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December 11, 1992
"Where the Tax Money Isn't - Foreign Films Won't Cough Up Too Much More"
San Jose Mercury News

By Timothy Taylor
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FOREIGN-CONTROLLED corporations are ostentatiously alien. They don't swing a lot of votes. So they make a convenient target for politicians hungry for tax revenue. During the presidential campaign, candidate Bill Clinton proposed raising $45 billion over the next four years by requiring foreign- controlled corporations to "pay their fair share."

The evidence that foreign-controlled corporations are not paying their fair share of taxes, such as it is, comes from data on profits. Corporate profits can be measured in a variety of ways -- relative to sales, relative to assets, categorized by industry, and more -- but no matter how you slice it, foreign-controlled corporations in the United States seem to have substantially lower profit levels than American-controlled firms.

To some, this fact can have only one interpretation; it must mean that foreign-controlled corporations are manipulating their accounting systems in a way that shifts profits out of the United States, reducing their U.S. tax bill. That sort of financial skulduggery is surely one explanation. But here are five others:

  • Perhaps foreign-controlled corporations have more debt, and the higher interest payments hold down their profits.
  • Perhaps foreign investors recently bought U.S. companies that are currently earning low profits, hoping to turn those companies around in the future.
  • Perhaps most foreign investment is more recent, so that investment and other start-up expenses are high enough to hold down profits in the short-term.
  • The fall in the value of the dollar since 1985 has certainly hurt foreign investors, by reducing the value of their U.S. investments, so that might be holding down profits.
  • If foreign-controlled corporations have access to cheaper capital, as was commonly argued during the 1980s, then perhaps they can settle for lower profits and still make money.

In short, it is simple-minded to argue that because foreign- controlled companies earn lower profits, they must be evading taxes. Factors like these five account for about half of the gap in profits between U.S.-controlled and foreign- controlled corporations, according to a November 1991 study by Harry Grubert of the Treasury Department, Timothy Goodspeed of Florida International University, and Deborah Swenson of Duke University.

Based on that study, the Commissioner of Internal Revenue, Shirley Peterson, testified before Congress that if all the rest of the profit gap was a result of accounting tricks, and if taxes could be collected on that other half, the total amount of revenue raised would be $3 billion per year. That's about one-fourth of what Clinton was promising during the campaign.

So the real issue is how much more tax can be collected from foreign-controlled corporations through grimy, unglamorous tax audits. In 1989 and 1990, Congress passed several laws encouraging the IRS to step up audits of foreign-controlled corporations, and the IRS has responded by increasing the number of enforcement personnel and its in-house training on the subject.

In July 1990, about 1,100 foreign-controlled corporations had their tax returns under IRS scrutiny; by April 1992, the number was 2,500.

Data won't be available to evaluate the success of this effort for a couple of years. But no one seriously doubts that at least some multinational corporations finagle their taxes, so there should be a billion or two in tax revenue to be gained. Of course, stepping up audits on U.S. corporations and U.S. taxpayers would bring in considerably more, but American voters aren't usually too thrilled about the promise of tax audits that might affect them directly. (If you don't believe me, ask Michael Dukakis, who advocated such a step.)

Before Clinton and Congress are too quick to accuse foreign- controlled corporations, they should remember that these corporations are, after all, investing in the United States. Recently released statistics from the Department of Labor show that about 5 percent of U.S. workers are employed by foreign- owned businesses. As the U.S. economy becomes ever more interrelated with the rest of the world, this number will surely grow.

Moreover, when overall U.S. employment was stagnant during the recession year of 1990, employment by foreign-owned companies grew by 6.6 percent. On average, workers in those foreign-owned companies earned 22 percent more than the U.S. average.

Next year will bring more than its share of contentious trade issues: discussions of the North American Free Trade Agreement, the GATT talks, and the allegations that many foreign importers are "dumping," or selling their products below cost to injure American businesses. These issues are all potentially explosive, with substantial economic consequences.

By contrast, making a big push to tax foreign-controlled corporations would upset a number of international tax treaties, and create a spitting match with our trading partners, and make all these more important issues more difficult to resolve -- while probably not raising much more revenue than the IRS is already set to do.

The sensible strategy for Clinton on the issue of taxing foreign-controlled corporations is to avow his strong support for the stepped-up IRS audits, declare victory, set this particular bit of campaign rhetoric behind him, and focus his attention elsewhere.

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