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The Global Tax Avoidance Dance

America’s most successful multinationals make great products and offer superior services. But they have another, less enviable quality in common — they have become world leaders in tax avoidance.
General Electric’s global effective tax rate for 2010 was 7.4%. Pfizer’s was 11.9%; Cisco came in at 17.5%. The nominal U.S. corporate tax rate is 35%.
Each company has its own tax story, but all — like other multinationals — have for years relied heavily on low-taxed foreign income to drive down their worldwide tax obligations, including those of their U.S. businesses.
American multinationals claim they are taxed on their worldwide income, but in reality the “active” income they earn through foreign subsidiaries is not taxed in this country until the cash is repatriated. In addition, financial accounting practices (the lens through which we view these firms because their tax returns are not public) permit a company not to book any U.S. tax liability on foreign earnings if the firm states that the income is “indefinitely invested” abroad.
General Electric has $94 billion in indefinitely reinvested earnings. The total for corporate America is more than $1 trillion.
If the story was simply that U.S. firms have successfully expanded into international markets and are paying taxes abroad at lower rates, one could argue that there is no U.S. tax mischief afoot. But these are not the facts.
Tax collectors in the U.S. and in high-tax foreign countries are the direct victims of the tax avoidance, but we all suffer from the resulting budget deficits and distorted investment decisions that firms make as a result of their ability to generate what I call “stateless income” — income derived from selling goods and services in a high-tax country but that, through internal tax legerdemain, surfaces in a low-taxed affiliate.
What’s going on is a highly choreographed six-step dance.
Step 1: U.S. firms rely on aggressive “transfer pricing” to sell, at bargain prices, high-profit U.S. assets or business opportunities to their low-taxed foreign subsidiaries in countries like Ireland. It cannot be simply the luck of the Irish that explains the extraordinary profitability of the Irish subsidiaries of U.S. firms relative to their European sister companies.
Step 2: U.S. multinationals move income from higher-tax foreign countries, where their customers actually are located, to lower-taxed ones not only through transfer pricing but also through “earnings stripping.” For example, a corporation funds its German subsidiary with loans secured in Ireland, so the interest is deductible in Germany.
Step 3: Not satisfied with low corporate tax rates in Ireland (12.5%) or in other countries, U.S.

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