Despite common knowledge..Raising taxes on the “rich” is not always the answer

By: ispeculatornew
Date posted: 11.17.2010 (4:00 am) | Write a Comment  (3 Comments)

      Post a Comment

I rarely get into rants but today is going to be one. I’ve been tired about this for years and just can’t understand why as a society we cannot get to more sophisticated thinking. We have a tendency to simplify problems and solutions usually because it is much easier to debate. I will give one example…Tax Cuts.

For or against them?

My argument is that those debating both sides either do not know enough about the issue or they simply prefer to stay on the safer side of the argument. Yes, yes, I will explain myself. There are complex relationships involved in raising or diminishing taxes. If you increase taxes on the corporations, the government WILL NOT receive 10% more taxes. It will likely be slightly less than 10% but could be less and in some situations, the government might even end up receiving less money. Why? Let me go to an example that I read about last week. I must say, I am not putting Google or Bombardier on the spot here because all multinationals have these decisions to make. No matter if you are building airplanes or selling intangible assets, there are ways to change the tax burden of a corporation.

Example A – Bombardier: This is a fairly simple exam. Let’s imagine that Bombardier, a Canadian company that has entities in Mexico, Canada and the United States builds an airplane to be sold in the US. Let’s imagine a scenario where the tax rate is the same in all 3 of the countries.

Major pieces of the plane are built by Bombardier Mexico
Plane is assembled in by Bombardier Canada
Plane is sold by Bombardier USA sales team

If the costs involved for each part are the following

Bombardier Mexico        $10M
Bombardier Canada         $5M
Bombardier USA             $5M

Now, let’s imagine a scenario where the plane is sold for $30M. You can imagine that each entity would gain 50% of profits which means:

Bombardier Mexico        $5M
Bombardier Canada         $2,5M
Bombardier USA             $2,5M
Total = $10M

If the level of corporate taxes is the same, at 25%, this translates into:

Mexican Government    $1.25M
Canadian Government    $625,000
US Government        $625,000
Total = $2,5M

Now, let’s imagine a scenario where the US government raised taxes to 35% (on rich corporations). For Bombardier, this would translate into $250,000 of additional taxes on that plane. You might say that they can afford it. You might be right…

There is another way…

Instead of paying $250,000 of additional taxes for each plane sold, Bombardier would likely switch for a more tax efficient structure. A lot of words but it’s actually very simple…. Basically, Bombardier Canada would sell the plane at a higher price to Bombardier USA. That would result in higher profits for Bombardier Canada and lower profits for Bombardier USA. Instead of selling the plane for $22.5M, let’s imagine that it sells the plane for $24.5M. In this scenario, the profits for Bombardier are the same:

Bombardier Mexico        $5M
Bombardier Canada         $4,5M
Bombardier USA             $0,5M
Total = $10M

That results into these taxes =

Mexican Government    $1.25M
Canadian Government    $1,125,000
US Government        $175,000
Total = $2,55M

End result = Bombardier loses $50,000 (compared to the pre-tax scenario), the Canadian Government receives $500,000 more and the US Government receives $450,000 less. This is much more common than you could imagine and it becomes much more difficult to regulate when you have 20 or 30 countries involved instead of 3. Increasing the taxation level in this specific case results in less income for the US government.

Google

Google continues to be a growth company as its revenues increase every year. Despite that fact, it cut its taxes by $3.1 billion in the past 3 years thanks to increasing profits in its operations in Bermuda, Ireland and other “more favorable” tax centers. How much more favorable? Google’s overseas profits were taxed at a rate of 2.4%!! You could read a much more in depth analysis of how the company is doing it but needless to say that the US is making less out of Google than it was a few years ago despite rising profits. Like other multinationals, these methods are far from illegal and they are in fact very difficult to dispute. How can you prove where the profit & revenues should be made.

Basically, any company that did business with Google’s advertising likely did business without knowing with Google’s Ireland operations as 88% of the $12.5B from  the sales of advertising were “made” by Google’s Ireland operations which then funnel the money to Bermuda through complex but legal steps.

Who should be blamed?

It would be easy to blame Google or Bombardier but that would be too easy:

They are acting legally
-They are in direct competition with other similar structures
-Their duty is to maximize returns for their shareholders within the rules

What to do?

I personally think this is the more interesting question. Next time you hear someone talking about taxing the rich as the miracle solution, please remind them that it’s much more complex than that. Raising the taxes might be a good idea but it should be decided after considering all of the direct and indirect impacts.

Ask French citizens how much more they are making on taxes from their wealthiest citizens. The answer will get you a sad face as a large proportion of the richest French have moved to neighbor countries to avoid the tax increases.

There are no easy solutions and these problems should be treated as what they are: Complex Global Problems.

I’d love to hear your thoughts on this. Am I the only one who is tired of these simplified arguments?

If you liked this post, you can consider subscribing to our free newsletters here


3 Comments

  1. Comment by Zavi — November 17, 2010 @ 7:13 am

    quite amazing for Google. Didn’t analyze this like that. And it’s actually legal. Is it called “tax avoidance”??

  2. Comment by IS — November 17, 2010 @ 8:02 pm

    @Zavi – Yes that would be one name for it, no doubt:)

  3. […] discussed how companies such as Facebook ($FB), Google ($GOOG) and General Electric ($GE) have managed to pay a tax rate that is often below 5% through various strategies. The high US corporate tax rate is a big reason why these companies have been given enough of an […]

RSS feed for comments on this post.

Sorry, the comment form is closed at this time.