"I'm happy to help," my imaginary friend replied, as I ordered another round. (Where I drink, there's nothing unusual about a person ordering two beers for himself and muttering to no one in particular.) "It's not an easy time to make a living. The city may raise the occupational privilege tax from $10 a year to $10 a month; the state is contemplating raising the income tax to help pay for public schools. Gov. Rendell says the extra money will allow school districts to lower their property taxes, but you don't own any more property than I do. And unfortunately, you exist."
"I've often thought the same thing," I agreed. "But I think I've figured out a solution to the tax problem. I'll create an out-of-state bank account in your name, and transfer all my earnings into it. When the taxman comes around, I can just say, 'Hey, don't look at me: The other guy made all the money. Talk to him.' He couldn't do it even if you did exist, because the state can't tax people outside its borders."
"How would you get the money back when you needed it?" my friend asked.
"You'd just 'loan' it to me at an interest rate lower than what I would've paid in taxes. After all, what are imaginary friends for?"
"That's ridiculous," my imaginary friend scoffed.
"You're right," I conceded, "but only because I'm not a corporation."
"What do you mean?"
"If I were a corporation, I could set up a 'passive investment company,' or PIC. Companies in Pennsylvania and across the country have done it for years. As an April report by the Washington-based Center on Budget and Policy Priorities explains, a PIC is a subsidiary that a parent company creates in a low-tax state like Delaware. The parent firm transfers ownership of some intellectual property -- a patent, for example -- to the subsidiary, and then pays the subsidiary for the right to use it. That lets companies convert profits into an expense paid to a separate company -- even if that company exists only as a post office box."
"Wouldn't the company just get hit with taxes in Delaware?"
"Delaware doesn't tax revenue earned from 'non-tangible' items like intellectual property, so the subsidiary doesn't pay any tax either. The subsidiary then 'loans' the money back to its parent at a low rate. And since interest on loans is tax-deductible, you get a tax break coming and going."
"Are you always this lucid about tax policy when you're drinking?" my imaginary friend interrupted.
"Of course not. But this is an imaginary conversation, remember? I always sound this smart in my own head. Especially after a few beers."
"That's true," my friend conceded. "But wouldn't you get in trouble for such an obvious tax scam?"
"Not at all. Like any great scam, this one is entirely legal. While seven states -- including New Jersey and Ohio -- have passed laws mostly barring the use of PICs as tax shelters, it's allowed in Pennsylvania and 21 other states. It's been used by corporations ranging from Toys R Us to the paragon of respectable corporate accounting: Enron."
"Surely someone in Harrisburg has realized this," my friend replied.
"Well, Gov. Rendell has said that closing the loophole would raise about $100 million in taxes, and last month state Rep. David Levdansky, the Democrat representing Elizabeth, sponsored a bill that would disallow the exemption. Levdansky told me there was 'Nooooo doubt that this is a tax shelter for a lot of companies, and it's of dubious value to the state.'"
"Did you really talk to Levdansky, or was he just a figment of your imagination as well?"
"I'm sure it was Levdansky, though I often think the state legislature is just the product of a twisted madman's fantasies."
"What do you mean? If other states have closed the loophole, surely state legislators will see that it could work here."
"That's the problem: The measure might work too well. New Jersey raised nearly $1 billion in tax revenue, and Levdansky told me Pennsylvania could see an increase much bigger than Rendell anticipated. In April, a business lobbyist told the Philadelphia Inquirer that three of his clients alone would see their tax bills go up by $100 million. Neither the business community nor the Republicans controlling the legislature are happy about that. And one of the companies who uses the tax shelter, the Inquirer reported, is Comcast, a cable leviathan that has 400 subsidiaries in Delaware -- and that has close ties to Rendell. David Cohen, Rendell's longtime adviser and formerly his chief of staff, was a Comcast executive. Sources in Harrisburg say Rendell has cooled on the proposal, and Levdansky says that if the business community comes up with $100 million in new revenue on its own, his measure will likely be dropped."
"That's still a lot of money," my friend noted.
"But it's just a dime for every dollar that New Jersey brought in. And corporations have gotten away with carrying a smaller and smaller share of the tax burden for the past decade. According to the state's Department of Revenue, in the 1992-93 fiscal year, corporate taxes accounted for 24 cents of every dollar the state took in. A decade later, corporate taxes would account for only 18 cents of every tax dollar. The difference was made up for by taxes on money you and I earn, and by sales taxes on things we buy."
"Wait a minute," my imaginary friend objected. "The Pennsylvania Economy League calculates that Pennsylvania firms are taxed at a rate 25 percent higher than the national average. And some Pennsylvania taxes are really unfair: One state levy, the capital stock and franchise tax, taxes a company's gross receipts -- even if it didn't make any profit after expenses are deducted."
"That's true," I nodded wearily. My imaginary friend often sounds like a conservative think-tank -- an issue I'm working on with a therapist. "But if schemes like the Delaware loophole can make a profit look like an expense, what else can the state do? If businesses wanted to lower the tax rate, they could close loopholes so that everyone had to pay. As Ray Murphy of the Harrisburg advocacy group Pennsylvanians United puts it, 'It's silly to say that the tax is too high if most businesses don't pay it.' And it is silly -- unless you're one of the companies that do pay. You end up paying taxes on your losses while other firms just hide their gains."
"So one man's loophole is another man's noose," my friend observed.
"How come I'm giving you the good lines?" I asked.
"Look at it this way," he replied. "If you incorporate yourself, you can pay me to use them in this week's column."