Computing Does Not Support Its Infrastructure

The forthcoming IPO by Twitter valued the company at $11 Billion [Demos:13] (today it’s over $22B). To keep from paying tax on the majority of its expected revenues, Twitter has already set up offshore subsidiaries, as reported by [Blagdon:13] The rights to the intellectual property, generated by its staff in San Francisco, will reside in a taxhaven subsidiary. Such arrangements are already in place for any major software and electronics company [Linebaugh:13]. Their computer scientists, programmers, and engineers don’t care: where the profits and taxes for their work go is best left to accountants [W:13b]. Computer scientists will argue for governmental support of research, education, and our communication infrastructure [AsprayMV:06]. Few of them recognize that the loop is open in the software economy and unfair to others that bear the full burden. Those include individual taxpayers, other industries that are by nature domestic, and smaller companies that cannot yet avail themselves of the benefits of multinational taxation.

Many computer scientists do believe that software should be free [Gay:02]. In practice, broadly used software, as operating systems, compilers, editors and the like, can be free, whereas creating applied software remains a business, contributing over 3% to the U.S. GDP [BEA:13]. Most software creators expect to be reimbursed for their efforts. They will have to be supported by universities and foundations that do not have taxable earnings, or be paid by enterprises that have earnings from sales, but those explicitly minimize their taxes.

How can the computing industry avoid paying substantial taxes? Globalization helps. All large enterprises are multinational. The creators work in one place, say Silicon Valley; duplication or production of gadgets that embed software takes place in another place, say Ireland; the revenues from product sales are collected in a third place, say the Netherlands, while the majority of the profits are accumulated in yet another place, let’s call it Palm Island. All these places differ in location, in services provided, and in laws and regulations governing transfer of IP rights and funds. While an individual is bound to one location at a time, a multinational corporation (MNC), now including Twitter, will claim simultaneously residency in many locations, taking advantage of local capabilities and benefits in each of four different places.

Home: Intellectual property (IP) is created in a place where creators, facilities, and intellectual excitement prevails. When a promising product emerges, as software for tweets, rights to its exploitation are exported to a subsidiary in Palm Island. Those rights have a value, formally the discounted future income. But that value is hard to assess, while Twitter’s shareholders think it will be worth well over $10 billion, an accountant will have a hard time justifying more than $100 million for the transaction, letting the US IRS take about $30M of that export to Palm Island [Fleischer:13]

Sales:Most income of MNC’s is collected by financial subsidiaries, often in small, trustworthy countries, as the Netherlands [W:13, Ch.6] The shell companies pay for product costs and transfer the remainder, the profits due to the IP, to MNC’s taxhaven company. Nominally those countries are the location where the sales are made and profits can be taxed, but after paying costs and for use of IP rights they don’t show net profits, so they don’t pay taxes.

Costs: The actual costs for creating, assembling, and distributing products incurred, say, in the U.S. and in Ireland. Those are reimbursed, perhaps adding a 5% markup. Only on that markup will US and Irish taxes be collected.

Profit: Over the years, as its IPO participants expect, Twitter’s income should grow and it will become as profitable as its peers. That profit is considered to be due to its IP. Its Palm Island subsidiary has the rights to it, so that the Dutch financial intermediary will ship those profits there. Few of the creators of the IP share directly in those profits. The stock options given to some do become very valuable, yielding another tax benefit [Primack:13]. Their shares will be sold to the public, and on those sales they pay taxes at a reduced rate (now 20%), to compensate for the assumed double taxation — corporate at the negligible rate followed by individual taxation. The purchasers of the shares are happy that Twitter’s funds are accumulated in untaxed accounts, no matter where.

Although all the many accounts held in offshore shell companies are hard to aggregate, the amounts now accumulated by knowledge-based industries in Palm Island and other locales in the Bermuda triangle are immense, range from a documented minimum of $1.5 trillion [Gale:] for US corporations to an exuberant $32 trillion, when private wealth is included [Henry: If they were to be repatriated to the U.S., taxes would be due. The taxes from a single company could support NSF and DARPA’s computing support for a year [Chambers:10].

However, halting Twitter’s move to exploit offshore places, even if the U.S. legal system could react that fast, would be unfair. Twitter’s past and future multinational competitors would be given an advantage. The stock options of its founders and employees would be worth less than those of its peers.

As things stand, each of the four places can claim it is not doing anything illegal [Drucker:13]. Together they enable a level of tax avoidance that domestic taxpayers can only dream of. Those taxpayers may want to fix the system in order to achieve what seems to be a fairer distribution of the tax burden. Some computing professionals may even want to change the tax structure of their employers, using the leverage that their abilities to create and maintain IP give them, and try to move the rights to their work back home. Unfortunately, the processes that were started, in many cases more than a dozen years ago, cannot be reversed. Since the accountants ignore intellectual capabilities and values much of the process is invisible. The aggregated profits, and the IP rights of those enterprises are where they are now, in sovereign countries that have the right to set their own laws and conventions.

A radical alternative would be not to tax corporations at all and instead tax the individual recipients of dividends and capital appreciation fully [W:13, Chap.19, recommendation 20]. While drastic, it would continue the trend of the reducing contribution of US corporate taxes to total tax revenues, which, if linearly extrapolated, becomes zero by 2050 [Drum:11]. Not paying corporate taxes would remove the motivation for their complex financial structures and allocations of IP rights. Business investments would be made without considering tax consequences. Specific tax exemptions for deserving enterprises and social goals become meaningless, and those deemed worthwhile would have to receive explicit grants, making lobbying for such benefits more direct.

The issues described here for the computing industry also apply to other knowledge-based industrial segments. But the computing industry is unique in that its professional members have been able to ignore economic realities.

There are many facets to the issue raised in this blog. Comments will be more than welcome, and I will do my best to address them.