Offshore Tax Loopholes Cost States $40 Billion

For years tax reformists have been outraged by a loophole that allows U.S. corporations to avoid paying federal income tax on their offshore profits. Just last year, the Treasury lost $150 billion in revenue as companies shifted profits to low-tax countries like the Cayman Islands.

But states are also taking a huge beating from this tax dodge. State governments came up nearly $40 billion short in tax revenue in 2011 because of this loophole exploited by U.S. corporations and wealthy taxpayers, according to a new study released this week by the  U.S. Public Interest Research Group (PIRG), a liberal group based in Washington. 

Bank of America, American Express and American International Group (AIG) are among hundreds of mega-corporations that accounted for nearly two thirds of the $39.8 billion in tax revenue that slipped through the fingers of state tax departments in 2011, the most recent year for which data is available.  These corporations not only avoid paying federal tax but are also immune to paying taxes in states where they operate.

Business groups like the Business Roundtable see the discussion of tax reform as an opening to push for a territorial system, which would exempt profits made outside the United States from taxes. The groups argue that other developed nations have territorial tax exemptions and the American system puts them at a competitive disadvantage.

The stakes for tax collectors are huge and growing. Last year, 290 of the top Fortune 500 companies using offshore tax havens collectively held $1.6 trillion of profits in accounts  outside of the United States, up from $1.1 trillion in 2009, according to Citizens for Tax Justice.

“States are not merely onlookers to the federal failure to address problems with offshore tax havens. Each state suffers an unjustified and painful loss of revenue, typically in the range of hundreds of millions if not billions of dollars annually,” the U.S. PIRG report said.  The states that lost the most to  offshore tax havens – California, New York and New Jersey – were out  a combined $15 billion.

“Tax dodging is not a victimless offense,” said Dan Smith, tax and budget advocate for U.S. PIRG Education Fund and co-author of the report. “When corporations skirt taxes, the public is stuck with the tab. And since offshore tax dodgers avoid both state and federal taxes, they hurt everyday taxpayers twice. States should be using that money to benefit the public.”

Sam Blair of the  Main Street Alliance, a national network of small business owners, said that corporations using offshore tax loopholes create “an uneven playing field” for small businesses and “rob states of resources” they need to create a competitive business climate.

“Most small business owners are never going to set foot in the Cayman Islands let alone set up subsidiaries there,” Blair said in the conference call with U.S. PIRG officials. “It’s time for action. It’s time to level the playing field.”

The report provides more ammunition in the longstanding debate over tax fairness and the widespread use of the offshore loophole. It’s possible that it could become a target for reformists when Congress begins debating tax reform later this year.

Last week, Sen. Carl Levin, D-Mich., told Democratic Senate committee leaders he plans to introduce a bill that will close tax loopholes and penalize corporations using offshore tax havens. Levin said his plan, estimated to bring in $200 billion in revenue over ten years, could be attached to a broader effort to avert the sequestration cuts slated to take effect March 1.

Levin’s proposal is just one of a handful of plans that have attempted to curb the use of these offshore loopholes, and it’s unclear how successful it will be.