For corporate America, tax sheltering is all the rage these days. Big accounting firms like PricewaterhouseCoopers, investment banks like Merrill Lynch, and a legion of unscrupulous tax advisers are aggressively marketing their services to otherwise "respectable" companies by promising to help them abuse the tax laws with little chance of detection by the IRS.
In 1998 PricewaterhouseCoopers bragged to Forbes magazine that it was promoting some 30 "mass-market" corporate tax shelters, plus specialty items for big firms willing to pay extra. It said that it had hired 40 salespeople to push its corporate shelters.
We know a little about how some of these shelter deals purport to work because a few of the tax abusers, such as UPS, Colgate-Palmolive, Compaq, and AlliedSignal, have actually been caught. The courts threw out their tax shelters as "sham" transactions, entered into for no purpose other than to escape taxes. But these cases, although very recently decided, all date back to shelters from the early 1990s or earlier. Since then the issue has gotten much worse.
The scope of the problem can be gleaned by looking at income tax collections. From fiscal 1996 to the current fiscal year, total federal income taxes are up by about 36 percent. That's good in many ways; it's how the government has finally balanced its budget. But while personal income taxes are up by 44 percent, corporate income taxes have risen by only 10 percent, despite a huge rise in profits. Indeed, last year, corporate income tax payments actually fell by $4 billion.
Had corporate taxes risen at the same rate as overall income taxes, then corporate income taxes this year would be $45 billion higher. That's $45 billion that could go for enhanced public programs, more debt reduction, or individual tax relief--to the tune of about $500 each for the average income taxpayer.
In 1996 corporations paid 21 percent of total income taxes, and individuals paid 79 percent. This year, the corporate share is down to only 17 percent, while individuals will pay 83 percent. And by 2004, the corporate share of income taxes is expected to fall to only 15 percent, the lowest level since the loophole mania of Ronald Reagan's first term.
Although corporate tax-shelter arrangements are made intentionally complex to try to avoid detection, the gist of most of the deals is pretty simple. A company enters into a paper transaction, often with a foreign subsidiary or a nontaxable third party it pays to help. The idea is to generate deductions against the company's otherwise taxable U.S. profits, while shifting the resulting income either offshore or into some other tax-exempt form. The deals have no economic substance other than tax avoidance.
Because the deals are so well-hidden, they are rarely detected by the IRS. Even when the IRS discovers an abusive shelter, the penalty rules are so lax that usually the worst result a company faces is having to give back the money it stole.
The Clinton administration and others want to attack corporate shelters with beefed-up enforcement, tough disclosure requirements, clearer anti-abuse rules, and big new penalties on both corporate tax evaders and tax-shelter promoters. The hope is that such reforms might deter tax-sheltering activity in the first place.
In late February, the Treasury issued new regulations requiring companies to disclose some of their tax-shelter deals and said it plans more rules in the future to try to punish unethical shelter promoters. But the most significant reforms will take legislation, and so far these ideas have run into problems in Congress. House Majority Leader Dick Armey and Ways and Means Chairman Bill Archer, two Texas taxaphobes, are wary of "raising taxes" even on tax cheats. It probably doesn't help that Archer's former top tax aide is making millions devising tax-shelter schemes at PricewaterhouseCoopers.
Despite these roadblocks, Treasury officials say that the corporate tax-sheltering problem has become so serious that even a reluctant, tax-hating Congress will have to act. Let's hope so.
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