Shell companies are dangerous. Taxing them would help solve two big problems.

The Treasury Department, led by Secretary Scott Bessent, has scaled back reporting rules for shell companies.

This month, the U.S. Treasury Department made two ominous announcements: that it will no longer require shell companies to identify who owns them, and that the U.S. federal debt has hit $40 trillion.

These two announcements may sound unrelated. But there's a connection. Shell companies are dangerous because they are used both by criminal organizations to evade sanctions and launder money and by the rich to avoid taxes. Instead of letting hundreds of thousands of shell companies sink further into the shadows, policymakers can address both problems with a new weapon: a shell-company tax.

There is no universal definition, but shell companies are businesses that exist primarily on paper and lack direct human owners. They form webs of businesses without storefronts that are owned by other businesses, passing vast sums of money back and forth and even overseas with minimal oversight. For bad actors, they're perfect masks: The owner of Anonymous Inc. is not a person but rather Unidentified Corp. LLC. Criminal networks like the Sinaloa cartel, sanctions-evading Russian oligarchs and Iranian agents exploit these incomprehensible thickets to remain anonymous.

Unfortunately, many legitimate-looking companies also use shell-company gimmicks to lower their tax bills. The watchdog Government Accountability Office has highlighted the problem of "circular partnerships," where Business No. 1 owns Business No. 2, which owns Business No. 3, which in turn owns Business No. 1. Because these businesses technically own themselves, it can be nearly impossible to identify the actual people responsible for their income and taxes when it comes to tax time.

When law enforcement tries to trace bribes or tax evasion, criminals can easily hide among the hundreds of thousands of legal shell companies whose owners were only using them to lower their taxes. It's like police hunting for a couple of rogue graffiti artists on a crowded street where everyone is carrying a can of spray paint.

Compounding the anonymity, these shell companies often benefit from an enormous loophole: They rarely pay federal taxes. While traditional corporations face a 21% tax rate on their profits, shell companies are often organized as privately owned "partnerships" that do not pay tax directly. In 2022, over $3.7 trillion flowed through these business-to-business partnerships. Owners are legally required to pay taxes on this income, but no one pays if the IRS can't identify who they are or prove what they owe.

This shell-company tax exemption is a massive engine for wealth inequality. A 2015 study found that partnership owners paid an average tax rate of just 15.9% - roughly half the rate paid by owners of traditional C corporations. The top 1% receives 69% of all partnership income, and partnerships now routinely report more total income than standard corporations.

Furthermore, foreign investors use shell companies and offshore "blocker corporations" in places like the Cayman Islands to shield billions of dollars in American income from the IRS. As a result, the U.S. collects a meager 3% tax rate on income flowing through shell companies to foreign tax havens.

To end this evasion, lawmakers must target the two main advantages shell companies enjoy: their complex structure and their tax exemption. The solution is a shell-company tax that scales up based on how convoluted an organization is.

The tax would start small - perhaps just 1% on the revenues, deductions and assets passed between entities - but would compound with every duplicative layer of ownership. The GAO found that in 2019, more than 6,000 businesses had over 20 different ownership tiers. Under this proposal, assets buried inside a 20-layer Russian nesting doll of shell companies would face a 20% tax penalty when distributed, or 1% for every layer.

This policy would not ban shell companies outright, but it would make them expensive to maintain. It would penalize cartels, force foreign investors to pay their fair share and stop wealthy Americans from gaming the tax code. Because it would only be triggered when a business is owned by another business, that means directly owned, standard small businesses would be completely exempt. Given that $4.4 trillion flowed between entities or foreigners in 2022, a shell-company tax could raise enough revenue to cover the deficit impact of the largest tax cuts given out in the One Big Beautiful Bill Act last year.

Ultimately, a shell-company tax would render many deceptive corporate structures uneconomical and drive businesses into the sunlight of traditional business structures. Faced with compounding fees, hundreds of thousands of shell companies would likely dissolve. This would allow law enforcement to more easily zero in on actual criminal activity, while simultaneously raising tens of billions in revenue yearly to shrink the federal deficit.

Corey Husak is the director of tax policy at the Center for American Progress.