I’ve mentioned before, tax experts tend to grimace at the mention of a “fair share” of taxation. While it’s a phrase you might hear often from politicians of all parties, at a tax conference it would be met with some rolled eyes and groans.
To kick off the new year, I thought it might be worth going into why that is.
For starters, it’s imprecise and subjective. What is a “fair share,” and who decides it? The answer would be Congress, presumably, but it’s normally used to imply that lawmakers have somehow fallen down on the job.
More importantly, it blurs the distinction between positive questions of defining the tax base, and normative political determinations that go beyond that. I can see why, for many, those issues may seem like a single larger question, or two sides of the same coin. But they’re different, and the difference is important to understanding tax policy.
Defining the tax base–what economic activity should be taxed–is hard and complicated, and there a lot of different views and philosophies on how to best do it. This is especially true in the international sphere, where taxable income must be allocated across national borders that are economically arbitrary. Should tax authorities use the location of sales or workers to determine whose income is whose? Or should they try to apportion it based on the arm’s-length determinations of assets–using pricing for what independent parties would have paid to determine the cost side of the income formula?
That’s something that policymakers have to decide, and in that process there are plenty of political factors and compromises. But, generally speaking, everyone agrees on the goal of coming up with a consistent and balanced system.
When there are results that fall well outside any conception of economic reality–say, large amounts of income without any physical presence in a low-tax jurisdictions–it’s reasonable to allege that this is well beyond a fair determination. Which is to say, it results in tax payments that are less that a “fair share.”
But often, it’s trickier to spot these than one might think. Maybe the situation I described above is a clear violation of the spirit of international taxes–but what would be the correct allocation? Where should that income go? Without some principle to decide, the more ambiguous cases are much harder to characterize.
Those are some cases. However, “fair share” often refers to policies which are determined after the tax base is defined. They’re more about what a government chooses to tax. You can disagree with the choice, but it’s not about some violation of economic reality. (And frequently, the speaker doesn’t disagree with the choice itself–just the result.)
One example I like for its clarity is taxing billionaires. There appears to be an emerging consensus that the ultra-wealthy are under-taxed, and it’s leading to decreasing faith in the overall tax system. If you spend time on political social media, “Just pay your darn taxes!” is something you’ll frequently see hurled at Jeff Bezos or Elon Musk. That makes it sound like there’s an obvious amount in tax that Bezos or Musk should be paying--like there is for the rest of us--and it’s only through chicanery that they don’t.
There certainly is a lot of tax planning that the very, very rich can engage in. But the potentially stark differences in effective tax rates really come down to how the tax code treats assets, versus how it treats income. Income, as it’s currently defined, is taxed immediately, while the owners of valuable property often have much more control over when that property is taxed. And when it is taxed, it’s normally at a lower rate–a policy that’s meant to encourage saving and investment, but is also a valuable perk for the rich.
On the margins, one can point to the tactics that individuals allegedly use to avoid directly monetizing assets, and to therefore enjoy the benefits of that ownership without additional taxation. Borrowing against them is one maneuver that’s often cited–Sen. Ron Wyden, D-Ore., has dubbed it the “Buy, Borrow, Die” strategy.
But really, the central issue is that key question, the difference in taxation between assets and income. It's a fundamental design issue for the tax system. And there are a lot of considerations–the complexity (and constitutionality) of taxing wealth, how to treat reductions in the value of assets (should the rich get a refund?), and whether the system should treat theoretical gains the same as realized gains. This is something that Congress has weighed in on repeatedly, and more often than not it chooses to put assets at an advantage. Most recently, it nixed a proposal to end the step-up in basis at death--which would have been a modest move towards more asset taxation--from the Inflation Reduction Act, due to objections from Sen. Jon Tester, D-Mont. (Who's also a farmer and was concerned about how it would affect the inheritance of family farms.)
For another example, let's go back to international taxes and consider the issue of territoriality. In 2017 the Tax Cuts and Jobs Act overhauled the U.S. tax code, and instituted a quasi-territorial system which, in general, exempted the overseas income of U.S. corporations from U.S. taxation. This was a huge benefit to many multinational corporations–but it was also arguably a recognition of reality, for companies that previously used indefinite deferral to avoid taxation of offshore earnings for decades. The TCJA also enacted anti-abuse rules which, in theory, stop taxpayers from shifting income that’s actually earned in the U.S. to other low-tax jurisdictions.
The overall philosophy matched the basic idea of territoriality. It says, let's just focus on correctly and fully taxing economic activity within our borders, and let other countries do the same. Then let the chips fall where they may.
In the new system, it can be tempting to accuse any company that achieves lower overall taxation due to foreign income of shirking its responsibility. Why should a multinational get a lower tax rate than a purely domestic company? If a company chooses to put investment in a low-tax jurisdiction, isn’t that a purely tax-motivated action?
Maybe the U.S. ought to have a purely worldwide system that immediately taxes all of the income of its companies, regardless of where it’s earned. (Though it’s worth asking why no other country does this.) But this is clearly a policy decision that Congress has made. Lower taxation of foreign income isn’t an abuse of the system, it’s the way it’s supposed to work.
There are other examples I could get into. How Congress is always passing minimum taxes that negate the very policy preferences it enacted into the original tax code. How the Biden Administration passed generous tax incentives to encourage de-carbonization, and then endorsed a global minimum tax which could target those incentives. The difference between a tax loophole and a tax policy isn’t nearly as clean-cut as it sounds–as Sen. Russell Long, D-La., put it, a loophole is something that benefits the other guy. If it benefits you, it’s tax reform.
And sometimes people use "fair share" to mean that the rich ought to pay more in taxes, period--through a higher tax rate if nothing else. That's an issue that may seem connected to discussions about the tax base, but ultimately it's a political judgment about values.
I'm not trying to say that tax loopholes don't exist. It just might help political debates to nix that word, as well as “fair share,” from the vocabulary, and focus on the underlying policies.
DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.
A message from RoyaltyStat:
RoyaltyStat® is the market leader in databases of royalty rates and service fees from third-party transactions to facilitate transfer pricing compliance and the valuation of intangibles. Our focus on high-quality data, unique transfer pricing analytics, and knowledge-based customer support makes us the choice of transfer pricing practitioners worldwide, including the top accounting and law firms, Fortune 500 multinational entities and more than 15 tax administrations. Find out more at royaltystat.com.
LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK
- Hope you all had a restful holiday break, because 2024 is looking to be a very exhausting year–both in tax policy and the general state of the world. On Jan. 1, the Organization for Economic Cooperation and Development’s Pillar Two global minimum tax finally went live, at least for countries that are following the OECD’s timeline. Many of the most controversial measures, such as the under-taxed profits rule, won’t go into effect until later, and taxpayers can currently use transitional safe harbors to ease the initial pain. (The OECD released new guidance on some of those safe harbors in December.) Several European countries either enacted or moved to implement the rules at the end of 2023, and the European Commission published a lengthy “Frequently Asked Questions” page about the technical details. Meanwhile, the OECD has promised further guidance on several outstanding questions. This is a bit like fine-tuning a car while also driving it, but the car has finally left the garage.
- This is outside our normal wheelhouse, but it’s worth noting regardless–the U.S. Department of the Treasury’s Financial Crimes Enforcement Network issued a final rule for a new beneficial ownership reporting requirement enacted through the 2022 Corporate Transparency Act, which also took effect on Jan. 1. Companies that qualify must submit information about who ultimately can access and benefit from a financial entity under their control, which can be shared between government agencies. This is a way to unwind complex legal structures used to hide whatever activity is behind the money. According to Treasury, this could help enforcement efforts against everything from corruption to drug trafficking, but tax evasion will no doubt be another key activity targeted by this. It’s a new tool in an increasingly transparent world where illegal tax evasion is getting more and more difficult to pull off.
- The OECD on Dec. 20 announced that Tim Power, the deputy director for business and international Tax in His Majesty's Treasury of the United Kingdom, has been elected chair of the organization’s Committee on Fiscal Affairs, which oversees its tax work. In this capacity he will also be co-chair of the Inclusive Framework, the 140-jurisdiction coalition to implement the OECD Two-Pillar project. This comes as Scott Levin, previously of the law firm Jones Day, replaces Michael Plowgian as the deputy assistant Treasury secretary for international tax affairs. Both of these new faces will have their work cut out for them for the upcoming year.
PUBLIC DOMAIN SUPERHERO OF THE WEEK
Every week, a new character from the Golden Age of Superheroes who's fallen out of use.
Shaking it up a bit this week, with a figure who’s much less obscure than my usual choices. On Jan. 1, the Walt Disney’s iconic 1928 animated black-and-white short Steamboat Willie lost its copyright protection and entered the public domain. Which means its star, a certain well-known rodent, is also technically a character that anyone can use. But would-be plagiarists should be forewarned–while Disney has finally given up on efforts to perpetually extend the length of copyrights, it’s still expected to vigorously protect its brand through trademark enforcement, as well as copyright protection of later iterations of Mickey. (So you’d have to wait a few more years to use him in color.) Other characters will fall into public domain with the same conditions in the upcoming years, including Superman in 2034 and Batman in 2035. Meanwhile, next week I’ll get back to my usual habit of excavating long-lost and bizarre superhero characters who lost their copyright protection due to disuse, not age.
Contact the author at email@example.com.