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Senate Aims at Offshore Tax Evasion

Baucus.jpg
Baucus.jpg

Sen. Max Baucus (D-Mont.)(WDCpix)

Spurred by reports that abusive offshore tax havens are syphoning hundreds of billions of dollars in federal revenues, Congress’s leading voices on tax policy called Thursday for tighter restrictions on companies and individuals doing business abroad.

The issue is of particular significance to Democratic leaders, who have accumulated a challenging legislative wish-list for next year — much of which they hope to fund by closing the $345 billion tax gap. Experts warn, however, that a slew of hurdles stands in their way.

Fueling the debate, the Government Accountability Office unveiled a report Thursday revealing that a single, five-story Cayman Islands building is home to almost 19,000 different financial entities. Roughly 900 of those entities are U.S.-owned, the GAO found, and between 40 and 50 percent have a U.S. billing address. The report came one week after a Senate panel estimated that abusive offshore arrangements deprive the federal government of roughly $100 billion per year.

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Congress_5536.jpg

Illustration by: Matt Mahurin

The news brought a vow from top lawmakers to rein in the abuses.

“We’re going to find a way to make a huge, big dent in this problem,” said Sen. Max Baucus (D-Mont.), chairman of the Senate Finance Committee, which oversees tax policy.

But tax experts say that won’t be easy. One complicating factor is the pace of globalization, which has forced an increasing number of businesses overseas to optimize profits. Victor Fleischer, a University of Illinois law professor who specializes in federal tax issues, said that offshore tax havens are often abused, but are also “an accepted method of structuring cross-border transactions, many of which are not abusive.”

That leaves regulators to sort through the mix to identify those violating the process — something many experts say the government lacks the resources to do. Jack Blum, an offshore tax specialist with the law firm Baker & Hostetler, likened the regulators to bicycle riders trying to keep pace with autobahn speedsters.

Lawmakers, meanwhile, face the equally unenviable task of crafting legislation that targets only the bad actors. “If they can find the major loopholes that no one can defend with a straight face,” Fleischer said, “then they’ll probably close those. But those are difficult to find.”

Businesses and other financial institutions are attracted to the Caymans for its political stability, absence of direct taxes and modicum of regulations. From the IRS’s perspective, much of the trouble stems from the slack reporting requirements, that allow individuals and companies to file with the agency without any third-party oversight. As long as the IRS continues to rely on this self-reporting, the GAO report says, “the Cayman Islands and other similar jurisdictions will remain attractive locations for persons intent on legally minimizing their U.S. taxes and illegally avoiding their obligations.”

Congressional leaders seeking to change that will face strong opposition from industries that now benefit from this self-reporting. One such group is the private-equity and hedge-fund managers. Some experts say their inclusion makes little sense.

“We have a hedge fund problem,” said Blum. “Hedge funds are in Connecticut. The managers are in Connecticut. The shareholders are in the United States. But they’re Cayman Islands companies. Excuse me — that’s ridiculous.”

But efforts to pass bills targeting hedge funds have run aground in the past, for equity firms donate heavily to the Democrats — and they hold a peculiar sway over the party as a result. Late last year, for example, a proposal to stave off a middle-class tax increase by hiking rates to private-equity managers died in the Senate. That bill was popular with many Democrats, but as The Washington Post reported, “the party’s money men … are reluctant to bite the hand that has generously fed them.”

The issue of tax havens is a different beast, experts say, because so many industries outside the realm of private equity also benefit.

“If every hedge fund in the world disappeared, you would still have a haven issue,” said Viva Hammer, formerly with the Treasury Dept.’s Office of Tax Policy and now a tax partner at the law firm Crowell & Moring.

But that could mean that opposition to proposed changes would be even more fierce — and remedies even more elusive.

The significance of the debate reaches far beyond tax policy. Democrats have a wide-ranging legislative agenda to tackle next year, everything from an expansion of children’s health coverage to greater investment in renewable energies. If they pick up enough congressional seats in November, those things might be attainable. But they won’t be cheap. Many key Democrats have pointed to closing the tax gap as a way to pay for much of their ambitious tab.

Baucus floated a plan Thursday that would create stricter reporting requirements for offshore dealings and a longer window to prosecute rule violators. But, many experts say, no change will come easily, even in 2009.

“If it’s a part of a broad-based reform,” Hammer said, “it could go places. If it’s a targeted provision, I don’t give it a chance.”

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