What Is Involved in Closing Tax Loopholes?

Closing tax loopholes usually involves one of two approaches by government. First, the government can begin to actively enforce rules in the tax code that have been ignored in the past in order to increase revenue. Secondly, it can enact new legislation that has the effect of closing tax loopholes, which can be made up of a variety of former government incentives such as subsidies, credits, and deductions that are no longer considered to be worthwhile. Closing a tax loophole can also involve eliminating methods of avoiding tax on investment income where it has been previously categorized as deferred income, or by disallowing tax breaks for divisional business losses or overseas investments, where the overall profits of a corporation have been positive in a recent year.

As tax law has become increasingly complex, changing tax code provisions for special cases on a periodic basis has become necessary to avoid creating large tax loopholes for corporations or individuals. It is estimated that, in the United States, closing tax loopholes in their entirety could bring in the federal government an additional $1,000,000,000,000 US Dollars (USD) in revenue annually as of 2011. A significant portion of this lost revenue is from major internationally-recognized US corporations. One prominent example of a corporation that made $6,320,000,000 USD in annual profit paid taxes to the government on only 7%, or $445,000,000, of this profit for the 2011 fiscal year. It did this by channeling much of its sales earnings through off-shore tax havens in nations such as Ireland, Singapore, and Puerto Rico to reduce its federal tax obligation in the US.

Using overseas investment and earnings as funneling processes to avoid paying taxes are known as Double Irish and Dutch Sandwich schemes, which are heavily exploited by major technology companies and are estimated to cost the US $60,000,000,000 in annual revenue as of 2011. Closing tax loopholes like this requires the creation of vigorous new tax legislation and its long-term enforcement. The same tech companies owed average corporate taxes of over 30% as recently as 2006, and managed to use these tax loopholes in the law to reduce it to below 10% without violating the law.

Another important approach to closing tax loopholes can be to thoroughly examine existing tax laws and their weaknesses that have been largely ignored by government in the past. In the US state of Massachusetts, Governor Mitt Romney did exactly this as soon as he was elected to office. Within a few months of taking the governorship in 2003, Romney's staff examined the tax code to increase state revenue by $110,000,000 USD in corporate taxes. Closing tax loopholes over the next three years in the state brought in hundreds of millions of dollars in additional revenue.

One prominent example of how Massachusetts accomplished this was by going after banks who had reduced the tax that they owed to the state by investing their profits into real estate investment trusts, which were by law subject to essentially no taxation. In a parallel to what tech companies were doing with overseas branches to avoid federal tax, the state banks were legally avoiding tax by claiming that the real estate trusts were part of normal banking business. In fact, these "investments" were a form of tax shelter that banks exploited until it became illegal, when state law was revised by Governor Romney to forbid the practice.