax losses in the select countries, especially the United States. Great work!

  3. April 25, 2020 by Brian

    I’m curious what your thoughts are about major companies (such as cruise lines) who register in foreign countries to avoid the US tax base who then ask for or receive bailout money from the US government.

  4. April 25, 2020 by Maya

    Riley, this was a very interesting presentation! You take a very complex topic and explain it extremely clearly. I had never really understood destination-based taxing, but I am definitely on board with that idea. Are you planning to start lobbying for destination-based tax? Awesome job!

    • April 26, 2020 by Riley

      Hi Maya! I really appreciate your feedback. I’m glad that I could help you understand this problem. I don’t know how much lobbying I can do with the current situation, but I am definitely excited to see where this project leads me in the future!

  5. April 27, 2020 by Jenna

    Hi Riley! This project is super fascinating to me. I have never understood taxes to be honest, but your project explained it so well that I can actually learn what they are, and what their place in society is. I had a vague idea of what tax avoidance is, and I’ve heard of the Panama Papers, but I can tell you know a lot about your project based on how well-written your paper and solution is. Great work!

  6. April 27, 2020 by Kalissa F

    Hi Riley! This topic was so interesting to read about. I’m not surprised how many corporations create loopholes but it’s insane how much they have already! I mean the gap between US and China with corporations is insane! In addition, never heard of the Panama Papers and now want to look more into that.

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