From the report:

“Most taxes have adverse effects on economic performance by distorting incentives to work, save and invest. Raising taxes therefore could be costly. Indeed, GDP could fall by 1 to 1.5% if the overall tax/income ratio were increased to provide revenue equal to 2% of GDP (OECD, 2003). A rise in the tax ratio would be particularly harmful if it was concentrated on corporate or labour income taxes; increasing indirect taxes and taxes on immovable property would be much less costly. In particular, the estimates in Arnold (2008) suggest that the economic cost of raising government revenue by increasing taxes on labour income could be up to five times higher than that from raising the same amount of revenue from higher indirect taxes.”

Raising a corporate tax rate that is already the second highest among the G20 will push more companies – and therefore jobs – out of the U.S. At the very time that unemployment is reaching new highs in America, the tax policy put forth by Congress to pay for health care reform is forcing jobs overseas. Cutting the corporate tax rate will create jobs and expand the dwindling individual tax base. The issue is not figuring out how to divide the proverbial pie, but rather how to expand it.

An excerpt:

Singapore today signed a protocol with France that brings the two countries’ bilateral tax treaty into line with the OECD standard on transparency and exchange of information for tax purposes. This is the twelfth agreement it has signed in accordance with the OECD standard, thereby moving Singapore into the category of jurisdictions deemed to have substantially implemented the standard. This required that Singapore pass legislation to enable its authorities to exchange information, including bank and fiduciary information, with tax authorities in other countries.

Tax havens. Tax havens are not merely jurisdictions with nil or low tax rates; many countries attract business in this way. Explicit appellation is also misleading: for example, the OECD has never defined Singapore, nor Switzerland, as a ‘tax haven.’ The critical aspect of a tax haven is non-cooperation with other jurisdictions in the realm of tax information, and implicitly offering a refuge for tax evaders and money-laundering.

G20. The big economies are now pressing for compliance in transparency as a tool to put pressure on tax and asset-management aspects of tax havens. In practice, the main issue is use of tax havens for aggressive tax competition and homes for asset management in offshore funds:

• In 2009, the US Government Accountability Office (GAO) estimated that 83 of the largest 100 US corporations were doing business in tax havens.
• The US Treasury estimated it was losing 100 billion dollars in revenue per annum.

Market fundamentalism. Growth of tax havens was possible mainly because, in the absence of global cooperation, piecemeal regulatory efforts would merely push business from one tax haven to another. In the prevailing climate of market fundamentalism, banks successfully argued that they needed freedom to organise their affairs. That time is over. The list of those who had not made “substantial progress” (ie had not signed twelve individual tax information exchange agreements with other jurisdictions) shrank by 15 in the April-November period:

• All jurisdictions of relevance have committed to tax transparency standards.
• About 20 small states remain to implement their commitments and seven larger economies have yet to do so.

There’s no question that OECD and G20 countries see tax havens as the enemy of their tax revenue. However, dismantling those regimes may have an unexpected, adverse effect on the capital markets. In the short-run, the cost of capital will likely rise in real terms impeding economic expansion as business and consumers find they are unable to afford the capital markets’ prevailing rates. Under this scenario an increase in inflation would also be likely as businesses would have to raise prices to obtain needed capital. Perversely, the very governments in the vanguard of the movement to dismantle tax havens would likely find themselves the most adversely impacted. Governments who have been running deficits will find the cost of funding those deficits as a percentage of their GDP will increase sharply, due to constraints being placed on the capital markets.

Ultimately, tax havens are a symptom of a much larger problem. Developed countries’ governments have grown to such gargantuan proportions that they must continually squeeze taxpayers to fund themselves. Corporations and individuals are essentially paying for the privilege of being taxed. Tax havens exist because there is a market for them. Contracting government, creating and implementing tax policies which align corporate and governmental interests, and efficient enforcement of existing rules is the better, albeit less sexy, answer.

In response, Mr. Shay avoided the question completely stating that the policy must be carefully evaluated in context. His point: The U.S. relies more heavily on corporate tax receipts as compared with the other G20 nations; thus, it is unlikely the U.S. would adopt a consumption-based system at the Federal level. In other words, since we are already so good at pillaging corporate taxpayers, why do we need to branch out and further pillage individuals?

If only it were so simple.

The Congressional Budget Office forecasts a continued decline in U.S. corporate tax receipts – due to, among other things, the U.S. having the second-highest corporate tax rate in the developed world, lack of available capital and general economic malaise.

So, if 1) corporate tax receipts are declining and 2) a Federal consumption tax is not on the menu, what’s left? Perhaps Mr. Shay’s position presages the Administration’s likely next move – despite statements to the contrary – to seek repeal of deferral of non-U.S. earnings, so that there would be current taxation and a likely residual U.S. tax, since many of those earnings are subject to rates of taxation below the U.S.’ current confiscatory 35% rate?

In the immortal words of Han Solo, “I’ve got a bad feeling about this.”

The U.S. government is inefficient and overrun with bureaucracy. The current direction of U.S. tax policy – a confiscatory corporate tax-rate – will continue to stifle job growth and constrain Foreign Direct Investment. The U.S. needs to follow the lead of Canada, Ireland, the UK, and other trading partners who have reduced corporate taxes as a means of stimulating employment and GDP growth. Every 1% point drop in the corporate tax rate translates into a 0.1% increase in GDP.

Given the wealth of empirical and anecdotal evidence, and despite Mr. Shay’s statement to the contrary, we believe the Federal consumption tax option must remain in play.

Macallan's approach to tax reform

Congress seems to have the same issue. With respect to the economy, the focus appears to be on short-term quick fixes and the “flavor of the week” (e.g., job credits) more so than on addressing the fundamental, systemic problems that have resulted in our current predicament.

U.S. tax policy plays a key role in the health of our economy and current policy is hindering our ability to be competitive in the global economy. Among the many reasons:

1. The U.S. has the highest corporate tax rate (second only to Japan) among developed countries in the world.
2. The U.S. is the only OECD member country without a consumption-based system of taxation.
3. The U.S only provides a temporary incentive for Research and Development (“R&D”) related activities resulting in businesses wondering whether the R&D credit will be around long-term and if it’s worth investing in U.S. R&D if there is not going to be an incentive to do so.

Businesses make investment decisions based in large part on taxes – the higher the corporate tax rate, the lower the after-tax-return from those investments.

By cutting the corporate tax rate by 10% or more over time, including a permanent extension of the R&D credit, eliminating the domestic manufacturing exemption, and imposing a value-added or consumption-based tax the U.S. can bring its tax policy into the 21^st Century and provide incentives for companies to take advantage of the vast resources in the U.S.

Ireland exemplifies the benefits of this approach. Less than twenty years ago, Ireland was the poorest country in the European Union; today it is one of the wealthiest. The country’s turnaround has been credited to a highly-educated English speaking workforce, targeted incentives for knowledge-based businesses that have since morphed into a 12.5% corporate tax rate, and an effective government-private sector partnership aimed at reducing bureaucratic friction and other impediments to inward investment. The Irish understood that Foreign Direct Investment (“FDI”) creates inward investment in infrastructure that creates jobs for its citizens. There is absolutely no reason that the U.S. cannot replicate the success of the Irish.

Canada has also been very successful by cutting corporate tax rates and implementing a consumption-based system of taxation. And, like the U.S., they have states that have their own systems of taxation. We need a permanent R&D credit because it will eliminate the “brain-drain” in the U.S. and act as an incentive to locate knowledge-based personnel in the U.S. which will help spawn new industries and create additional jobs. To pay for the corporate tax rate reduction, a consumption-based tax should be implemented at the federal level with some type of harmonization with the states overtime so that consumer consumption is taxed. These steps will improve the long-term savings rate in the U.S. significantly improving the quality of life in this country and strengthening the embattled Dollar.

Despite much debate in Washington, the hundreds of gallons of ink spilled and pounds of paper consumed – not to mention the billions of 1s and 0s expended in cyberspace – nowhere does the Obama administration’s Green Book or other tax-legislative proposals provide for a national sales tax. The focus is entirely on increasing the federal wage tax base.

Kenneth Baer, a spokesman for White House Budget Director Peter Orszag, told the Washington Post in May that “while we do not want to rule any credible idea in or out as we discuss the way forward with Congress, the VAT tax, in particular, is popular with academics but highly controversial with policymakers.”

It would seem that at some point in the not-too-distant future employees will be faced with an increasing burden on their wages with little hope of receiving the benefit such taxes promise. Social Security is on shaky ground at best. With some form of nationalized healthcare in the offing (increasing the burden on employees and their employers) Congress should be considering a national sales tax or consumption-based tax.

NOTE: We could devote an entire series of blogs to the differences between and benefits and drawbacks of a true sales tax verses a value-added (or goods and services) tax. We’re not going to do that. Mostly because it would be pretty dull for all but the most hardcore tax wonks. Suffice it to say that if you really, desperately want to read more about it. Go here, here or here.

Consider that the U.S. is the only OECD member state that does not have some form of nationalized healthcare or a consumption tax at the federal level. Other OECD member states that have enacted nationalized healthcare have resorted to consumption-based tax systems to pay for those benefits.

Such systems are tax-neutral for businesses for the most part and are borne by the consumer. They also have the added benefit of allowing exemptions and /or reduced rates of taxation for certain classes of products, e.g., ethical pharmaceuticals, children’s clothing, etc., thereby constraining the regressive nature of the tax with regard to social causes. Individual states in the U.S. have managed to provide a sales-tax base that is fair for the most part. Why not at the federal level too?

From the perspective of preserving the dwindling corporate tax base, a consumption tax should allow the U.S. to reduce the corporate tax rate – currently the second highest amongst the OECD member states.

U.S.-based multinational enterprises are increasingly moving their operations out of the U.S. to lower-tax jurisdictions. High corporate tax rates affect Foreign Direct Investment (“FDI”) into the U.S.; which provides jobs and other opportunities for American workers.

Examples abound. Currently the Japanese have the world’s highest corporate tax rate and have suffered economically for almost two decades. By contrast, Ireland suffered significant unemployment and declining FDI in the early ‘80s. By reducing the corporate tax rate (now at 12.5%), the country generated a significant increase in FDI leading to historic employment levels and economic growth. Closer to home, Canadian corporate taxes have been steadily reduced and are expected to be around 25% in 2012. The Canadian economy has grown.

It’s time for the US Congress to bring U.S. tax law into the 21^st century. Apparently it is more politically expedient to tax the working class with an outmoded payroll tax without any regard to the longer-term implications of having the second highest corporate tax burden in the OECD.

In a move sure to raise systolic and diastolic numbers everywhere, Caroline Silberzstein, head of the Transfer Pricing Unit in the OECD Centre for Tax Policy and Administration, went on the record last week at the OECD transfer pricing and treaties conference in Paris supporting the proposition that there was no need to define “intangible” for treaty purposes.

Huh? We’re confused.

In other words, if we don’t have a standard definition of an intangible asset what is to prevent different jurisdictions from asserting their own definition and wreaking havoc on transfer pricing? Nothing. That’s what. Without a definition, tax authorities could argue that a given piece of intellectual property is or is not an asset and therefore (based on the more favorable treatment for the tax authority) deny or force an arm’s length payment. Sounds like open season on taxpayers with significant cross-border transactions involving intangibles.

For example, U.S. law defines “intangible” for purposes of Section 482 – the transfer pricing statute – as “an asset that has substantial value independent of the services of any individual if it derives its value not from its physical attributes but from its intellectual content or other intangible properties.” (Treas. Reg. § 1.482-4(b)).

Other countries differ as to the definition of “intangible.” Case in point, India believes that an “intangible” asset should have human intelligence and uniqueness to be recognized. Given this construct, query then to what extent “distribution rights” would be valued in the U.S. versus India? Clearly the U.S. definition of intangible would include a distribution right as an intangible, as the right has value from its “other intangible properties,” notwithstanding that there may be no employees as yet. India, apparently, would reach an inapposite conclusion in the absence of employees. Apparently the ability to distribute vis-à-vis current employees is paramount from an Indian point of view. Given the dichotomy of views as to what constitutes an “intangible” for transfer pricing purposes, it will be difficult at best for tax authorities to agree on what an arm’s length result should be in the absence of a definitional framework as to what constitutes an “intangible” asset for treaty purposes.

This should be a clarion call for the OECD and its member states to put forth a common definition of “intangible” for treaty purposes or if not a definition, at least agree on the indicia of an “intangible” so that taxpayers and tax authorities alike will have a framework to foster negotiation. Moreover, in light of convergence of financial reporting standards there will likely be differences between what is reported for financial accounting purposes, statutory accounting purposes (the starting point for the tax return) and tax reporting in the U.S. versus non-U.S. jurisdictions. Thus leading to a further mudding of the waters as to intangibles that may or may not be reported for financial accounting purposes, but may nevertheless exist for tax purposes.

Absent a definition or at least an agreement as to the indicia of intangible asset(s) for treaty purposes, we will be left with the so-called Pornography Standard: You’ll know it when you see it. The OECD can and should do better.