The Hidden Cost of Offshore Tax Havens in Illinois

7/29/2019 The Hidden Cost of Offshore Tax Havens in Illinois

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The Hidden Cost of

Offshore Tax HavensState Budgets Under Pressure

from Tax Loophole Abuse


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The Hidden Cost ofOffshore Tax Havens

State Budgets Under Pressure

from Tax Loophole Abuse

Illinois PIRG Education Fund

Jordan Schneider and Elizabeth Ridlington,Frontier Group

Phineas Baxandall and Dan Smith,

U.S. PIRG Education Fund

January 2013


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Acknowledgments

Layout & Graphic Design: Harriet Eckstein Graphic Design

Cover image: Handshake and beach scene photos by bigstockphoto.com contributors Ljupco Smokovskiand Maria Skaldina. Photo design by To the Point Publications, tothepointpublications.com.

The authors wish to thank Matt Gardner, Executive Director at Institute on Taxation and

Economic Policy, or his review o this report. The authors would also like to thank TonyDutzik and Travis Madsen o Frontier Group or editorial assistance.

The authors bear responsibility or any actual errors. The recommendations are those oIllinois PIRG Education Fund. The views expressed in this report are those o the authorsand do not necessarily reect the views o our unders or those who provided review.

2013, Illinois PIRG Education Fund. Some Rights Reserved. This work is licensed undera Creative Commons Attribution Non-Commercial No Derivatives 3.0 Unported License.To view the terms o this license, visit creativecommons.org/licenses/by-nc-nd/3.0/us.

You are ree to display, reproduce, and distribute this work in its entirety or non-com-mercial purposes, with proper attribution. To attribute this work, please credit Illinois

PIRG Education Fund and provide a link to illinoispirgedund.org.

With public debate around important issues oten dominated by special interests pursu-ing their own narrow agendas, Illinois PIRG Education Fund oers an independent voicethat works on behal o the public interest. Illinois PIRG Education Fund, a 501(c)(3)organization, works to protect consumers and promote good government. We investigateproblems, crat solutions, educate the public, and oer meaningul opportunities or civicparticipation.

Frontier Group conducts independent research and policy analysis to support a cleaner,healthier and more democratic society. Our mission is to inject accurate inormation andcompelling ideas into public policy debates at the local, state and ederal levels. For more

inormation about Frontier Group, please visit www.rontiergroup.org.


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Table of Contents

Executive Summary 1

Introduction 4

How Offshore Tax Havens Work 5Impacts of Avoided Federal Taxes 5

Recent Federal Action to Limit Tax Havens 6

Offshore Tax Havens Cost States Billions 9

How Federal and State Taxes Are Linked 9State-Level Tax Losses to Tax Havens 10

States Can Reduce the Fiscal Impact 11of Offshore Tax Havens

Methodology 16

Appendix A. Tax Haven Use by 83 of the 18

100 Largest Publicly Traded Companies

Appendix B. Tax Avoidance by State 19

Notes 22

in Avoided Taxes


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Executive Summary 1

Executive Summary

When U.S. corporations and wealthyindividuals use oshore tax havensto avoid paying taxes to the ed-

eral government, it is an abuse o our taxsystem. Tax haven abusers beneft romour markets, inrastructure, educatedworkorce, and security, but they pay nextto nothing or these benefts. Ultimately,taxpayers must pick up the tab, either in theorm o higher taxes, cuts to public spend-

ing priorities, or increased national debt.

Tax havens are countries or jurisdictionswith minimal or no taxes. Corporationsand individuals shit earnings to fnancialinstitutions in these countries to reducetheir U.S. income tax liabilitycostingthe ederal government $150 billion in lostrevenues each year.

Federal taxpayers are not the only vic-tims o oshore tax havens. Tax havens

deprive state governments o billions odollars in badly needed revenues as well.Based how much income is ederally re-ported in each state, and on state tax rates,it is possible to calculate how much eacho the state governments lose as a result ooshore tax dodging.

In 2011, states lost approximately$39.8 billion in tax revenues rom cor-porations and wealthy individuals whosheltered money in oreign tax havens.

Multinational corporations account ormore than $26 billion o the lost tax rev-enue, and wealthy individuals accountor the rest.

$39.8 bill ion would cover education

costs or more than 3.7 millionchildren or one year.

This sum is also roughly equivalent tototal state and local expenditures onfrefghters ($39.7 billion) or on parksand recreation ($40.6 billion) in FY2008.

Table ES-1 lists the top 10 states withthe most revenue lost to tax havenabuse.

Some o the largest companies in theUnited States use tax havens, includ-ing many that have taken advantageo government bailouts or rely ongovernment contracts. As o 2008, 83o the 100 largest publically traded


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2 The Hidden Cost of Offshore Tax Havens

corporations in the United Statesmaintained revenues in oshore taxhavens, according to the GovernmentAccountability Ofce.

At the end o 2011, 290 o the top For-

tune 500 companies using tax havenscollectively held $1.6 trillion in proftsoutside the United Statesup rom$1.1 trillion in 2009according toCitizens or Tax Justice.

Federal policymakers must crack downon tax haven abuse, but with Congressoten gridlocked, states should act indepen-dently to reduce the impact o oshore taxhavens on state budgets.

States can act immediately to restoreairness to the tax system and minimizethe fscal impact o oshore tax havenabuse through policy changes that willclose loopholes and increase their abil-ity to detect and penalize tax avoidance.For example:

1. States can decouple their taxsystem rom the ederal tax system.Because states typically use the samedefnitions o income as those in theederal tax code, they automaticallylose money when tax haven users dont

report income to the ederal govern-ment. Decoupling would help preventthose automatic losses. Rather thanallow income that has been shited outo sight rom ederal tax authorities todiminish the tax baseline, states canclose loopholes that restore this hid-den income.

2. States can require worldwidecombined reporting or multi-national corporations. Combinedreporting is the practice o treatingthe parent and subsidiary companieso a multinational corporation as onecorporation or the purpose o cal-culating taxes. Adding up all proftsearned worldwide by a company, andthen taxing a share o those combinedprofts according to the companyslevel o activity in each country, wouldeliminate the tax benefts o shitingprofts to tax havens such as Bermuda

or Ireland.

3. States should urge their ederalrepresentatives to reject a territo-rial tax system,which would urthererode state revenue. Such a systemwould allow companies to bring all othe profts they have parked oshorein tax havens back into the UnitedStates without paying U.S. taxes.

4. States can require increased

disclosure o fnancial inormationabout corporations business presencein other countries and how they pricetheir transers with their own oreignsubsidiaries; as well as to explainwhy large disparities exist betweenthe profts corporations report to

Table ES-1. Total Annual Income TaxRevenues Lost to Tax Havens(Individual and Corporate IncomeTaxes Combined)

RevenueLosses

Rank State (Millions)

1 Caliornia $7,147

2 NewYork $4,275

3 NewJersey $2,833

4 Illinois $2,545

5 Pennsylvania $2,105

6 Minnesota $1,953

7 Massachusetts $1,688

8 NorthCarolina $1,049

9 Florida $979

10 Maryland $966


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Executive Summary 3

shareholders and tax authorities.These measures would provide moreinormation or state authorities tosearch or red ags, decide when toaudit, and crack down on abuse.

5. States could withhold taxes as parto ederal FATCA withholding.TheForeign Account Tax Compliance

Act (FATCA) prescribes a 30 percentederal withholding tax on companiesthat transer unds to oreign fnancialinstitutions that do not comply withU.S. disclosure and reporting require-ments. States that collect income taxes

could withhold state taxes on theseunds at the same time.


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The recent economic recession cre-ated severe budget shortalls or stategovernments. Consumer spending,

income, property values and businessprofts have been depressed, and so havestate tax revenues. In the last our years,state policymakers have had to close morethan $540 billion in budget shortalls bymaking tough choices about cutting criti-cal public services, such as fre and police,

cutting pensions or public employees,fring and urloughing teachers, and evenreducing the number o days that childrengo to school.1

The problem is compounded when cor-porations and wealthy individuals in thosestates avoid paying their taxes by hidingtheir taxable income in oshore tax havens.While large multinational corporationssuch as Apple, ExxonMobil, or GoldmanSachs routinely make national headlines or

the billions o dollars in ederal taxes theyavoid annually by parking profts oshore,the impact o missing ederal tax revenuesonstate budgets has received virtually noattention. States automatically lose bil-lions o dollars in revenue each year simplybecause their tax codes are closely linked

to ederal tax codes. When multinationalfrms shit the reporting o profts oshoreon their ederal taxes, those profts go un-reported or state tax purposes too.

Companies and wealthy individuals thatabuse oshore tax havens still beneft romtheir access to each states markets, work-orce, inrastructure, security, and publicservices. But they pay little or nothing or

those beneftsviolating the basic airnesso the tax system and orcing other taxpay-ers to pick up the tab.

The tax burden created by tax havenabuse that is shouldered by the public isordinarily invisible. State residents have noway to know i a bridge in their communityremains in disrepair because o tax havenabuse. Nor do taxpayers send a separatetax check in the name o General Electricor some other company when they pick up

the tab. But the eect is the same.

This report shines a light on those oth-erwise unseen burdens placed on ordinarytaxpayers. It estimates the tax revenues lostto state governments through the use ooshore tax havens by U.S. multinational

Introduction


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Introduction 5

corporations and wealthy individuals eachyear.

Fortunately, states have other optionsbesides simply waiting or a gridlocked

Congress to come to their rescue. Statepolicymakers have numerous toolsthat they can use to reduce the iscalimpact o oshore tax havens on theirbudgets.


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Tax havens are countries or jurisdictionswith very low or nonexistent taxes, towhich U.S.-based multinational frms

transer their earnings to avoid payingtaxes in the United States.2 Income earnedby oreign subsidiaries o U.S.-basedcompanies is not taxed until the money isreturned to the United States. I the moneyis kept overseas, the company pays no taxeson it.3 Companies have many strategies or

moving money oshore, including takingon debt in high-tax countries rom a lenderin a low-tax country, or transerring pat-ents to subsidiaries located in tax havensand paying royalties to the subsidiary touse them in the United States.

Wealthy individuals also use tax havensto avoid paying taxes by setting up o-shore shell corporations or trusts. Incomeearned in the United States can be paid tothese oshore entities, thereby avoiding

U.S. taxes. These entities also can makeinvestments in the United States withoutpaying taxes because they are considerednon-residents.4

Many tax haven countr ies are smallnations, such as Bermuda, the Cayman

Islands, Belize and Switzerland.5 Finan-cial secrecy laws in these nations thwartinternational rules by limiting disclosureabout fnancial transactions made withintheir jurisdictions.

Impacts of AvoidedFederal TaxesAbuse o tax havens by multinat ionalcompanies and wealthy individuals rep-resents a major loophole in the Americantax system. The ederal government losesapproximately $150 billion in ederal taxrevenues every year due to corporationsand wealthy individuals sending theirmoney to oshore tax havens.6 The ederalgovernment currently shoulders this bur-den by cutting public services or adding to

the national debt.

These companies and individuals beneftrom the taxes paid by other corporationsand citizens. The profts they shelter over-seas are generally earned rom Americaslargest-in-the-world consumer market;

How Offshore Tax Havens Work


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How Offshore Tax Havens Work

produced by Americas well-educated work-orce, which was trained in our extensivepublic school system; sustained by our road

and rail systems that help transport goods tomarket; and protected by Americas strongprivate property rights as enorced by Amer-icas court and probate system. Despite theirdeep dependence on American economicand social inrastructure, the companiesand individuals who use oshore tax havensshirk their duty to pay or it.7

Recent Federal Action toLimit Tax HavensMarkets work best when companies pros-per based on their productivity and abilityto innovate, rather than their access tosophisticated tax lawyers and ability to

employ complex tax-avoidance schemes.Closing loopholes that allow corporationsto avoid paying their share o taxes would

thereore improve market competition aswell as increase ederal revenues and im-prove the airness o the tax system.

The president and Cong re ss haverecently taken some steps to eliminateoshore tax haven abuse, but much morestill needs to be done.

The Foreign Account Tax ComplianceAct (FATCA), adopted in March 2010,added new reporting requirements and

penalties to discourage individuals, com-panies and banks rom hiding money inoshore tax havens.12 The law will imposea 30 percent withholding tax on U.S. sourcepayments to oreign fnancial institutionsthat ail to meet disclosure requirements ontheir American clients accounts.

The Delaware Loophole

D

elawares extremely lax corporate tax laws, including those governing the incorpo-ration o new companies, have made Delaware shell companies a standard tool or

multinational tax dodging. At last count, more than 945,000 corporate entities werelegal residents o the statemore than the states actual population o 898,000.8

Businesses operating in other states can transer their profts to holding compa-nies in Delaware to reduce their tax liability in their own states. This Delawareloophole, has helped U.S. corporations reduce their state taxes by an estimated $9.5billion in the last 10 years, according to theNew York Times.9 U.S. corporations canboth register their U.S. subsidiaries in Delaware to avoid taxes in other states andmake use o oshore tax havens to dodge ederal taxes.

The same tax laws that attract U.S. businesses seeking to reduce their tax liability

also attract criminal activity and illegal tax evasion. In Delaware, criminals can set upvirtually anonymous shell corporations with no connections to a U.S. bank accountand without disclosing their identity.10 Criminals have used anonymous Delawareshell corporations as a tool or illegal activities, including arms dealing and drugtrafcking, Medicare and mortgage raud, embezzling and money laundering, givingand receiving bribes, and circumventing international sanctions.11


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While much o the law has not yet beenimplemented, progress has been made. InFebruary 2012, the United States orgedreciprocal agreements with France, Brit-ain, Spain, Germany and Italy to provideor the automatic exchange o inormation

about the oreign bank accounts o U.S.citizens.13 In November, the TreasuryDepartment announced it is now workingwith more than 50 jurisdictions to enablethe exchange o tax inormation.14 Despitethe progress, FATCAs impact has beenlimited because fnancial institutions havebeen drawing out the stakeholder consulta-tion process. These maneuvers have pushedback its eective date into 2014.15

Other legislation also adopted in March2010 should acilitate IRS enorcemento the Economic Substance Doctrine byincorporating that doctrine into the IRS

code. The Economic Substance Doctrineensures that transactions have an eco-nomic purpose beyond manipulating taxexposure. The law places the burden oproo on taxpayers rather than regulatorsto demonstrate that a tax strategy is legal.

It is projected to produce revenues o $4.5billion over a decade.16

Finally, in September 2011, Congresspassed legislation to ban tax strategy pat-ents, which allowed tax lawyers to patent amyriad o tax avoidance strategies, includ-ing setting up shell companies in oshoretax havens.17 While this ban does not nec-essarily reduce tax shelter abuse, it at leastreduces its proftability to the lawyers thatacilitate it, and thus removes an incentiveor companies to pioneer new ways to ripo the public.


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Offshore Tax Havens Cost States Billions in Avoided Taxes 9

When companies and individuals useoshore tax havens to avoid payingtheir share o ederal taxes, they

also reduce how much they pay in statetaxes. This adds up to billions o dollars orevenue each year that state governmentsdo not receive and cannot use to repairroads, improve schools, or maintain parks.

Based how much income is ederally re-

ported in each state, and on state tax rates,it is possible to calculate how much eacho the state governments lose as a resulto oshore tax dodging. Altogether, taxhavens cost state governments nearly$39.8 billion in lost revenues in 2011.18O that total, corporations were respon-sible or $26 billion in lost revenues totax havens, while wealthy individuals

were responsible or the rest.19

How Federal and State TaxesAre LinkedState and ederal tax burdens are closelylinked. State tax burdens are typically

calculated using the same (or similar)defnitions o income as those used in thecalculation o ederal taxes. This is doneor the sake o simplicity and to reducethe cost o enorcement and compliance.The result, however, is that income thatcorporations and wealthy individuals avoidreporting or ederal tax purposes is alsolet unreported or state tax purposesde-priving state governments o billions o

dollars in revenue.

There are numerous tactics companiescan use to manipulate their defnition otaxable income to lower their ederaltax burden, which translates to a lowerstate tax burden as well. For example,U.S. companies can take advantage oa loophole in the ederal tax code thatallows them to deer U.S. taxes on pas-sive income. Passive income includesroyalties, dividends, rents, and interest,

and companies are required to pay annualU.S. taxes on this income even i it staysoshore. However, companies avoid thisby creating transactions between oreignsubsidiaries that transorm this passiveincome into active income, or incomeresulting rom actually doing business,

Offshore Tax Havens CostStates Billions in Avoided Taxes


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which is not taxable by the U.S. govern-ment until it is brought onshore.20

For example, in order to reduce itspassive income tax liability, Google cantranser ownership o patents to a Bermuda

subsidiary; then, an Irish subsidiary paysroyalties to the Bermuda subsidiary orthe right to use the patents. Normally, thisroyalty payment would be considered pas-sive income and subject to U.S. taxation.However, the tax loophole states that ithe payment is related to the active busi-ness o the Irish subsidiary, the companycan deer paying taxes. Google used thistactic to move $5.4 billion in royalties toits Bermuda tax haven in 2008, completelyremoving those royalties rom its U.S. tax-able income and keeping them out o thereach o states, as well.21

State-Level Tax Losses toTax HavensThrough the use o oshore tax havens,U.S. corporations and wealthy individuals

are reducing their overall state tax liability.Altogether, tax havens cost state governments

nearly $39.8 billion in lost revenues in 2011.22O that total, corporations were responsibleor $26 billion in lost revenues to tax havens,while wealthy individuals were responsibleor the rest.23 Table 1 and Appendix B breakdown the lost revenues by state.

To put this fgure into perspective, thisamount could pay or the education oabout 3.7 million school-age children orone year.24 This sum is also roughly equiva-lent to total state and local expenditures onfrefghters ($39.7 billion) or on parks and

recreation ($40.6 billion) in FY 2008.25

Well-known companies engage in taxavoidance through the use o oshore taxhavens, including the majority o Americaslargest publicly held corporations. Accord-ing to the Government Accountability O-fce, 83 o the 100 largest publicly tradedU.S. corporations maintained revenues inoshore tax haven countries as o 2008.26(See Appendix A.) Ater 2008, despite thefnancial crisis, large corporations increasedthe amount o profts stored overseas. Atthe end o 2011, 290 o the top Fortune 500companies using tax havens held a collective$1.6 trillion in profts outside the United

Statesup rom $1.1 trillion in 2009ac-cording to Citizens or Tax Justice.27

Table 1. Total Annual Individual and Corporate Income Tax RevenuesLost to Tax Havens (Millions)

State Individuals Corporations Total

Caliornia $2,936 $4,211 $7,147

NewYork $1,840 $2,435 $4,275

NewJersey $1,058 $1,776 $2,833

Illinois $607 $1,939 $2,545

Pennsylvania $324 $1,780 $2,105

Minnesota $629 $1,324 $1,953

Massachusetts $439 $1,248 $1,688

NorthCarolina $426 $623 $1,049

Florida NA* $979 $979

Maryland $277 $690 $966

*NA(notapplicable)indicatesthatstatesdonotcollecttaxesonthistypeoincome.


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States Can Reduce the Fiscal Impact of Offshore Tax Havens 11

States can minimize the fscal impacto oshore tax haven abuse throughpolicy changes that close loopholes

and increase their ability to detect andpenalize tax avoidance. For example:

States can decouple their tax sys-tem rom the ederal tax system.

States can avoid losing billions o dollars

in revenues due to unreported ederal taxesby decoupling their tax systems rom theederal tax system. States use a two-stepprocess to determine how corporationsshould be taxed: frst, they determine netprofts; then, they use state-specifc ormu-las to determine the share o those proftsthat should be subject to taxation in thatstate. States can decouple their defni-tion o income rom the ederal code toavoid lost revenues when corporations andindividuals dont report income or ederal

tax purposes.

For example, 22 states and the Districto Columbia have decoupled rom a ederaltax break known as the Qualifed Produc-tion Activities Income (QPAI) deduction.28This tax break was meant to help American

manuacturers by allowing them to deductup to 9 percent o income earned or do-mestic production activities. However, thelegislation that enacted the QPAI deduc-tion is loose in its defnition o produc-tion activity, allowing corporations suchas Starbucks and Walt Disney Companyto use the QPAI deduction to avoid pay-ing $48 million and $370 million in taxes,respectively, over fve years.29 The 25 states

that have not decoupled rom the QPAImeasure stood to lose more than $505 mil-lion in 2011 alone, according to the Centeron Budget and Policy Priorities.30

Likewise, more than 30 states have de-coupled rom bonus depreciation measurespassed by Congress in 2002, 2003, 2004,2008, 2009 and 2010, which allow companiesto immediately deduct up to 100 percent othe cost o investments in machinery andequipment, according to the Institute on

Taxation and Economic Policy.31 As o 2011,22 states had decoupled rom this measure byrequiring companies to add these deductionsback into their taxable income.32

States can minimize losses to oshoretax havens by decoupling rom the ederal

States Can Reduce the FiscalImpact of Offshore Tax Havens


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determination o income. Two speciicexamples o ederal loopholes rom whichstates could decouple are the active fnanc-ing exemption and the credit deault swaploophole.

The active fnancing exception is an ex-ception to the general rule in the tax codethat companies must pay taxes on passiveincomesuch as dividends, interest, orroyaltiesas it is earned. Instead o payingtaxes right away, companies can use thisloophole to deer tax payments on passiveincome earned overseas until the money isbrought back into the United States. TheU.S. Congress Joint Committee on Taxa-tion estimates that this recently extendedloophole will cost $11.2 billion in lostederal revenue over the next two years.33States could decouple rom this ederalexemption to recoup lost revenue.

Credit deault swaps are complex fnan-cial instruments that many argue were atthe center o the 2008 fnancial crisis. Aloophole in the tax code allows companiesto send swap payments oshore as or-eign income even though the paymentoriginated in the United States. States

should also decouple rom this loopholeand treat swap payments that originate inthe United States as taxable U.S. income.

The limitat ion o decoupl ing is thatlocal tax authorities traditionally coupletheir taxes or simplicity, which also makestracking compliance and enorcementeasier. The Multistate Tax Commission(MTC), an intergovernmental state taxagency charged with determining stateand local tax liability or multistate taxpay-

ers; settling apportionment disputes; andpromoting uniormity in state tax systems,could play a role in elevating best practicesor greater decoupling.

States can require global combinedreporting or multistate corporations.

Combined reporting is the practice otreating the parent and subsidiary com-panies o a multi-state corporation as onecorporation or state tax purposes. The23 states that currently require combinedreporting have eliminated many o the tax

benefts o shiting profts to tax havenstates such as Delaware or Nevada byadding up all profts earned nationwideby a company, and then taxing a share othose combined profts according to thecompanys level o activity in that state.34

States can extend combined reportingto oshore subsidiaries, as well. Thisworldwide approach would requirecompanies to report on profts earned bysubsidiaries overseas as well as their do-mestic profts. Adding up all profts earnedworldwide by a company, and then taxing ashare o those combined profts accordingto the companys level o activity in eachcountry, would eliminate the tax beneftso shiting profts to tax havens such asBermuda or Ireland. It would also preventcompanies rom arbitrarily apportioningprofts to jurisdictions where they wontbe taxed.

Tax authorities would have the largerpicture or a group o worldwide afliates,and companies could not so easily portraycontradictory stories to each country aboutwhere their business activities take place.

States should urge the ederal gov-ernment to reject a territorial taxsystem.

A territorial tax system would allowcompanies that temporarily shit profts

to tax haven countries to reely bring thoseprofts back to the United States withoutpaying U.S. tax. Current loopholes alreadyallow some corporations using tax havensto indefnitely deer much o their taxeson income earned abroad. A territorial taxsystem would exempt these earnings rom


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States Can Reduce the Fiscal Impact of Offshore Tax Havens 13

taxation altogether, creating a permanenttax holiday.

Such a move would increase existingincentives or corporations to disguiseprofts as oreign to unairly avoid pay-

ing U.S. taxeswhile also encouragingcompanies to move jobs and actories outo the country. State leaders should presstheir colleagues in the ederal governmentto reject such a system.

States can require increased disclo-sure o fnancial inormation.

State tax authorities could require com-panies to disclose more inormation abouttheir business presence in other countries andhow they price their transers with oreignsubsidiaries; and to explain why large dispari-ties exist between the profts they report toshareholders and to tax authorities. Thiswould provide more inormation or stateauthorities to search or red ags, decidewhen to audit, and crack down on abuse.

For example, states could share fnancialinormation about companies and indi-viduals suspected o tax avoidance. Current

IRS rules prohibit states rom exchanginginormation about taxes. However, theserules could be relaxed when certain suspi-cious tax activities occur, which would helpstates gather inormation to decide whichcompanies and individuals to more closelyscrutinize. Two such potential red agscould include:

oWhen the profts that companiesreport to shareholders exceed proftsreported to the ederal government

by 10 percent. When this happens,current ederal law requires thesecompanies to fle supplementary taxinormation. States should be able toshare tax inormation when there arelarge discrepancies between reportedearnings.

oWhen companies or individuals trig-ger FATCA withholding (see below)by transerring unds to overseasfnancial institutions that dont com-ply with U.S. disclosure laws. Statesshould know when companies or

individuals within their borders aresuspected o tax avoidance throughoshore tax havens.

States should also require all companiesincorporated within their borders to dis-close inormation about the true ownerso the company, allowing law enorcementand local tax authorities to more eectivelytrack raudulent activity and protect thepublic, and avoiding the many problemsassociated with criminals using anonymousshell companies.

States could withhold taxes as part oederal FATCA withholding.

The Foreign Account Tax ComplianceAct (FATCA) prescribes a 30 percentederal withholding tax on unds that cor-porations or individuals transer to oreignfnancial institutions that ail to complywith U.S. disclosure and inormation shar-

ing requirements.

Since states also lose tax revenue whenmultistate companies siphon o incometo oshore tax havens, states could alsoimpose a withholding tax on this income.States could withhold taxes on transac-tions according to the percentage o thecompanys share o income earned in thatstate.

ConclusionStates are not merely onlookers to theederal ailure to address problems withoshore tax havens. Each state suers an


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unjustifed and painul loss o revenue, typ-ically in the range o hundreds o millionsi not billions o dollars annually. Statescan exercise their own leadership and makeindependent fxes to their own tax systemsand require more comprehensive disclosure

o suspicious tax avoidance. Working with

the ederal government, they can also urgegreater inormation sharing, withhold statetaxes on shady transactions that also trig-ger ederal withholding, and insist againstinstituting a territorial tax system thatwould open the door to even greater o-

shore tax dodging.


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Methodology 15

To estimate the amount o revenueorgone by state governments dueto oshore tax havens, we needed to

know the ollowing:

1. How much ederal income tax ineach state is avoided by oshore taxhavens,

2. How much ederal income tax is

avoided or business versus indi-vidual flers,

3. How much income individuals andcorporations using tax havens earnbased on their tax flings, and

4. How much state tax would havebeen generated on that income i ithadnt been shited oshore.

1. How much ederal income tax in

each state is avoided through oshoretax havens?

We ollowed the methodology used byPhineas Baxandall, Abigail Caplovitz Fieldand Dan Smith o U.S. PIRG in Picking

Up the Tab (April 2012), in attributing theederal income tax avoided through taxhavens to each state. To apportion theselost revenues to the states, we obtainedIRS data or total income tax revenuesrom each state. We then subtracted thetotal reunds, with interest, or each stateto obtain net income tax revenues by state.We divided that number by the nationalnet income tax revenue (national revenue

minus national reunds with interest). Theresulting percentage was the amount o netrevenue attributable to each state, and wemultiplied $150 billion by those percent-ages to apportion the $150 billion.35

2. How much o the money in o-shore tax havens is rom businesses

versus individual flers?

The Senate Committee on Joint Investi-gations estimates that 60 percent o money

in oshore tax havens belongs to businessesand 40 percent belongs to individual orhousehold ilers. We assumed that thenumber holds constant or each state, andsplit the state-level fgures obtained in step1 accordingly.

Methodology


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3. How much income is not sub-jected to taxation due to the use o taxhavens?

To estimate the amount o taxable in-come that corresponds to this avoided tax,

we multiplied the corporate and individualavoided taxes by the eective ederal taxrates or each category. For corporations,we per ormed a ur ther adjust ment toincorporate the act that businesses typi-cally can deduct their state taxes rom theirederal taxable income. For individuals, weadjusted our state taxable income estimateto account or deduction o ederal incometax rom state taxable income in some statesthat allow it.

For businesses, we assumed that theeective ederal corporate tax rate is 24.2percent (versus a statutory rate o 39.2percent), per Thomas L. Hungerord, Con-gressional Research Service,An Analysis othe Buett Rule,28 March 2012.

We then multiplied each states statutorycorporate tax rate (per Federation o TaxAdministrators,Range o State Corporate In-come Taxes, February 2012) by our estimate

o ederal taxable income, and added the re-sulting fgure to the ederal taxable incomefgure. The result is that, in states withstate corporate tax, state taxable income ishigher than ederal taxable income.

For individuals, we assumed that tax

avoidance strategies are used by thewealthiest individuals in society and there-ore we chose to use the eective ederaltax rate or the wealthiest 0.01 percent oflers. Those taxpayers paid a 24.77 percent

eective income tax rate (total tax dividedby total income) in 2006, per Thomas L.Hungerord, Congressional Research Ser-vice, Changes in the Distribution o IncomeAmong Tax Filers Between 1996 and 2006:The Role o Labor Income, Capital Income,and Tax Policy, 29 December 2011. For

Alabama, Iowa and Louisiana, three statesthat allow individual taxpayers to deducttheir ederal taxes rom their taxable stateincome, we subtracted taxes that would bepaid on oshore unds rom our calculationo ederal taxable income.

4. How much state tax would havebeen generated on that income i it

werent shited oshore?

Corporations: We estimated the amounto state tax that would be paid on corpo-rate income by multiplying the corporatetaxable income shielded rom taxationthrough the use o tax havens (as estimatedin step 3) by each states corporate taxrate. In states with multiple corporate taxbrackets, we used the rate or the highesttax bracket, per Federation o Tax Admin-istrators, Range o State Corporate IncomeTaxes, February 2012. We modifed thismethod or several states based on state-specifc conditions.

For Delaware, we chose to use the rateor large fnancial institutions becausethe largest institutions are most likelyto use oshore tax havens. Delaware

charges a at 8.7 percent tax to cor-porations except or fnancial institu-tions, which are subject to a rate thatis lower or larger institutions. Finan-cial institutions in the top bracket inDelaware pay 1.7 percent.

In Hawaii, Iowa, Kansas, Maine, Mas-sachusetts, Missouri, North Dakota,South Carolina and South Dakota, weused the tax rate or fnancial institu-tions instead o or all corporations.

In Indiana, we used the new tax rate o8 percent that took eect July 1, 2012.

In Texas, we used the 1 percent taxrate that applies to corporations withrevenues o more than $1 million.


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Methodology 1

Individuals:We calculated state tax thatwould be paid by individuals in a similarmanner by using state-specifc individualincome tax rates, per Federation o Tax Ad-ministrators, State Individual Income Taxes,January 2012. Because we assume that in-

dividuals who use oshore tax havens areo signifcantly above-average wealth, weused the marginal tax rate or the highestincome bracket.

By using the statutory tax rate ratherthan the eective tax rate or both indi-viduals and corporations, we may be over-stating potential tax revenues. Presumably,i individuals and corporations had to paytaxes on unds currently oshore, they

might seek other tax avoidance strategies,thereby reducing the revenue generated.


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Appendix A. Tax Haven Use by 83 of the 100 LargestPublicly Traded Companies*

2007Subsidiaries RevenueLocated in Combined

State Companies that Use Tax Havens Tax Havens (Millions)

NewYork Alcoa;AmericanExpress;AmericanInternationalGroup;Bank oAmericaCorp.;Citigroup;GoldmanSachsGroup;Hess Corporation;InternationalBusinessMachinesCorporation; J.P.MorganChase&Co. ;LehmanBrothersHoldings;Merrill Lynch;MetLie;MorganStanley;NewsCorporation; PepsiCo,Inc.;Pfzer;TimeWarner 1,373 $1,213,989

Texas ConocoPhillips;Dell,Inc. ;ExxonMobilCorporation;Marathon Oil;SYSCOCorporation;ValeroEnergyCorporation 193 $804,359

Illinois AbbottLaboratories;Allstate;Archer-Daniels-Midland Company;Caterpillar,Inc.;Deere;KratFoods.Inc. ;McDonalds; Motorola,Inc.;SearsHoldings;TheBoeingCompany; WalgreenCo. 178 $443,687

Caliornia Apple;Chevron;CiscoSystems;CountrywideFinancial; Hewlett-PackardCompany;IngramMicro;Intel;McKesson Corporation;Saeway;WaltDisney;WellsFargo 148 $696,155

NewJersey HoneywellInternational,Inc.;Johnson&Johnson; Merck&Co.,Inc.;PrudentialFinancial 116 $154,283

Ohio CardinalHealth,Inc.;Kroger;TheProcter&GambleCompany 107 $235,075

NorthCarolina WachoviaCorporation 59 $55,528

Michigan Delphi;DowChemical;FordMotorCompany;GeneralMotors Corporation 57 $434,488

Minnesota 3M;BestBuy;SuperValu;Target;UnitedHealthGroup 46 $236,600

Connecticut Aetna;GeneralElectricCompany;HartordFinancialServices; TravelersCompanies;UnitedTechnologiesCorporation 43 $310,948

Virginia AltriaGroup,GeneralDynamicsCorporation 43 $65,345

Tennessee FedEx 21 $35,214

Washington CostcoWholesale;Microsot;WashingtonMutual 12 $141,053

Pennsylvania Comcast;GMAC;Sunoco 10 $104,486

Delaware DuPont 9 $30,653

Georgia Coca-Cola 8 $28,857

Kansas SprintNextelCorporation 7 $40,146

Florida TechData 7 $23,423

Arkansas TysonFoods,Inc. 6 $26,900

Nebraska BerkshireHathaway,Inc. 1 $118,245

Indiana WellPoint 1 $61,134

*TabledoesnotincludesomeU.S.companiesthatbeganusingtaxhavensater2008.Source:U.S.GovernmentAccountabilityOfce, International Taxation: Large U.S. Corporations and Federal Contractors withSubsidiaries in Jurisdictions Listed as Tax Havens or Financial Privacy Jurisdictions ,December2008.

Indicatescompaniesthathavebecomedeunctorwereboughtbyothercompaniesaterthe2008fnancialcrisis.


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Appendix B 19

Appendix B. Tax Avoidance by State*

*Note:NAindicatesthatthestatedoesnotcollecttaxesonthistypeoincome.

Total Annual Income Tax Revenues Lost to Tax Havens (Individual and Corporate

Income Taxes Combined)

RevenueLosses


1 Caliornia $7,147

2 NewYork $4,275

3 NewJersey $2,833

4 Illinois $2,545


6 Minnesota $1,953

7 Massachusetts $1,6888 NorthCarolina $1,049

9 Florida $979

10 Maryland $966

11 Virginia $936

12 Georgia $918

13 Connecticut $904

14 Missouri $843

15 Wisconsin $814

16 Michigan $755

17 Indiana $733

18 Ohio $707

19 Louisiana $656

20 DistrictoColumbia $549

21 Oregon $506

22 Colorado $504

23 Arizona $503

24 Arkansas $478

25 Tennessee $468

26 Kentucky $380

RevenueLosses


27 Oklahoma $367

28 Nebraska $323

29 Texas $307

30 Iowa $260

31 Alabama $257

32 RhodeIsland $229

33 Delaware $22034 SouthCarolina $220

35 Kansas $200

36 Utah $183

37 Hawaii $133

38 NewMexico $126

39 NewHampshire $124

40 Idaho $119

41 WestVirginia $106

42 Mississippi $92

43 NorthDakota $78

44 Alaska $77

45 Vermont $75

46 Montana $72

47 Maine $58

48 SouthDakota $2

49 Nevada NA

50 Washington NA

51 Wyoming NA


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RevenueLosses


1 Caliornia $2,9362 NewYork $1,840

3 NewJersey $1,058

4 Ohio $707

5 Minnesota $629

6 Illinois $607

7 Massachusetts $439

8 NorthCarolina $426

9 Georgia $349

10 Virginia $347

11 Pennsylvania $324

12 Connecticut $318

13 Wisconsin $303

14 Missouri $289

15 Maryland $277

16 Michigan $233

17 Oregon $223

18 Colorado $193


20 Arkansas $190

21 Louisiana $166

22 Delaware $158

23 Indiana $150

24 Kentucky $145

25 Arizona $143

26 Kansas $129

RevenueLosses


27 Oklahoma $12828 Iowa $118

29 Nebraska $112

30 SouthCarolina $108

31 Utah $70

32 Alabama $67

33 RhodeIsland $65

34 Hawaii $61

35 Maine $49

36 Idaho $46

37 WestVirginia $36

38 NewMexico $36

39 Mississippi $35

40 Vermont $29

41 Montana $28

42 NorthDakota $20

43 Alaska NA

44 Florida NA

45 Nevada NA

46 NewHampshire NA

47 SouthDakota NA

48 Tennessee NA

49 Texas NA

50 Washington NA

51 Wyoming NA

Total Annual Individual Income Tax Revenues Lost to Offshore Tax Havens



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Appendix B 21

RevenueLosses


1 Caliornia $4,2112 NewYork $2,435

3 Illinois $1,939


5 NewJersey $1,776

6 Minnesota $1,324

7 Massachusetts $1,248

8 Florida $979

9 Maryland $690

10 NorthCarolina $623

11 Virginia $589

12 Connecticut $587

13 Indiana $584

14 Georgia $569

15 Missouri $554

16 Michigan $523

17 Wisconsin $512

18 Louisiana $489

19 Tennessee $468

20 Arizona $360


22 Colorado $310

23 Texas $307

24 Arkansas $288

25 Oregon $283

26 Oklahoma $239

RevenueLosses


27 Kentucky $23528 Nebraska $211

29 Alabama $190

30 RhodeIsland $164

31 Iowa $141

32 NewHampshire $124

33 Utah $113

34 SouthCarolina $112

35 NewMexico $91

36 Alaska $77

37 Idaho $73

38 Hawaii $72

39 Kansas $71

40 WestVirginia $69

41 Delaware $62

42 NorthDakota $58

43 Mississippi $57

44 Vermont $46

45 Montana $44

46 Maine $9

47 SouthDakota $2

48 Nevada NA

49 Ohio NA

50 Washington NA

51 Wyoming NA

Total Annual Corporate Income Tax Revenues Lost to Offshore Tax Havens



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1 $540 billion in budget shortalls, per PhilOli, Chris Mai, and Vincent Palacios,Center or Budget and Policy Priorities,States Continue to Feel Recessions Impact, 27June 2012.

2 Jesse Drucker, Bloomberg News, Avoid-ing Taxes on Oshore Earnings an Art; TaxHoliday at Issue but Who Needs It? Pitts-burgh Post-Gazette, 30 December 2010.

3 Jane Gravelle, Congressional ResearchService, Tax Havens: International TaxAvoidance and Evasion, 9 July 2009.

4 Ibid.

5 Ibid.

6 Multinational corporation income-shitingcost the Treasury $90 billion in 2008, per:Kimberly A. Clausing, The Revenue Eectso Multinational Firm Income Shit ing, TaxNotes, 28 March 2011, 1580-1586; Individualincome-shiting costs the Treasury in therange o $40 to $70 billion annually in lostrevenue, per: Joseph Guttentag and ReuvenAvi-Yonah, Closing the International TaxGap, in Max B. Sawicky, ed., Bridging theTax Gap: Addressing the Crisis in Federal TaxAdministration, 2006. The total amount orevenue lost ($150 billion) combines thesetwo estimates.

7 Kenneth Rapoza, China Ofcial SaysCountry to Top U.S. Consumer Market by2015,Forbes.com, 29 May 2012.

8 Leslie Wayne, How Delaware Thrivesas a Corporate Tax Haven,New York Times,30 June 2012.

9 Ibid.

10 Ibid.

11 Michael Findley, Daniel Nielson, andJason Sharman, Center or Governance andPublic Policy, Grifth University, Global ShellGames: Testing Money Launderers and Terror-ist Financiers Access to Shell Companies, 2012;Brian Grow and Matthew Bigg, SpecialReport: Phantom Firms Bleed Millions romMedicare,Reuters, 21 December 2011.

12 On March 18, 2010, the Hiring Incen-tives to Restore Employment Act o 2010,Pub. L. 111-147 (H.R. 2847) (the Act) wasenacted into law. Section 501(a) o the Actadded a new chapter 4 (sect ions 1471 - 1474)to Subtitle A o the Internal Revenue Code(Code). Chapter 4 expands the inormationreporting requirements imposed on oreignfnancial institutions (as defned in section1471(d)(4)) with respect to certain UnitedStates accounts (as deined in section1471(d) (1)) (U.S. accounts), and imposes

Notes


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Notes 23

withholding, documentation and reportingrequirements with respect to certain pay-ments made to certain oreign entities.

13 U.S. Treasury Department, Treasuryand IRS Issue Proposed Regulations Under theForeign Account Tax Compliance Act to Improve

Oshore Tax Compliance and Reduce Burden(press release), 8 February 2012.

14 U.S. Treasury Department, U.S. Engagingwith More than 50 Jurisdictions to CurtailOshore Tax Evasion (press release), 8November 2012.

15 See Internal Revenue Service, Notice2011-53 at www.irs.gov/pub/irs-drop/n-11-53.pd and Treasury regulations publishedon 8 February 2012, available at www.irs.gov/pub/newsroom/reg-121647-10.pd.

16 Angie Drobnic Holan, Require Eco-nomic Justifcation or Tax Changes, St. Pe-tersburg Times PolitiFact.com, 10 June 2010.

17 President Signs Patent Reorm BillBanning New Tax Strategy Patents,Journalo Accountancy, 16 September 2011.

18 See Methodology.

19 See Methodology.

20 Citizens or Tax Justice, Dont Renew theOshore Tax Loopholes: Congress Should Kill

the Extenders that let G.E., Apple, and GoogleSend Their Profts O shore, 2 August 2012.

21 Ibid.

22 See Methodology.

23 See Methodology.

24 On average, states spend $10,615 per yearper student in the primary and secondaryschool systems per Mark Dixon, U.S. CensusBureau, Public Education Finances: 2010Table19. Per Pupil (PPCS) Amounts and One-Year

Percentage Changes or Current Spending oPublic Elementary-Secondary School Systems byState: 20052010, June 2012.

25 U.S. Census Bureau, The 2012 StatisticalAb s tra c t Tabl e 436. St ate and LocalGovernments Revenue and Expenditures byFunction: 2007 and 2008, downloaded romwww.census .gov/compendia /st atab/cats/state_local_govt_inances_employment/

state_and_local_government_fnances.htmlon 6 January 2013.

26 Government Accountability Ofce, In-ternational Taxation; Large U.S. Corporationsand Federal Contractors with Subsidiaries inJurisdictions Listed as Tax Havens or FinancialPrivacy Jurisdictions, December 2008.

27 Citizens or Tax Justice, Fortune 500Corporations Holding $1.6 Trillion in ProftsOshore (press release), 13 December 2012.

28 Institute on Taxation and Economic

Policy, The QPAI Corporate Tax Break:How it Works and How States Can Respond,August 2011.

29 Ibid.

30 Nicholas Johnson and Ashal i Singham,Center on Budget and Policy Priorities,States Can Opt Out o the Costly and IneectiveDomestic Production Deduction Corporate TaxBreak, 14 January 2010.

31 Inst itute on Taxation and EconomicPolicy, Corporate Tax Dodging In the Fity

States, 20082010, December 2011.32 Ibid.

33 U.S. Congress Joint Committee onTaxation, Estimated Revenue Eects o theChairmans Mark as Modifed to the Provisions othe Family and Business Tax Cut Certainty Acto 2012, Scheduled or Mark Up by the SenateCommittee on Finance on August 2, 2012, 2August 2012.

34 See note 31.

35 See note 6.


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The Hidden Cost of Offshore Tax Havens in Illinois

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