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Massachusetts Liberal

Observations on politics, the media and life in Massachusetts and beyond from the left side of the road.

Thursday, April 24, 2008

So what are the real numbers?

The Globe offers a different side to the corporate tax loophole closing bill passed by the House a couple of weeks ago -- and it ain't pretty.

The story tells of a 2,300-word amendment that could allow certain corporations to shift a large portion of their income to overseas subsidiaries and avoid paying corporate income taxes in Massachusetts.

Says Department of Revenue Commissioner Navjeet K. Bal:
"These changes primarily benefit a limited group of very large, sophisticated, multinational businesses," reads the letter, which was obtained by the Globe. "If left unchanged, these changes will materially reduce the additional revenue anticipated from the governor's combined reporting bill by at least $100 million to $200 million annually."
Lexington Democrat Jay Kaufman, one of the chamber's good guys, admits he goofed.
"It's somewhat embarrassing. "Since it was introduced at the last minute - and there was a desire to get this voted on that day - there was an understanding we would be working with incomplete information."
House Emerging Technologies and Economic Development Chairman Dan Bosley, the amendment's sponsor, is having none of it, saying he thinks DOR's numbers here are as good as Deval Patrick's estimates on casino gambling revenue.
"I just don't trust their figures," Bosley said of the department. "It's a ridiculous estimate. They're just bad at numbers."
But Bosley doesn't offer his own numbers -- or at least the Globe didn't print them. Nor is there any discussion of how to resolve what would obviously be a larger problem of a tax collector that doesn't know how to count.

As a public service, I'm happy to provide Bosley, who I'm pleased to know is a pretty regular reader, with a forum to respond. I know I'm not the front page of the Globe (but at the rate it's going you never know when I'll catch up!)...

In the meantime, the Massachusetts Budget and Policy Center is planning to release a report later today with its view of the amendment and its cost.

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Blogger dan bosley said...

Thanks ML, for the opportunity to respond. I appreciate it. There are three basic arguments that I will try to make as succinctly as possible. That said, this is corporate tax policy and it is incredibly complex and arcane. That is one of the problems. We had an opportunity to change our tax policy, closing opportunities to game the system while making it much fairer and simpler through the tax commission, but that was not to be. So what we are now attempting to do is place a combined reporting statute on top of all other tax law in Massachusetts and it is a difficult fit.

I had no idea that this would be controversial. It was an amendment was in the hands of the clerk all day long and no one raised any objections until late in the day. And it is an amendment that seeks, not to give business or the Department of Revenue (DOR) an advantage over the overall goals of the legislation, but seeks to provide specificity to the policy therein. Most businesses that I have talked to have thrown up their hands and said that they understand that combined reporting is coming. But they aren’t sure what that means, as there are no specifics behind the original proposal. That troubles them and troubles me as it gives enormous power to DOR to set not just regulations over tax collection, but over tax policy. That concerned me and many of my colleagues in the House. I was attempting to provide transparency and predictability to our combined reporting bill. Now to the three issues:

First, there are very few tax attorneys among those who are criticizing this bill and we have heard a lot of rhetoric. Take, for instance, the Wall Street Journal article concerning Wal-Mart. What is lost in the rhetoric is that Illinois disallowed this tax shelter scheme and collected the taxes from Wal-Mart. It is now in court and I believe that Illinois will win. My amendment states that the corporation can claim 80-20 foreign status if 80% of their receipts, payroll, or property is sourced outside the US. In a state where we go after income derived in state from out of state taxpayers that may have made money here, I doubt we are going to accept that a foreign “paper” corporation is the source of payroll, receipts and property located within the boundaries of the state, or the country under combined reporting. Also, this “safe harbor” for legitimate outside taxes that have no nexus under combined reporting is something that DOR agrees with in principle. They have, however, failed to suggest alternative language.

There are other reasons for placing some percentage within the bill. Other states have similar provisions. Some have suggested that foreign countries take a dim view of our going after taxes they think are rightfully theirs. It may cost us more in time, audits and personnel to go after the taxes than they are ultimately worth. There are other issues that have been raised, such as apportionment (which tries to get to the policy of apportioning tax from different states with different tax policies), but this seems to be the focus for everyone’s ire.

Second is my suspicion of DOR numbers. I am very leery of their numbers for good reason. In this bill, their revenue figure for the administration’s proposal was tens of millions greater than their figure for House generated revenues even though the language of the bill was identical coming out of committee! This is not the first time this has happened, raising, I think, legitimate questions about their numbers. In the Life Science bill, my committee asked for an analysis of extending the Governor’s tax breaks without the yearly limitations included in his bill. We asked several times and were told they could not answer the question nor should they as the Governor’s bill limited tax credits to $25 million per year. Not only is it not their role to refuse a request based on policy, but it calls into question the honesty in delivering numbers in a timely and accurate manner. After being requested again by House Ways and Means, a report was sent to us on the effect of the administration’s suggested tax credits. In looking at the numbers, it was immediately apparent that the numbers were suspect. One company had given us a figure, based on their tax liability that was larger than the DOR number for every life science company eligible for this credit. The second set of numbers we received were just as bad. I believe that the Department of Revenue based on their responses, is more interested in setting policy than enforcing it. It is the responsibility of the Governor and the Legislature to set tax policy. The Department of Revenue should provide revenue analysis that is not tainted by politics or policy. In these cases, it appears that this may not be the case and that troubles me. However, people shouldn’t take my numbers at face value either. I believe we need an independent budget office to give us honest estimates without political pressure from any side. We need an office like the Congressional Budget Office – bipartisan and independent to study all our fiscal and revenue proposals for their cost and financial impact. This is the only way we can get numbers that are beyond question.

Third, it is clear to me that this issue is not about tax fairness, but increased taxes. If that is the issue, we should stop using the words “closing tax loopholes” and have an honest discussion on what a fair tax is for corporations. But that discussion should also be about what we want our economy to look like. If we are closing tax loopholes, should we open another seven of them in the life science bill? More importantly, we need to look at corporate tax policy in the context of cost here in Massachusetts. I hear very few businesses complain about taxes in Massachusetts. But we have the highest electric rates in the continental United States, the highest health care costs, the second highest unemployment insurance rates, much higher than US average wage rates, land development costs, regulatory costs, housing costs and transportation costs to name some of the factors of doing business in Massachusetts. We are still down over 90,000 jobs behind our 2000 figures and we are making it increasingly difficult to do business here. We need to take that into account.

A good friend of mine who passed away many years ago used to ask me, “Is it the first straw or the last straw that broke the camel’s back? It is the synergistic accumulation of straw.” If we pass this bill without clarification and predictability, business will not pack up en masse and leave the state. But they will make decisions based on what their costs are in other states versus the ability to be successful here. That is a shame as there are a lot of good reasons to build a business here. But we never get to those reasons as our above the line costs make decisions easy for firms to locate elsewhere. I am not suggesting that we roll back taxes for businesses. I am suggesting that we should be intelligent with our tax policy and if we are going to tax businesses with increased policy such as combined reporting, we let them know what the rules are with precision, specificity, predictability, and transparency. After closing “loopholes” several times over the last four years, we need to let the business community have a level of comfort that they can plan based on the law. That was the amendment that I filed attempted to do.

April 24, 2008 11:59 PM  
Blogger Outraged Liberal said...

Thanks. Yes, it is incredibly complex and I won't pretend to understand this on the first read.

In the spirit of equal time, let me cut and past a copy of the Mass. Budget and Policy Center (taken by way of Blue Mass. Group, which did the tough part of getting it out of the PDF available at the MBPC site,)

The Legislation Creates New Loopholes and
Tax Reduction Opportunities for Corporations

The House adopted a floor amendment that opens new loopholes, creates special rules to allow certain types of companies to reduce their taxable income in Massachusetts, provides new tax deductions, and weakens the capacity of the Department of Revenue to enforce the corporate tax laws effectively. The Department of Revenue estimates that the provisions of this amendment will "reduce the additional revenue anticipated by the Governor's combined reporting bill by at least $100 million to $200 million annually"1

A New Loophole for Companies with U.S. Subsidiaries That Operate Overseas

The floor amendment creates a new loophole that allows companies that have U.S. subsidiaries doing business overseas to shelter income from taxation by funneling it into those subsidiaries. The state Department of Revenue estimates that this new loophole could cost the Commonwealth more than $100 million annually.

In the combined reporting legislation filed by the Governor, any U.S.-incorporated subsidiary that was part of a unitary business was required to be part of the combined group. Including in the combined group all subsidiaries that are part of the same unitary business protects against income-shifting strategies. This amendment identifies a particular type of subsidiary that the company can exclude from its combined group: subsidiaries with 80 percent of an average of their payroll, tangible property, and sales sourced outside the U.S. This loophole can allow multinational companies to develop tax avoidance strategies that shift substantial amounts of income into these subsidiaries and reduce their state taxes accordingly. A recent Wall Street Journal article explained how Wal-Mart used a similar loophole in Illinois.

Wal-Mart set its affairs so that its Italian outpost is the only operating unit of a real-estate subsidiary that controls billions of dollars of the retailer's property in Illinois and other states. Because technically its only employees are based in Italy, the real-estate unit claims its operations are foreign, exempt from Illinois corporate income taxes. Earlier this year, the Illinois Department of Revenue objected to the Italian tax maneuver, demanding $26.4 million in back taxes, interest and penalties....

The dispute with Wal-Mart is part of a wider effort by some states to crack down on what they believe is abusive use of so-called 80/20 companies. These companies are domestic subsidiaries that conduct at least 80 percent of their business overseas. States typically don't tax income from outside the U.S., and many companies have used 80/20 subsidiaries to legitimately shield foreign operations from state taxation. But authorities in several states have challenged a number of companies over the 80/20 units, claiming the structure was improperly used to shift income away from the purview of state taxing authorities. The misuse of 80/20 companies is "shocking to the conscience," said Brian Hamer, director of the Illinois Department of Revenue.

Why Wal-Mart set up shop in Italy
Jesse Drucker, Wall Street Journal, November 14th, 2007

A New Opportunity for Tax Avoidance for Corporate Groups that have Both Financial and Non-Financial Businesses

The House amendment also introduces special rules about how Massachusetts should determine what share of a company's income is earned in this state ("apportioned" to Massachusetts) if the company has both financial services operations and other operations. Many states, including Massachusetts, apply different rules to financial services companies than to other companies when determining how much of their income should be taxed in each state.

The House amendment would create a system in which the apportionment factors are all added together and no adjustments are made for the differences between the apportionment rules for different sectors. As a result, a company that does a large amount of business in Massachusetts could pay taxes on a very small share of its income here if a member of its corporate group is a financial institution that has large amounts of intangible assets in other states.

In describing the potential cost of this loophole, the Massachusetts Department of Revenue states, "as a majority of revenue from combined reporting would be attributable to a few dozen large corporations, potentially tens of millions of dollars could be lost if even a limited number of them dilute their Massachusetts apportionment percentages through the combination of financial and non-financial entities."

A New Tax Deduction for Companies If the Book Value of Tax Benefits Falls

The House amendment includes a provision stating, in part, that if the changes related to the adoption of combined reporting "result in an increase to a net deferred tax liability or decrease to a net deferred tax asset for any taxpayer affected by this section, taxpayer shall be entitled to a deduction." The Department of Revenue explains why this new deduction could be costly:

The Department is concerned that deferred tax liabilities of a business may increase any time that its effective state tax rate increases. A taxpayer that has been shifting income out of Massachusetts and that will no longer be able to do so because of combined reporting will see an increase in its effective tax rate (even if the Commonwealth's stated tax rate decreases). Under the House bill, such a taxpayer could claim a new Massachusetts deduction as an offset.

While the Department of Revenue does not provide a specific estimate of the likely cost of this provision, it does state that the provision "would likely negate significant amounts of income that would otherwise be taxed under the combined reporting rules, thus significantly reducing the tax revenues that would otherwise be collected from adoption of combined reporting."

The Department of Revenue's Regulatory Authority Reduced

The amendment appears to take away from the Massachusetts Department of Revenue much of the standard authority that departments of revenue generally have to adopt regulations that implement the law. Reducing the regulatory authority of the department could strengthen the hand of companies with the capacity to design sophisticated tax avoidance strategies by weakening the capacity of the department of revenue to ensure that our tax laws are implemented in a fair, effective and efficient manner.

1 Letter from Navjeet Bal, Massachusetts Commissioner of Revenue, to Senate President The Honorable Therese Murray, April 18, 2008. All quotations of the Department of Revenue in this MassBudget Brief are from this letter.

April 25, 2008 5:42 AM  

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