The Obfuscation Report

WASHINGTON - When Robert M. Silva's job moved to Singapore two years ago, his company flew him overseas so he could train his replacement. Then the company closed its North Reading factory, laid off Silva and 119 co-workers and began importing from its Asian plant medical products once made in Massachusetts.

Moving jobs to Singapore had obvious advantages for Baxter International Inc. Taxes are low, and Silva's $26,000 salary was far higher than what the company pays his replacement.

But Baxter reaped another reward for moving overseas: a tax break, courtesy of the United States government. In the name of boosting US business, the tax code offers a special benefit to companies that move jobs offshore, a gift also accepted by Massachusetts employers such as Stratus Computer Inc. of Marlborough (500 layoffs last year), Augat Inc. of Mansfield (260 layoffs) and the Shrewsbury division of Quantum Corp. (85 layoffs), among others.

It is one of many tax breaks that ripple perversely through the economy - favoring multinationals over small firms, investors over average taxpayers and foreign workers over those at home.

The federal government gives up about $70 billion each year through corporate tax breaks, enough to cover the IRS bill for every Massachusetts resident two times over. Corporate tax breaks carry a lower political profile than direct subsidies to businesses for programs such as the one that helps McDonald's Corp. sell Chicken McNuggets overseas. But they cost about as much. For a nation trying to balance its budget and pay for social services, tax benefits to businesses are a gold mine.

``The tax code is a major source of corporate welfare,'' says US Rep. Lane Evans, an Illinois Democrat. ``Not only that, but we are using our tax dollars in a way that hurts our own economy. It drains our treasury. It forces average Americans to bear a larger share of the tax burden.''

The Clinton administration says that closing some tax breaks may force companies to raise prices and lose customers, and therefore pay less taxes. ``There are two sides to every part of this,'' says Leslie Samuels, until recently the Treasury Department's tax policy chief. ``If you're thinking that there's hundreds of billions of dollars, it's not there.''

Republican lawmakers have actually moved to widen some tax breaks. A 1993 law, for example, narrowed the provision that benefited Baxter International, Stratus and Augut, but a GOP bill scheduled for debate on the Senate floor today would fully restore the loophole.

Other lawmakers and analysts disagree with that approach. At a time when Medicare, Medicaid and other social welfare programs are being curtailed, they say, many tax policies which explicitly benefit corporations cannot be justified. These critics argue:

The US should not give tax breaks for breaking the law. For example, after testing faulty medical products on unwitting hospital patients, C.R. Bard Inc. paid $61 million in penalties in 1993. But the pain was tempered by the tax code, which allowed Bard to take half the fine as a tax deduction.

Tax breaks to boost exports are not worth the cost. Companies naturally will try to sell their products overseas, so export incentives worth at least $7 billion a year are a waste of money.

Too many companies pay no taxes at all. Nearly 60 percent of US-controlled corporations and 74 percent of foreign firms doing business here paid no federal tax in 1991, the last year figures were available. Critics say the US is not tough enough on companies that use illegal accounting maneuvers to shift profits to low-tax nations. The amount lost to the Treasury each year: as much as $40 billion over and above the $70 billion in legal tax breaks.

Congress must stop the bidding war among the states for jobs, in which companies win ever-greater tax breaks to relocate. It should not let states use federal tax dollars when ``poaching'' jobs from other states. Labor Secretary Robert Reich calls it ``one of the most egregious forms of corporate welfare.''

Congress and the Clinton administration have cut some tax concessions to businesses. They curtailed deductions for meals, sports tickets and country club dues, raising $3 billion a year in tax revenue. They also banned write-offs for ``excessive'' executive salaries, those over $1 million, raising $70 million annually. And they have worked out a deal - not yet final - to phase out a tax break for companies that build plants in Puerto Rico, which costs $2.6 billion a year in tax revenue.

But as a presidential candidate, Clinton promised more. He vowed to make foreign companies, widely accused of underpaying US taxes, pay $45 billion more over four years. Clinton has taken steps in this direction, but Treasury officials cannot show how much money has been gained. Moreover, the president has done little to fulfill another promise in his 232-page campaign platform, called ``Putting People First,'' to ``end tax breaks for American companies that shut down their plants here and ship American jobs overseas.''

Incentive to leave

A 33-year-old father of two, Silva spent six years at the C.R. Bard plant in North Reading. He assembled and tested infusion pumps, devices that allow patients to receive regular injections without a nurse or traditional needle. In 1993, the Bard unit was bought by Illinois-based Baxter. ``They promised us the world. Then they moved the plant to Singapore after telling us they wouldn't,'' says Silva of Nashua. About 130 people lost their jobs. ``It was quite the shock. People were in tears that day.''

One incentive for Baxter's move, critics say, was a tax break known as the ``runaway plant loophole,'' which accounts for $1.7 billion each year in lost tax revenue. Here's how it works:

The US taxes the worldwide profits of American companies. A million dollars earned in Ireland, for example, will be taxed at the US rate of 35 percent, minus the 10 percent tax the company must pay to the Irish government.

But Baxter, or any other company, is not required to pay the US tax bill unless it moves the money home to give to shareholders or to reinvest in the business here. As long as the money remains overseas - invested in foreign plants or banks - Baxter will pay only a small tax to Singapore. That is a total $191 million tax on its overseas profits over the years that the company has no intention of paying.

``The tax code literally says, `Move your plant overseas and we'll give you a tax break,''' says Sen. Byron Dorgan, a North Dakota Democrat.

The ``runaway plant loophole'' also has saved millions of dollars for Stratus, Quantum, Digital Equipment Corp. of Maynard and many others that have moved New England jobs overseas while deferring US taxes on overseas profits.

``Closing it would discourage further investment in growing our business,'' said Mark Fredrickson, a spokesman for EMC Corp. of Hopkinton, a computer equipment maker that has accumulated $388 million in untaxed overseas profits over the years. ``It helps our profitability and helps secure the local jobs we have. The bigger we become, the more people have to be employed here at corporate headquarters.''

Many companies take advantage of two other tax breaks designed to encourage exports. By creating a ``foreign sales corporation,'' which often exists only on paper, a firm can claim a tax exemption on some of its export sales. For example, Zoom Telephonics Inc. of Mansfield said recently it lowered its tax rate by selling more products through its foreign sales corporation. These tax rules, created in 1971 and refined in 1984, cost the government $1.5 billion a year.

The US Treasury also forfeits $3.6 billion annually through the ``title passage loophole,'' as Sen. Edward M. Kennedy has dubbed it, which allows companies to claim that some US sales were actually made on foreign soil. Companies do this because they sometimes have foreign tax credits they cannot use unless they show more foreign income.

A break for lawbreakers

While the tax code causes pain for some US workers, it provides comfort to some companies that break the law. Last year, for example, three former executives of C.R. Bard Inc. were convicted of conspiring to conceal flaws in medical catheters manufactured in Billerica and Haverhill. Two deaths allegedly were linked to the catheters, and prosecutors said the faulty devices caused 21 emergency surgeries. Bard's $61 million legal settlement with the government was the largest ever for violations of Food and Drug Administration rules.

But the tax code cushioned the New Jersey-based company. Half of the settlement - $30.5 million - could be used as a tax write-off against earnings. That was the amount Bard paid to settle civil charges. The money was meant to reimburse the Medicare program for buying catheters that should not have been on the market. ``When they earned the money they should not have earned from the catheters, they paid taxes on it. So when they give up those earnings, they should get the taxes back,'' said Michael Loucks, the assistant US attorney who prosecuted Bard.

After agreeing last year to pay the second-largest amount ever in a health-care fraud case - $161 million - Caremark International Inc. plans to take a $110 million charge against earnings, on top of a write-off to cover its legal costs.

Tax law prevents companies from deducting criminal penalties, avoiding an incentive to commit criminal acts. Loucks said Bard did not negotiate with the Justice Department over what portion of the settlement would be a civil penalty, and therefore tax-deductible. But some companies try to. ``Part of the reason companies would rather do civil settlements is because they are deductible,'' he said.

Zero-tax accounting

Some companies have gone beyond shielding profits from taxes. By stretching or even breaking US accounting rules, they pay no tax at all. Their goal is to shift profits out of the country into low-tax nations like Bermuda, Ireland or Honk Kong. Their tool is the accounting ledger, and critics of the tax code say it is effective. International Business Machines Corp., for example, paid virtually no tax in 1987, despite $25 billion in US sales. Sen. Kennedy says IBM shifted an undue amount of its worldwide research costs onto its US operation. That raised its American expenses, he says, and lowered its profits. IBM says its accounting practices are legal, but will not comment further.

Similarly, Nissan Motor Corp. of Japan overcharged its US subsidiary for cars, the IRS charged several years ago, lowering its US profits and tax bill. Nissan agreed to pay the IRS $160 million, one of several settlements with the agency the automaker signed between 1987 and 1993.

Both US and foreign companies cut their taxes by profit shifting, but many lawmakers and tax analysts believe the practice is particularly widespread among foreign companies. More than 70 percent of foreign firms paid no tax each year between 1987 and 1991, the IRS reports, compared to about 60 percent of US companies. Clearly, some paid no tax because they did not make a profit, but many lawmakers believe others are illegally shifting profits overseas.

Estimates on the tax revenue loss range from $10 billion to $40 billion a year. Treasury officials say the figure will decrease over time because of tighter regulations created under the Clinton administration.

Will the new rules raise the $45 billion that Clinton said he would draw from foreign companies over four years? ``It would be nice to say, `Here's what's going to happen,' but I don't think anyone in the trenches can reliably say that,'' said Samuels, the former Treasury tax policy chief.

One group of lawmakers says the transfer-pricing system must be scrapped. In its place, they propose a formula similar to what the states use now to determine what portion of a company's profits can be taxed. The formula bases the tax on what portion of a company's sales, property and personnel are in each state.

The Treasury Department, under pressure from Sen. Dorgan, is holding a conference this year to consider how such a formula might be created.

A $143 million jolt

Every year, the US government spends $143 million to help generate electricity and run recreation programs for Tennessee and six neighboring states. Now 63 years old, the Tennessee Valley Authority keeps the region's electricity rates low. By contrast, electric rates in Massachusetts are high. And that is a key reason Lexington-based Raytheon Co. last year threatened to take 15,000 jobs out of state unless it won $40 million in tax and electric rate relief. Had it left, Raytheon's likely new home would have been in Tennessee. In other words, says US Rep. Martin T. Meehan, a Lowell Democrat, Washington collected tax dollars from Massachusetts, then sent them to Tennessee, effectively helping to lure Massachusetts jobs.

Now, Fidelity Investments of Boston and the mutual fund industry, as well as life insurance companies, are demanding similar tax relief. Increasingly, other states find themselves being forced to offer tax breaks to businesses that threaten to leave town.

``This is one of the most egregious forms of corporate welfare, because the company essentially holds the state up to ransom,'' Labor Secretary Reich says. ``It's bad, because it's a zero-sum game. No new jobs are created. ... From the national standpoint, this is money that is subsidizing companies with no net benefit whatsoever.''

Furthermore, tax breaks don't always save jobs. Raytheon this year is trying to buy out 4,400 workers whose jobs the tax relief intended to save. In 1993, Digital Equipment Corp. angered Boston officials when it closed its Roxbury factory and laid off 190 workers after taking $7 million from the city in financing, tax cuts and other subsidies.

Now, some are calling for the federal government to step in. Last year, Massachusetts delegates to an annual small business conference at the White House urged the president to ban the use of federal money in interstate bidding wars.

Congress could tax businesses on the value of the incentives they receive from states, or it could deny federal funding to states that get into bidding wars. It also could bar states from using federal grant money or government-backed loans in incentive packages.

Massachusetts at times has used federal dollars to lure businesses. Springfield, for example, this year beat out sites in six other states to be the home of a new customer service center for First Notice Systems of Medford, which could employ as many as 900 people. As an incentive, the city offered federal funds to train company workers. It also borrowed money from the federal government and used the cash, in essence, to give First Notice a low-interest loan for building renovations.

Corporate darlings

Businesses like tax breaks because, unlike spending programs and direct subsidies, they are outside the federal budget and therefore not subject to annual review by Congress. Between 1913 and the major tax overhaul of 1986, Congress killed only 13 of the scores of tax breaks on the books, according to Congress' watchdog agency, the General Accounting Office. Moreover, they sometimes go to already prosperous industries. The oil and energy industry gets $2.4 billion in tax breaks each year, while $1.4 billion goes to timber and natural resources companies, and billions more go to insurance, agriculture, real estate and other concerns.

Tax benefits are sometimes applied in unforseen ways. A credit meant to boost research investment, for example, became the center of controversy recently as several defense companies sued the Internal Revenue Service for tax rebates on weapons programs that date to the early 1980s. The IRS says the tax credits are not deserved, since the Pentagon paid for the weapons research and usually covers the costs even of failed weapons programs. But the companies have won an early round in the courts, arguing that the Pentagon paid for the weapons, not the research that produced them. The tax refunds could total billions of dollars.

Each tax break is a choice, favoring one group of taxpayers over another. Export rules, for example, favor exporters over companies that sell in the US. The ``runaway plant loophole'' favors companies that hire foreign workers over companies that strive for the ``Made in the USA'' label.

Most broadly, corporate tax breaks generally favor wealthy Americans over the less-well off. Tax benefits are designed to help businesses create jobs, but when corporations win a tax break it is the owners of the company who gain most.

Last December, with Republicans and Democrats deadlocked over a plan to end a 21-day shutdown of the federal government, 91 corporate chief executives signed a two-page newspaper advertisement that urged Congress to balance the budget. ``Without a balanced budget, the party's over. No matter which party you're in,'' the ad said.

Seven of the CEOs were from companies that take advantage of a major tax break for purchasing new equipment, which costs the US $26 billion a year. Exxon saved $760 million because of the so-called accelerated depreciation rules, according to calculations by the Center for the Study of Responsive Law, a Washington-based Ralph Nader group. Ford Motor Co., Chrysler Corp., DuPont and others that signed the ad saved hundreds of millions dollars more.

General Motors is a major recipient of federal technology grants. Kodak claimed $37 million in export and manufacturing tax credits last year. In 1994, IBM paid no US taxes on $11 billion in profits it earned overseas, while the US Labor Department reported that 1,755 IBM jobs were moved abroad.

``How can you demand that the budget be balanced when you're taking tax breaks like this?'' asked Janice Shields, a former accounting professor now with the watchdog group. ``These things save the companies from going into debt, but it's causing the country to do that.''

This story ran on page 1 of the Boston Globe on 07/08/96.

# posted by The Punisher @ Thursday, June 21, 2007