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Reducing Tax Avoidance by Reducing Economic Activity: New Zealand’s Failed Experiment with Ending Deferral

3 min readBy: William McBride

An article by Meade Klingensmith at Remapping Debate discusses the major proposals to reduce corporate taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. avoidance, concluding that the best option is to end the rule that allows corporations to defer taxes on foreign income:

Some advocates for corporate tax reform believe it is possible to create an environment in which corporations would have fewer incentives and less opportunity to avoid paying U.S. taxes. With remarkable consistency, these advocates argued that the most important measure the U.S. could take would be ending its deferral policy. “The answer is to get rid of the rule that encouraged all the corporations to shift all their profits offshore in the first place, which is deferral. Until then, you’re going to still have a system where corporations have some sort of incentive to do that,” said Wamhoff.

Thomas L. Hungerford, a senior economist and the director of tax and budget policy at the Economic Policy Institute, a left-leaning think tank, agreed. When asked about what he believed would be the most effective measure the U.S. could take to combat tax avoidance, he replied, “The big thing would be just getting rid of deferral. It’s an incentive to basically shift as much profit overseas [as possible].”

And Nicole Tichon, the executive director of Tax Justice Network USA, the U.S. branch of an international coalition of tax researchers and activists based in the United Kingdom, added that deferral “incentivizes companies to not only defer their taxes, but to keep their operations offshore.”

A bill that would end deferral is currently on the floor of the U.S. House of Representatives. The Corporate Tax Fairness Act, developed by Senator Bernie Sanders (I-Vt.) in the Senate and Representative Janice Schakowsky (D-Ill.) in the House, was referred to the House Committee on Ways and Means in February, 2013, where it currently remains. The bill has only three co-sponsors: Representatives Keith Ellison (D-Minn.), Alan Grayson (D-Fla.), and Raul Grijalva (D-Ariz.).

Rep. Schakowsky asserted the importance of her bill in an interview with Remapping Debate. “Because of special rules for corporations and incentives we give them to set up foreign tax havens and engage in tax avoidance, [there is] about $590 billion over the next decade that could be in the U.S. Treasury.” Having that money, she said, “would avoid having to do things like cut nutrition programs for poor people, which we’re doing right now.” Tax avoidance by multinational corporations, she said, “really burdens…the vast majority of Americans in this country, and we should end that.”

And what would be the most important tool the U.S could use to reclaim the money lost to tax avoidance? “Really the big thing would be just to end the deferral of foreign source income and tax them for it,” Rep. Schakowsky said.

Hungerford recognized that ending deferral is, at least in this session of Congress, “kind of pie in the sky. I just don’t see any of this going through Congress at this time. But I think eventually [ending deferral] is probably the easiest thing to do…Then you just don’t have that problem.”

Sounds great, but the article fails to mention the experience of New Zealand, the only developed country to try such a policy. After ending deferral in 1988, New Zealand suffered a 20 year stagnation in foreign investment, which contributed to a concomitant decline in economic output and living standards, as the charts below illustrate. For these and other reasons, in 2009 New Zealand returned to a territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. that exempts entirely the active foreign income of their multinational corporations. Read more about it here.

Follow William McBride on Twitter @EconoWill