The High Cost of Tax Shelters

Corporate tax shelters are dangerous to the health of state budgets.

At least that's the conclusion of a new national study from the Multistate Tax Commission (MTC), created in 1967 to encourage states to adopt uniform tax laws and regulations that apply to multistate and multinational enterprises. Today 45 state governments participate in the MTC.

The tax commission found widespread use of tax shelters cost states as much as $12.38 billion in revenue in 2001. Had these devices not been in place, state corporate income-tax revenue, which totaled $35.4 billion in 2001, would have been as much as 35 percent higher.

That's nothing to sneeze at, particularly at a time when most governments are facing budget shortfalls due to the bad economy and higher spending on security and antiterrorism measures.

"The lost revenue attributable to domestic and international income-tax sheltering is adding to the size of state budget deficits while undermining the equity and integrity of state tax systems," the MTC asserted in a statement. "It is apparent that various corporations are increasingly taking advantage of structural weaknesses and loopholes in the state corporate tax systems."

The MTC study provides a range of estimated state corporate-tax collection losses, with a low-end estimate of $8.32 billion and a high-end estimate of $12.38 billion.

The hardest-hit state in dollar terms was California, which lost an estimated $1.34 billion. It was followed by Illinois ($693 million loss), Texas ($607 million loss), and Pennsylvania ($582 million loss).

California's loss works out to more than 19 percent of the state's corporate-tax revenues. However, the percentage is much smaller compared with other states.

For example, in West Virginia, the midrange loss due to shelters equaled 57.8 percent of collections. Ohio was right behind at 56.9 percent, followed by Florida (48.7 percent), and Mississippi (43.1 percent). Conversely, the estimated midrange loss for Michigan was 10.3 percent.

The average losses for states was 31.1 percent of tax revenues.

Not all states figured to have lost out due to the tax shelters, however.

Five states had no estimated corporate-income tax losses due to tax-sheltering activity: Alaska, Delaware, Nevada, South Dakota, and Wyoming.

What kinds of tax shelters are we talking about?

According to the MTC, most of the revenue losses are linked to such tax-sheltering techniques as reincorporating strictly for tax-income purposes in Bermuda; creating separate corporations to house "intangibles" (for example, trademarks) and then siphoning profits away from taxation in the states in which the companies actually do business; shifting taxable income away from the United States to other nations through the pricing of goods and services involved in transactions between jointly owned companies; and using complex interpretations of tax laws to create so-called nowhere income that is earned by a corporation but then not reported to states that impose corporate income taxes.

"The vast majority of U.S. businesses are not part of the state corporate income tax sheltering problem," the MTC asserted in its press release. "Very few small businesses can take advantage of the tax sheltering schemes studied by the MTC. Additionally, some major corporations choose not to engage in aggressive corporate income tax sheltering."

The MTC says its study estimates the impact of tax sheltering in two ways.

One part of the study gauges the impact of tax sheltering aimed exclusively at state corporate taxes. Factors that do not qualify as tax sheltering—such as state legislative changes to lower rates and the switch of regular corporations to S-corporations—were excluded from the estimate.

The second way the study estimates the impact of sheltering that affects both federal and state tax is through corporations shifting income earned inside the United States to other nations. Using conservative national estimates of international income shifting through transfer pricing, the study estimated state revenue losses of $5.3 billion.

Donaldson Endorses New Proxy Rules
Is Securities and Exchange Commission chairman William H. Donaldson supporting new rules that could make it easier to successfully launch a hostile takeover?

Yes, at first glance.

On Tuesday Donaldson apparently endorsed Division of Corporation Finance recommendations that would open up the process for dissidents to launch proxy fights.

"This has been debated for too long as far as I'm concerned," he reportedly said in a meeting with reporters and editors of the Washington Post. "It's a real, necessary companion piece to a much bigger picture that I see: a shift, a correct shift, away from a dominance by corporate executives and back to the board."

The SEC's recommendations:

• Require more-robust disclosure of the nominating committee's processes at public companies, including the consideration of candidates recommended by shareholders.
  
  

• Require specific disclosure of the processes by which shareholders may communicate with the directors of the companies in which they invest.
  
  

• Require that major, long-term shareholders (or groups of long-term shareholders) be provided access to company proxy materials to nominate directors. Examples of events that would trigger this access could include situations in which the results of the proxy process are not acted on by companies or in which there is substantial shareholder dissatisfaction with the operation of the proxy process.
  
  

The goal of the new rules will be to create a system in which "the board hires a chief executive, not the other way around," Donaldson told the Post.

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