GAO Sheds (very little) Light on an Important Question for Tax Reform
Do American corporations pay too much, or too little tax? Are U.S. tax rates excessively hindering American companies’ ability to compete in global markets? These are important questions, especially as the nation considers fundamental tax reform. Of course, companies say their tax rates are too high and tax burdens too heavy. And they have enough solid evidence on their side to build bipartisan support for rate relief - the United States has the highest statutory corporate tax rate in the industrialized world, and a recent hike pushed the tax rate on non-corporate businesses even higher.
But what say independent observers? A recent study by the General Accountability Office (GAO) on U.S. effective tax rates should shed some light. The key word there is “should”. For a variety of reasons, the GAO study tells us little about the competitiveness effects of U.S. tax rates and much about the limitations of analysis and perhaps the GAO’s own policy bias.
The GAO study calculates effective tax rates (ETRs) for large, profitable American companies between 2008 and 2010. As GAO is careful to point out, ETRs are average tax rates, useful perhaps as a benchmark for tax burdens but of little use in assessing the incentives effects of taxation more properly captured by the effective marginal tax rate – the incremental tax burden on an incremental dollar of income arising from an incremental unit of investment. In short, a study of ETRs tells us very little about competitive effects.
Another serious problem is that GAO provides information only on U.S. companies and their taxes. To the extent that the statutory rate in the U.S. exceeds companies’ ETRs, would it not be likely that statutory rates in other countries would exceed foreign companies’ ETRs as GAO calculates them? To be useful for assessing competitiveness effects, it’s necessary to compare apples to apples. That means calculating ETRs for foreign companies.
Yet another apparent and perhaps inescapable kink in GAO’s analysis is yet another apples to oranges-type issue. GAO calculates a company’s ETR as the ratio of taxes paid on its consolidated tax filing with income from its consolidated financial statement. Many of the companies studied are large, complex, multinational enterprises involving many types of business entities. Troubles arise in that the rules for determining the entities associated with the enterprise to include in a financial statement differ from the rules for determining which to include in a tax filing.
As the study notes, for 2010 “filers reported that they earned a total of $1.3 trillion from U.S. and foreign entities that were included in their consolidated financial statements but not in their consolidated tax returns." Such entities also reported $420 billion in losses, for a net of nearly $900 billion in mismatched income. Thus, because of the difference in rules as to which entities to include and which to exclude, the measure of income reported in the denominator appears significantly larger than the measure of income on which tax liability is calculated. This may be a data problem defying solution.
What did the GAO study conclude? That the average ETR of large, profitable corporations was 26.2% in 2008, (was likely substantially higher earlier), and that this figure fell to 21.5 percent over the course of the recession. What the study fails to indicate clearly are the factors reducing the average ETR below the statutory rate, why the average ETR fell over the period studied, or what the trend ETR is likely to be as the economy continues to recover.
Curiously, GAO observes that the information on which it based the study was first reported to the IRS in 2004. One would think GAO would then begin its study in 2004, rather than in 2008. One paragraph in the study refers to results from 2006, and one chart refers to ETRs for all companies from 2006 to 2010 but refers to the ETRs from the subset of profitable companies from 2008 to 2010. This begs the question: Why would GAO include the earlier years for all companies when ETRs were relatively high, yet chose not to report results from those years for profitable companies when the ETRs were reduced by the recession?
As tax reform continues to develop, one hopes that GAO will continue to refine its methodologies, including making similar calculations for foreign companies to enable proper international comparisons, and thus eventually provide solid information for the debate.