There’s probably no group of companies more alarmed about going over the “fiscal cliff” of tax increases and spending cuts due to take effect next month than defense contractors. The cliff is heavily geared toward inflicting pain on the industry, with $500 billion in cuts to government defense spending over the next decade, a process called for extraordinarily boring reasons “sequestration.”
In recent weeks, defense industry representatives have issued increasingly dire warnings about the dangers posed by the cuts.
“The dangers of sequestration are by now well understood, with more than 2 million jobs hanging in the balance and the Joint Chiefs warning of severe damage to America’s security,” David Hess, chairman of the Aerospace Industries Association, wrote to President Barack Obama earlier this week, in a letter signed by more than 130 aerospace and defense CEOs. “Accordingly, we are encouraged by the bipartisan commitment to stop sequestration and pursue a more responsible approach to our longer term fiscal challenges.”
Less understood is the role the industry has played in pushing the country to the economic precipice. For years, these companies have lobbied for — and won — lucrative tax breaks that have cost the government billions of dollars. Even now, their lobbyists are pushing for an extension of a break that allows some companies to avoid paying taxes on some income earned overseas.
According to a study by the nonprofit group Citizens for Tax Justice, aerospace and defense firms paid an effective tax rate of 17 percent from 2008 to 2010, much lower than the 35 percent corporate tax rate mandated by law and just under the 18.5 percent average effective rate paid by all industries.
Some of those companies, in fact, paid negative tax rates during that period, once you account for government tax breaks. One of those was aerospace giant Boeing, whose executive vice president Dennis Muilenburg signed the AIA’s letter to Obama. Boeing’s effective tax rate was -1.8 percent from 2008 to 2010, on $9.7 billion in profit, according to the Citizens for Tax Justice study. That cost the government more than $3 billion in tax revenue, had Boeing been taxed at the 35 percent rate.
Boeing spokesman Chaz Bickers pointed out that the Citizens for Tax Justice study does not include deferred taxes that the company expects to pay later. The study covers a period in which Boeing was investing in new products and hiring workers, for which it received government tax breaks. Once sales of its new jet, the 787, pick up, the company expects to pay much higher tax rates, Bickers said.
“We’re doing what we’re supposed to do: investing in jobs,” Bickers said. “We’re the biggest manufacturing exporter in the country, and we earn our revenue here in the U.S., and we pay the overwhelming majority of our taxes here in the U.S.”
And he’s right. The U.S. government gave Boeing tax breaks to encourage its investment, which may ultimately benefit the whole economy. Boeing claims to have created 11,000 new jobs in the past year.
But the defense industry also lobbied hard for those tax breaks and wants more, including some that will never go away.
David Hess, one of the signatories of the AIA letter, is the president of Pratt & Whitney, a division of United Technologies Corp., a large defense contractor that manufactures everything from escalators to aircraft engines. The company has actively lobbied for legislation that tax reform advocates say would enshrine into law an exemption that encourages multinational companies to use offshore shelters to avoid U.S. taxes.
United Technologies did not immediately respond to a request for comment. It’s not clear how much the company stands to save — or lose — should the exemption go away. But the company has joined more than a dozen other large U.S. manufacturers with sizable overseas operations, including Dow Chemical, Procter & Gamble and Koch Industries, to support a permanent extension of the tax break.
The bill, in essence, would permit a company with an overseas subsidiary that earns so-called “passive” income, such as royalties, to avoid U.S. taxes on that income indefinitely.
The details are complicated, but a sample scenario would work something like this: An overseas affiliate of manufacturing company, in France, for example, sells a product. Ordinarily, it would pay its U.S.-based parent a royalty on those sales. That money would be taxable under U.S. law.
To avoid that tax, multinational companies came up with a work-around: Set up a new corporation in a low-tax country, such as the Cayman Islands, and transfer over the patent on the product. Now, the French affiliate pays royalties to the Cayman-based company, instead of to the parent on U.S. soil. Under current law, companies still must pay U.S. taxes on that income. But Congress has renewed a tax loophole almost every year since 2006, allowing the companies to avoid the tax.
The exemption expired at the end of 2011. The bill United Technologies has lobbied to support would make the exemption permanent. It’s not clear what will happen to that effort, but a Senate committee recently approved another extension, which is likely to be approved.
The Joint Committee on Taxation estimates that extending the exemption, along with continuing a closely related regulation known as “check-the-box,” will cost the the government about $115 billion in lost revenue over the next decade.
Rebecca Wilkins, senior counsel at Citizens for Tax Justice, said a basic problem with the exemption, which she has argued should be eliminated, is fairness.
“It gives multinational companies an advantage over domestic companies, and big companies and advantage over small companies,” Wilkins said. “Mom and pop companies don’t have foreign subsidiaries.”