Tax Arbitrage

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Tax Arbitrage

There are some who legitimately believe businesses should pay no taxes whatsoever…

By J.M. Hamilton  (1-6-13)

Arbitrage is not a force majeure...   and for any CEO or COO worth their salt, arbitrage is like breathing air.  Quite simply arbitrage is finding discrepancies in tax rates, the cost of labor, regulatory law, and exchange rates between sovereigns, and taking advantage of those discrepancies - all other variables being equal - to enhance the corporate bottom line.  Put another way and more specifically, tax arbitrage is like water - always flowing down hill, continuously seeking out the most advantageous (read the lowest) tax rate.  An entire cottage industry of lobbyist, accountants, and lawyers has sprung up seeking out the most advantageous tax rates for their clients.

In order for tax arbitrage to take place it must have a willing partner; and in a democracy that partner is our elected officials, who grant tax concession to free enterprise.  By way of example, the NY Times recently wrote about Texas (in a piece entitled, Lines Blur as Texas Gives Industries a Bonanza, by Louise Story).

Per the Times, Texas offers tax concessions worth $19 billion dollars, per annum, in an effort to create a more business friendly environment and spur job creation; but there's a downside - the state's citizens suffer for want of funds for public education, and a regressive tax code.  Moreover, despite the state's generosity, some question whether or not these tax breaks actually generate benefits to the state and her citizens.  The Times goes on to note, Texas is number three in the nation for the proportion of jobs at or below minimum wage; Texas has the 11th highest poverty rate; Texas balances corporate tax incentives with reductions in public education spending- easily placing Texas in the bottom quartile of per student funding; much of these government giveaways require no reciprocal stipulations, covenants or hiring requirements on the part of corporations receiving the gift from the state. Texas is number 45 in education ranking and consistently produces some of the lowest SAT scores in the nation; Texas also has a very large percentage of the population that is uninsured for medical care.

What's in it for Texas politicians?  Well campaign contributions of course, with many lobbyist ponying up serious cake in return for tax breaks.  This presents Texan pols with a substantial conflict of interest, with significant repercussions, not just for the citizens of the lone star state, but for Americans nationwide, who reside in states competing for businesses and jobs taken up via Texas sized tax breaks.

Per the same Times piece, state and local governments give $80 billion in corporate incentives per annum; of that figure Texas would appear to be giving away 25% of it.

Many would argue Texas politicians are only harming its own citizens, neighboring states, and any states that want to provide quality public education and services for its citizens, by siphoning off business, in some instances jobs, and the resulting tax base.

This would appear to be a road to perdition, whereby wealthy and powerful economic and political interests continuously play one state off upon another; and the parties - who can afford to pay taxes - successfully dodge societal obligations, in exchange for lobbyist fees and campaign contributions.  Or put another way, this is simply tax arbitrage.

It's not just happening at the state level, even the Federal government is in on the action, as noted in this week's WSJ piece - Crony Capitalist Blowout.  Among some of the passages of this article, the following:

"There’s plenty to lament about the capital and income tax hikes, but the bill’s seedier underside is the $40 billion or so in tax payoffs to every crony capitalist and special pleader with a lobbyist worth his million-dollar salary. Congress and the White House want everyone to ignore this corporate-welfare blowout, so allow us to shine a light on the merriment."

And.... "The great joke here is that Washington pretends to want to pass 'comprehensive tax reform,' even as each year it adds more tax giveaways that distort the tax code and keep tax rates higher than they have to be. Even as he praised the bill full of this stuff, Mr. Obama called Tuesday night for 'further reforms to our tax code so that the wealthiest corporations and individuals can’t take advantage of loopholes and deductions that aren’t available to most Americans.'

The costs of all this are far greater than the estimates conjured by the Joint Tax Committee. They include slower economic growth from misallocated capital, lower revenues for the Treasury and thus more pressure to raise rates on everyone, and greater public cynicism that government mainly serves the powerful.

Republicans who are looking for a new populist message have one waiting here, and they could start by repudiating the corporate welfare in this New Year disgrace."

Tax arbitrage is not isolated to the Unites States, it's global.... Great Britain recently noted that its corporate revenues were down substantially at a time of tremendous corporate profitability - with many corporations sitting upon record amounts of cash.

To be fair, not all corporations are looking for tax breaks.  Some corporations and their management teams recognize that paying taxes is important for the long term health and viability of their labor pool, employee morale and welfare, as well as, their markets.  And some CEOs are forced into arbitrage knowing full well that if they don't play the arbitrage game - their competitor will.  Apple has recently indicated that it will bring some manufacturing back to the United States, which is to be applauded; and Apple, one can argue, with their cash reserves, and product demand and mark-up, is well positioned to return manufacturing to the U.S.  For many manufactures, however, the arbitrage choice is less simple.

And it is in this area that government, rather than being a part of the problem, could and can be a positive force for both the business community and society.  States and the Federal government need to work together, that is to say, collude to maximize tax revenue and services for its citizens, while maintaining a business friendly environment.

State and federal governments should naturally seek uniformity in the tax code nationally, so that free enterprise is operating in regions and states for legitimate business reasons.... Not because states are paying them to operate in their state.   Ideally, if a nation, say the United States were to achieve equilibrium/uniformity in taxes, regulation, and living wages across all fifty United States-  business will naturally locate to states and regions closet to their respective markets to save on storage, transportation, and logistical costs.  In short, if the states all agreed on tax policy, there would be no such thing as tax arbitrage within the United States; there would be no race to a revenue bottom lead by pols at the expense of government services; there would be less temptation for politicians to hand out tax breaks, since the paradigm would be turned upside down.

If a single state decided not to voluntarily abide by a uniform tax code/regime, say Texas, pressure could be brought to bear upon that state and the businesses operating in that state, by the contiguous/competing states, or even the Federal government, increasing the sales tax on any Texas produced - or originated- goods and services sold.  Federal funds allocated to the state of Texas could also be withheld, until Texas politicians climbed on board with a homogenous national tax code.

There are some who legitimately believe businesses should pay no taxes whatsoever, or pay lower rates, as long as business or enterprise hires that respective country's citizens; indeed some "socialist" northern European countries have adopted such corporate tax policies (i.e. minimize or lower corporate taxation, while taxing individuals at significantly higher rates).  And that is legitimate discussion that should be held in a public forum with our elected U.S. officials, as opposed to our elected officials making corporate concessions on a one off basis - to say, lure California businesses to the state of Texas; what should not happen - and the very dynamic that is failing this country - are pols making these tax decisions in smoke filled closed door sessions in exchange for campaign contributions, with no caveats or conditions or guarantees that such tax breaks will produce jobs and opportunities in a given state or even within the United States.

Once again, our elected officials are wreaking havoc on state and federal budgets at a time of economic hardship.  And these same pols continue to eviscerate the tax code with local, state and federal budgets running in the red.  Clearly our elected officials need to be reined in - a national tax code for all states would establish a new normal and highlight any politician, who was attempting to game the system for personal gain.  While politicians' coffers grow fat with campaign contributions, the constituency, labor, and markets wither for want of education and services.  Indeed, at the same time pols hand out government largesse to corporations, many of these same pols are seeking substantial cut backs in state services for their constituents.

A balanced and uniform state tax code, identical across all fifty states, is inherently most advantageous for citizens; such a universal code would help prevent the politician led downward spiral of tax cuts for the wealthy, followed by lost revenue and the resulting reductions in government funded education and services.

As mentioned, arbitrage is not limited to U.S. borders... Ultimately if nation states don't want to be played off against one another - they should work towards adopting uniform/global tax, accounting, and regulatory regimes as well, along with similar labor and wage policies over the course of time.

P.S.

Mission accomplished... The NRA can come out of its foxhole now.  With politicians incessantly arguing about the fiscal cliff, and now, the debt ceiling limit - the political news cycle has already pulled away from the travesty and tragedy in Connecticut.  It remains to be seen whether or not congressional leadership will actually govern in 2013, or will congress and the country continue to be hijacked by the Tea Party movement... A movement in rapid decline.

 Copyright JM Hamilton Publishing 2013