A wise person once observed that it’s difficult to fix something if you can’t measure the extent of the problem. I was reminded of this when I read Kimberly Clausing’s excellent Tax Notes article, “The Effect of Profit Shifting on the Corporate Tax Base,” in which she quantifies the revenue losses attributable to corporate profit shifting.
Clausing’s research is relevant to one of today’s most pressing priorities: The ability of policymakers to accurately monitor profit shifting, which will prove critical if Congress ever gets serious about tax reform. Her findings also shed light on the impetus behind the OECD’s BEPS project, which is why we chose to interview her for Tax Notes Live, our weekly webcast. You can listen to our conversation here.
When someone takes on such an ambitious project, it’s natural that scrutiny will be focused on the data set. Clausing uses a source that's well suited to the task. She relies on data compiled by the U.S. Bureau of Economic Analysis. The OECD describes the BEA figures as a best practice in data collection in analyzing BEPS. As a result, her estimates are likely to be far more accurate than what you’d get from studying financial statements.
Clausing estimates that for the 2012 tax year, federal revenue lost to profit shifting was between $77 billion and $111 billion. The variation is explained by two subgroups of BEA data.
How significant is that loss in relative terms? Consider this: Corporate tax receipts for the same year were $242 billion. In other words, the revenue lost was roughly one-third to one-half of what the tax brought in. And the magnitude of annual losses is growing over time. The graph below, taken from Clausing’s Tax Notes article, traces these losses over recent decades.
As you can see, they have grown larger with each passing year, apart from a blip attributable to the Great Recession. They’ve more than doubled over the span of eight years from 2004 through 2012. Given this trajectory one suspects that in the not-too-distant future the annual revenue loss from profit shifting will exceed corporate tax receipts.
Once that occurs, we might collectively view the corporate income tax in a different way. Perhaps society will regard it more as a mechanism for dispensing private subsidies and less as a tool for supporting public spending. Whatever one thinks of subsidies, surely there are more transparent means of delivering them than through the Internal Revenue Code. (Or is the opaqueness the point?)
For those wishing to assign blame, it’s worth noting the losses began accelerating in the late 1990s. The timing coincides with Treasury's decision to expand check-the-box treatment to foreign entities. This reminds us that rampant profit shifting does not occur by accident. The more permissive elements of our corporate tax regime are there by design. I cringe when people call them “loopholes.”
My takeaway from Clausing’s research is as follows: If the goal here is to tax capital income, we are doing a rather poor job of it. Alternately, if the goal is to distribute economic subsidies outside the conventional appropriations process, we are overachieving.