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Dr. Martin A. Sullivan

January 20, 2011

1. What are the statistics regarding tax compliance by individuals?

Details are important, and on the issue of tax compliance I must refer you to the detailed and excellent study by Eric Toder of the Tax Policy Center (“What is the Tax Gap?” available on the Urban Institute web site).

Let me summarize the situation as I see it. Individual compliance depends on what sort of income we are talking about. Different sources of income have hugely different compliance rates due to the differences in withholding and information reporting.

According to the IRS, underreporting by individuals can be divided into four categories:

1. When there is withholding and information reporting, the rate of underreporting of income is only 1.2 percent.

2. When there is substantial information reporting, the underreporting rate is 4.5 percent;

3. When there is some information reporting, the underreporting rate is 8.6 percent; or

4. When there is no information reporting, income is underreported by 53.9 percent.

Compliance is generally high in the individual sector because the bulk of income is wages (withholding and information reporting) and dividends and interest (extensive information reporting). Most individual noncompliance is due to small business. There is neither withholding nor information reporting on most small business income. Although they are now extremely unpopular on Capitol Hill, expansions of 1099 reporting are critical for reducing noncompliance and catching tax cheats.

2. Corporate tax: how important is the statutory rate?

At first glance, it would be reasonable to assume that the statutory corporate tax rate plays a minor role in location decisions. For a typical U.S. manufacturing firm, wage costs are about ten times larger than corporate tax payments. Obviously, the opportunity to cut wage costs in half in far more important than cutting taxes in half. And of course the other factors you mention—access to raw materials, infrastructure, political environment, etc.—are critical.

But, as you well know, business in the 21st century is more about patents and trademarks than bricks and mortar. It is easy to move intangible assets across international borders, and because our transfer pricing rules work so poorly it is easy to shift the profits attributable to these intangible assets to tax havens. So, by locating business operations in low-tax countries, U.S. corporations get a foothold on to which profits from high-tax countries—including the United States—can be directed. In short, the conventionally limited effect of the level of the statutory corporate tax rate on location decisions is turbo-charged by tax rules that allow significant profit shifting.

The signficant presence of U.S. multinational corporations in Ireland illustrates these points. U.S. multinationals employ about 90,000 workers in Ireland. Ireland has a 12.5 percent statutory corporate tax rate. And it is this rate was largely responsible for Ireland’s economic boom from 1990 through 2008. U.S. corporations report profit rates about three times greater in than elsewhere. This is not “the luck of the Irish.” This is tax law failing to do its job. If Ireland had a rate to 35 percent, it is fair to say the Irish economic miracle never would have happened. Alternatively, if the United States had lowered its corporate tax rate to 12.5 percent, the Irish economic miracle never would have happened.