In a worrisome trend which is bound to confront the winner of November's presidential election, U.S. multinational corporations are increasingly shifting more of their global profits to such tax havens as Ireland, Bermuda and Luxembourg.

This practice promises to accelerate the nation's shrinking corporate tax base and risk the loss of billions in federal tax dollars. Combined with the recent flurry of federal tax cuts for U.S. households, the decline of corporate taxes raises a big question: How will the federal government, already facing a hefty deficit, fund itself and its obligations in the coming years?

The alarm over the corporate profit flight to overseas tax havens was sounded in a new analysis by Martin A. Sullivan, a former official with the U.S. Treasury Department.
" There has always been a problem from the U.S. government point of view with shifting profits out of the United States and other high-tax countries into tax havens," Sullivan said in an interview. "What struck me was the dramatic change that I saw in the 2002 data" - the latest available.

According to his analysis, profits of foreign subsidiaries of U.S. corporations in 18 tax havens soared from $88-billion in 1999 to $149-billion in 2002. That means 58% of U.S. multinationals' total foreign profits now sit in tax havens. That figure far exceeds the share of economic activity that these corporations conduct in those low-tax countries.

What does this mean? On paper, U.S. multinational corporations are cramming more and more worldwide profits into countries with the cheapest tax rates, while in the process slashing what they owe in taxes back in the United States. Sullivan says the issue will become more acute for federal policymakers and whoever is elected the next president. "The winner almost surely will have to grapple with an eroding corporate tax base and, in turn, the potential loss of billions of dollars to federal coffers," Sullivan wrote.

Nor are dwindling tax dollars the only issue. As long as corporations can preserve more of their profits overseas, then those companies are far more likely to expand and hire more employees outside the United States. That means national tax strategies, not wage scales, are becoming a bigger factor in the overseas outsourcing of U.S. jobs.

Sullivan's analysis, which compares 2002 and 1999 data, shows Ireland soared to the top of the list of tax-haven profits, reporting $26.8-billion in before-tax profits from U.S. multinationals. Ireland, ranking 4th in 1999, has an effective tax rate of just 8 percent.
Bermuda, with a 2 percent effective tax rate, ranked No. 2 in 2002 by attracting $25.2-billion, a tripling of pretax profits. Other fastest-growing tax havens include Luxembourg (1 percent effective tax rate) and Singapore (11 percent effective tax rate).
Sullivan notes that profits generated by foreign subsidiaries in large industrial countries where U.S. companies conducted most of their overseas business have fallen sharply. And such countries as Denmark, Belgium and New Zealand have substantially dropped their effective tax rates. In the process, they have reignited a competition among some countries to see how low their tax rates can go.

Presently, the United States taxes corporate profits at 35 percent.

Traditionally, the United States taxes corporations on their profits, no matter where they are produced. If a foreign country taxes foreign profits, then this country generally reduces its own tax on the same profits, dollar for dollar, top avoid double-taxing the corporation.

But there's a catch. The profits generated overseas by U.S. corporations are not subject to U.S. taxes until the money is paid as a dividend to the U.S. parent. As long as that payment is deferred, then there is no U.S. tax. Sullivan says U.S. corporations increasingly will permanently defer taxes by reinvesting those foreign profits in low-tax countries.

That's not supposed to happen. Sullivan says an aggressive combination of new laws, regulations, court decisions, lobbying and sharp practices by tax lawyers have "severely diminished" the ability of the United States to track and tax deferred overseas profits. And that trend, he added, has only made more attractive the mad corporate dash to stash profits in tax havens.

Senator Kerry has proposed ending tax breaks encouraging companies to move jobs overseas by closing loopholes and eliminating the ability of companies to defer paying U.S. taxes on foreign income. He would also cut the corporate tax rate by 5 percent.

Perhaps the United States does not want to tax its corporations the old fashioned way. That's fine, Sullivan asserts, but what's the alternative? One possibility tossed around in tax circles is the VAT, or value-added tax. That's a consumption tax, popular in Europe, on a product levied at each stage of production and based on the value added to the product at each stage.

Suffice to say, U.S. multinationals are getting ever bigger and successfully paying a smaller and smaller percentage of their profits to the U.S. government.

At the same time, the federal government is on a tear trying to outdo itself with tax cuts to U.S. households. It sounds great, in the short run. But it does not take a genius to realize a debt-laden country can't escape big bills coming due by slapping even more of them on the nation's credit card.

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