“Economists” Enabling Tax Cheats: Why More IRS Resources Is Not Enough

Now that you have sent more than your fair share to the IRS, you might be wondering why the Federal deficit is so high. It turns out that when this clueless bear was praising Bob McIntyre and Max Sawicky, they were part of a conference addressing this issue. Max even provides pictures. Shorter Max: allocate IRS resources less towards going after the working poor and more to where the real money is. He also provides a link to Bob’s paper. Pages 11 to 13 are a very good discussion of transfer pricing manipulation, which includes:

Or a company may have a very valuable asset, such as a trade name. If it transfers the ownership of that name to a low-tax place and then charges its taxable operations large royalties to use the name, it can avoid huge amounts in taxes.

This is exactly the game that David Cay Johnson mentioned in his chapter “Letters to Switzerland”. Tax attorney Robert T. Cole critiqued Johnson with this:

One of the chapters in Perfectly Legal is entitled “Letters to Switzerland” in which Johnston alleges that a U.S. corporation can reduce its taxes by mailing the rights to intellectual property (IP) to a country that imposes no tax or a low rate of tax generally (or on the type of income which U.S. multinationals might locate there) in exchange for a payment that is far less than the true value of the transferred IP. Johnston notes that under the law “the price has to be reasonable,” but then goes on to give an example of a price that he regards as far less than reasonable and suggests that undervaluation is the norm. Whatever may have been the situation before and in individual cases, there are in place rules (and stricter enforcement) that should in most cases prevent the transfer of U.S. IP to foreign affiliates without full consideration. In 1982, §367(d) was added to the Internal Revenue Code to prevent transfers of U.S. IP for stock and in 1986 §482 was changed to add the commensurate-with-income standard for the transfer (or license) of intangibles to a related party. Thus, the Code now requires that a U.S. taxpayer take into account the full value of U.S. intangible property transferred overseas.

Cole is assuming that the “economist” working for the taxpayer provides an honest estimate of the value of the intangible asset. But we often see “analyzes” where an intangible asset that generates high royalties is supposedly worth very little. How? By assumptions of discount rates that are so high or economic lives so short that even Lawrence Kudlow would refuse to publish the rubbish at the National Review.

But when economists turn into hacks, the attorneys for both the taxpayer and the tax authority decide they are not worth very much. Joe Garrett, a tax policy attorney with the Alabama Department of Revenue, has this neat presentation of how the game is blame at the state level. Slide 6 asks “Is my economist better than your economist?” What Joe is saying he has no use for economists who play what is known as the Comparable Profits Method (CPM) game. You might ask – what is CPM? It’s more rubbish to bait and switch the tax authorities into giving a pass to aggressive tax plays. So why would any economists working for the tax authorities play the CPM game. Perhaps poor training?

But there is another cost of this game playing. Max noted some bizarre hearings held by Senator Roth:

His staff staged a parade of witnesses who recounted horror stories of mistreatment at the hands of the IRS. The hearings led to legislation constraining IRS enforcement efforts, and pushing them to chase after the low-wage workers who claim the Earned Income Tax Credit.

One might scoff at the notion that the taxman abuses multinationals. Perhaps, but there are some multinationals that simply wish to avoid double taxation without enormous compliance costs. Arm’s length pricing could be easy for them if they could find a smart and honest economist. If they cannot, this pathetic game played by the enablers of tax cheats also tends to interfere with free trade. Tax revenues are lost, honest taxpayers face absurd regulatory nonsense, and the economics profession is scoffed at by the tax attorneys who play the pesudo-economists for whores.