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Surprise! Facebook Avoids its European Taxes

If you are as cynical as I am, I know you are not surprised that Facebook paid Irish taxes (via Tax Justice Network) of about $4.64 million on its entire non-US profits of $1.344 billion for 2011.* This 0.3% tax rate is a bit below the normal, already low, Irish corporate income tax of 12.5%.

As with Apple, Facebook funnels its foreign profits into its Irish subsidiary. As the Guardian article explains:

Facebook is structured so that companies buying advertisements on the website in the UK, or anywhere outside of the US, have to pay Facebook Ireland.

As a result, Facebook manages to slash its taxes in other countries, paying, for example,  $380,800 in British tax on estimated 2011 UK profits of $280 million, or a little over 0.1%. What is shocking is that Facebook paid so much Irish tax since it managed to convert its $1.3 billion gross profit into a net loss of $24 million.

As you’ve no doubt figured out, it’s that “Double Irish” ploy again. Facebook operates a second subsidiary that is incorporated in Ireland but controlled in the Cayman Islands. This subsidiary owns Facebook Ireland, but the setup allows the two companies to be considered as one for U.S. tax purposes, but separate for Irish tax purposes. The Caymans-operated subsidiary owns the rights to use Facebook’s intellectual property outside the U.S., for which Facebook Ireland pays hefty royalties to use. This lets Facebook Ireland transfer the profits from low-tax Ireland to no-tax Cayman Islands. For more on the arcane mechanics, see Joseph Darby’s article “International Tax Planning,” downloadable at Wikipedia.

This makes no sense of course, but is, in David Cay Johnston’s inimitable phrase, Perfectly Legal. But it shouldn’t be. And in the UK, Chancellor of the Exchequer George Osborne has announced 

a £154m [$246.4 million] blitz on tax avoidance and evasion, with HMRC [the British equivalent of the IRS] hiring an extra 2,500 tax inspectors to target high earners who aggressively exploit loopholes to avoid or evade tax.

The U.S. should do the same.

* Dollar figures converted from pound sterling figures in the Guardian at an exchange rate of $1.60 per pound.

Cross-posted from Middle Class Political Economist.

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Conservative ALEC Economic Policies Have No Benefit, Some Risks, for States

The economic policies proposed for states by the conservative American Legislative Council Exchange (ALEC) not only don’t work, but carry risks for states’ economies, according to new research by the Iowa Policy Project and Good Jobs First.

As we have seen most recently with Michigan’s passage of anti-union so-called “right to work” legislation (which lets people free ride on union contracts and makes union organization and representation more difficult), the legislative agenda of ALEC proclaims that states should follow a low-tax, low-wage, non-union route to economic prosperity. Now, you or I might wonder how creating low-wage jobs is supposed to create prosperity, but luckily for us ALEC has ranked the states by how “competitive” their economic policies were beginning in 2007, giving us the chance to see how well their recommended policies have done.

ALEC’s 15 recommended factors (p. 18) include taxes, debt service, public employees per 10,000 residents, “quality” of the legal system, “right to work,” minimum wage, and workers’ compensation costs. As pointed out by earlier commentaries, it says nothing about education or infrastructure, which have clear effects on a state’s economy. The new report by economist Peter Fisher with Greg LeRoy and Phil Mattera undertakes a statistical analysis of these policies, using the ALEC ranking of all 50 states as of 2007 to see how well their economies have performed since then. Fisher et al. also highlight the shoddy statistical work by Arthur Laffer in creating the ALEC index and reporting results.

Whereas Laffer frequently makes his points simply by comparing the top vs. bottom 8-10 states, Fisher et al. start with a full comparison of all 50 states via a correlation analysis, then proceed to the necessary addition of holding other potential causes constant in what is know as multiple regression analysis. Beginning with the correlations, here is what the new report finds. Correlation runs from -1 (perfect negative relationship) to +1 (perfect positive relationship); the closer to +1 below, the better the ALEC competitiveness index predicted the following outcomes. All changes are from 2007 to 2011.

ALEC Competitiveness Index ranking correlated with–

State gross domestic product:  .02 (not statistically significant)
Percent change in nonfarm employment: -.09 (not statistically significant)
Percent change in per capita income: -.27 (statistically significant)
Percent change in state and local government revenue: -.16 (not statistically significant)
Percent change in median family income: -.30 (statistically significant)
Change in poverty rate: .21 (“statistically significant” at the .1 level*)

What this tells us is that the states which were following ALEC’s preferred policies the most in 2007 saw worse performance in per capita income growth and median family income as well as a worse performance n poverty that we can almost be sure was not due to chance. The only thing ALEC’s top states did see as predicted was an increase was in  population (Fisher et al. did not report the correlation coefficient, but their discussion makes it clear that it was statistically significant). However, population growth per se is not an economic outcome, as the report points out.

The concluding regression analysis weakens the case for negative consequences, but provides no support for positive effects of ALEC’s state policies. Fisher et al. show that the most important determinants of 2007-11 GDP growth, employment growth, and per capita income growth are the components of a state’s economy, with the strongest determinants being the presence of extractive industry (primarily due to the higher price of oil during this period) and a large health care industry. Once these are controlled for, none of the ALEC variables are statistically significant, though the closest is that the top personal income tax rate is associated with higher, not lower, per capita income growth.

If none of ALEC’s policies work as advertised for job and income growth, what do they do? They are, in fact, a prescription for economic inequality. So-called “right to work” does not increase growth, but it reduces workers’ bargaining power. Reducing taxes on the wealthy increases post-tax inequality. And so on, down the panoply of ALEC policies. Fisher et al. (p. 11) put it well:

The ALEC-Laffer strategies are exclusively those that would lower taxes on corporations and the wealthy, reduce public sector revenues (and hence public investments in education, health and infrastructure), and lower wages by eliminating minimum wages and weakening the bargaining power of workers. Yet the book claims that all of these measures would make states, and their populations, richer.

The report is Selling Snake Oil to the States, and that is precisely what ALEC’s policies are.

* Technical note: I’m old school on when we should consider something probably not due to chance. For generations, the standard cutoff was that you have to be 95% certain a result was *not* due to chance to call it statistically significant. In economics, and now increasingly in political science, researchers have sometimes called a result statistically significant using a 90% cutoff instead. In my view, this shift has been due to what is called “publication bias”: it is easier to get your study published in an academic journal if you have some statistically significant result. But this is a big problem in areas like minimum wage research, where not finding a statistically significant negative effect from increasing the minimum wage actually tells you a great deal. The key analysis of publication bias in minimum wage research can be found in David Card and Alan Krueger’s book Myth and Measurement.

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NYT Series Illuminates – And Confuses – State of the Subsidy Wars

Louise Story’s series in the New York Times this week has created a substantial buzz about the issue of economic development subsidies.This is a welcome development, because it’s an issue that doesn’t get nearly enough attention in the highest profile media. Story has, in addition, appeared on shows such as MSNBC’s “Morning Joe” and NPR’s “Fresh Air,” bringing subsidies to an even wider audience.

She crafted a number of stories that highlighted the big picture issues: imbalance in bargaining power between city governments and giant multinational corporations, the blatant conflicts of interest on display in Texas subsidy procurement, and a border war between Kansas and Missouri involving multimillion dollar incentives to move existing facilities across the state line, with no net benefit for the Kansas City metropolitan area, let alone for the U.S. as a whole.

The last few days have given me time to absorb the articles and the database Story created, as well as surveying the commentary on the web from well-known experts on subsidies. Several tentative conclusions seem in order.

First, as I pointed out in my last post, and backed up by Timothy Bartik’s detailed analysis of Michigan, 5/8 of the national total is in the form of sales tax breaks, and probably the overwhelming majority of those sales tax reductions should not be considered subsidies. Here is what Bartik says about Michigan:

For example, in my own state of Michigan, the New York Times database identifies $6.65 billion in annual state and local business incentives. Of this total, $4.83 billion is in “sales tax refund, exemptions, or other sales tax discounts”.  Of this $4.83 billion, almost all of these refunds come from two provisions of Michigan tax law. First, Michigan does not apply the sales tax to most services, including business services, which saves businesses $3.88 billion annually. Second, for manufacturing, Michigan does not apply the sales tax to goods used as inputs to the manufacturing process, which saves manufacturers about $0.92 billion in sales tax.

For those keeping score at home, that means that $4.80 billion of the $4.83 billion in sales tax breaks should not be considered subsidies, unless you consider manufacturing “specific” enough that this aid constitutes a subsidy, in which case only 80% of the sales tax breaks should be excluded from the subsidy tally.

Second, changes of this magnitude mean that the Times estimates are not sufficiently accurate to use in a statistical analysis, as Richard Florida attempts in The Atlantic Cities. Finding out if incentives affect outcomes like wages, employment, or poverty is precisely the type of analysis we would like to do, but the fragility of the data makes this premature. The good news is that since the data on these state programs are all in one place, it should be possible to get a better handle on state incentives by cutting out those programs which should not be considered subsidies. Different analysts will no doubt have different judgments about what should be counted as a subsidy, but since the database is so inclusive, it should be useful no matter what your definition of subsidy is.

Third, there are some smaller errors in the program database as well. The one I have identified so far is that it counts net operating loss (NOL) tax provisions as subsidies in Illinois and New Hampshire, but not in other states, even though all states with a corporate income tax will have an NOL provision. In any event, this should not be considered a subsidy at all, but a part of a state’s basic macroeconomic framework. In addition, Timothy Bartik pointed out to me in correspondence that the program database does not include single sales factor apportionment (only counting what percentage of a multi-state firm’s sales take place in a given state, rather than standard three-factor apportionment that uses percentages of payroll and property as well) as a subsidy, which it should.

Fourth, the program database does not distinguish between investment incentives (subsidies to affect the location of investment) and subsidies more generally, which may or may not require an investment to obtain them. This is an important distinction I have tried to make clear by providing separate estimates in Investment Incentives and the Global Competition for Capital: $46.8 billion in incentives, and $65 or $70 billion in subsidies, depending on whether or not you count non-specific accelerated depreciation as a subsidy.

Finally, as Phil Mattera at Good Jobs First points out, the deals database misses a number of large awards, leaving out Tennessee’s $450 million (present value) subsidy to Volkswagen and an even bigger package for ThyssenKrupp in Alabama. It also underestimates other awards, including Apple in North Carolina and Boeing in South Carolina. I also found that it underestimated subsidies to Dell and Google in North Carolina by omitting the local subsidy portion of the awards, a problem Ms. Story is aware of, as I noted in my last post.

The Times series has been great for the spotlight it has put on state and local subsidies and the sometimes vulgar politics surrounding the process of awarding them, and for compiling a great database of programs all in one place. However, its interpretation of the sales tax breaks, which are 5/8 of the national total but largely not subsidies, confuses the issue of total impact on state and local budgets and makes statistical analysis premature. This will require some work to fix, but it appears like most of the raw material is there to do it.

Cross-posted at Middle Class Political Economist.

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