How Much States Lose to Corporate Tax Havens and How They Can Recoup It

A recent report finds that states lost $20.7 billion to tax havens in 2011 and tallies how much they can save by closing the offshore tax loophole.
by | February 5, 2014 AT 4:00 PM
Bermuda is a well-known tax havens where companies place assets in subsidiaries based there to avoid paying taxes.
Bermuda is a well-known tax haven where U.S. companies place assets in subsidiaries based there to avoid paying taxes. FlickrCC/Bermuda Mike

Much of the public discussion surrounding offshore tax havens has long centered on how companies dodge paying federal taxes. What’s less well known is that states also lose out on uncollected revenue – often hundreds of millions of dollars annually.

A recent report by U.S. Public Interest Research Group (U.S. PIRG) examines how much money state governments fail to collect from these corporations, tallying savings they can recoup by closing the offshore tax loophole. In all, U.S. PIRG estimates states lost $20.7 billion to tax havens in 2011.

“It really matters to people at the state level, but the issue has been lost for so long in federal tax reform,” said U.S. PIRG senior analyst Phineas Baxandall, who co-authored the report.

Companies typically calculate state tax liabilities by adding income tied to subsidiaries incorporated within U.S. borders. If they place assets in subsidiaries based in the Cayman Islands, Bermuda and other well-known tax havens, it's not taxed. Tech giants and pharmaceutical companies are particularly known for taking advantage of tax havens, Baxandall said, by holding patents and other intangibles in shell companies.

The U.S. PIRG study identified 31 states that saw more than $100 million in corporate tax revenue go uncollected in 2011, led by an estimated $3.3 billion for California.

U.S. PIRG calculated how much tax revenue each state lost in 2011, based on federally-reported income and state tax rates:

Source: U.S. PIRG. See page 19 of the report for the methodology

So far, though, only two states have enacted legislation to recoup a portion of money corporations route to tax havens. Montana became the first state back in 2003, passing a bill requiring companies to report profits from subsidiaries in select foreign countries. Last year, Oregon enacted legislation of its own.

“Legislators on both sides of the aisle looked at it and saw it was something siphoning dollars away from the state,” said Oregon Rep. Peter Buckley, who authored the bill targeting tax havens.

The state expects the change to bring in an additional $18 million this year, and about $20 million in subsequent years. While that represents only a tiny fraction of the state’s total budget, it’s vital funding to be reinvested in education, mental health programs and senior services, Buckley said.

The bill encountered little opposition in Oregon, passing unanimously in the state House. “In the states, there’s a chance for this not to be a highly partisan issue,” Buckley said.

Closing the “water’s edge loophole,” as PIRG calls it, is relatively straightforward.

First, states must define a list a tax haven countries or utilize existing lists from the Internal Revenue Service or other agencies. They’ll then need to adopt “combined reporting” measures requiring companies to report income for all subsidiaries on state tax returns. Currently, 23 states and the District of Columbia already require such reporting. Finally, states apply existing formulas to determine taxable income.

So why haven’t more states moved to rein in companies utilizing tax havens?

U.S. PIRG’s Baxandall notes that well-funded business groups employ ample resources to oppose tax reforms. It’s also possible that the issue hasn’t attracted much attention because the amounts states can recoup pale in comparison to some other tax reforms.

Baxandall said he was aware of at least three states currently studying the issue.

“Given these tight budget times, it's important to remember that every dollar lost to offshore tax havens has to be cut from other public priorities or higher taxes,” he said.