IRS Budget: Penny-Wise, Pound Foolish

Kash recently posted a graph entitled Historical Profits, which had me looking for an excuse to post the following graph showing corporate taxes relative to corporate profits before taxes (see NIPA tables 6.17 and 6.18, which note that taxes income those paid to Federal, state, and local government and taxes paid by domestic corporations to foreign governments on income earned abroad).

Dustin Stamper published “Panelists Blame Growth in Offshore Tax Evasion on Inadequacy of U.S. Internal Revenue Service” in Tax Analysts on April 11, 2005:

Headlining an April 7 briefing on offshore tax evasion sponsored by Sen. Carl Levin, D-Michigan, and Rep. Lloyd Doggett, D-Texas, former Senate investigator Jack Blum and director of Citizens for Tax Justice Bob McIntyre spared almost no one from blame for increasingly widespread tax evasion, least of all an “undernourished” U.S. Internal Revenue Service. Characterizing offshore evasion as “a national crisis” in a time when the country is “hammered by deficits,” Blum, now with the Washington law firm Nobel, Novins, and Lamont, said that while he worked as counsel for the Senate Foreign Relations Committee, he helped the IRS identify 2.2 million credit card transactions from offshore accounts in tax havens. “The IRS can’t handle a million tax evasion cases,” he said. “We have undernourished the IRS to the point where it’s a joke.” According to Blum, hiring freezes and the retirement of many employees with offshore expertise have gutted the agency. Worse, he said, “we’ve sent them on fools’ errands,” like cracking down on tax credits for low-income individuals. “The mega-rich have basically walked away from the tax system,” he said. “One-third of the world’s wealth nominally is now held by shell companies.” McIntyre traced most of the IRS’s problems to low funding and the hearings on IRS abuses in the late 1990s. He also warned that things are unlikely to change anytime soon. “We have an unfavorable political climate with this Treasury and White House,” he said.
McIntyre accused Bush of selling tax shelters in his first job with the oil industry, and Treasury Secretary John Snow of frequently lobbying for loopholes while in the private sector. According to Blum, the first step to erasing the problem would be for the IRS to stop recognizing sham corporations in tax havens.

Bob McIntyre and T.D. Coo Nguyen produced this Citizens for Tax Justice report on the declining level of Federal corporate profits taxes relative to pretax income. This ratio is less than the overall effective tax rate to the degree that companies pay foreign income taxes as well as to the degree that companies pay state income taxes. In 1988, this ratio was above 25% but was just under 22% during the 1996-98. In 2003, this ratio was only 17%. They also note that Federal corporate income taxes represent less than 1.5% of GDP as compared a 4% of GDP in 1960. They also discuss a variety of reasons why Federal corporate profits taxes are so low including:

Offshore tax sheltering. Over the past decade, corporations and their accounting firms have become increasingly aggressive in seeking ways to shift their profits, on paper, into offshore tax havens, in order to avoid their tax obligations. Some companies have gone so far as to renounce their U.S. “citizenship” and reincorporate in Bermuda or other tax-haven countries to facilitate tax sheltering activity. Not surprisingly, corporations do not explicitly disclose their abusive tax sheltering in their annual reports. For example, Wachovia’s extensive schemes to shelter its U.S. profits from tax are cryptically described in the notes to its annual reports merely as “leasing.” It took extensive digging by PBS’s Frontline researchers to discover that Wachovia’s tax shelter involved pretending to own and lease back municipal assets in Germany, such as sewers and rail tracks, a practice heavily promoted by some accounting firms. Other tax shelter devices, such as abuses of “transfer pricing,” also go unspecified in corporate annual reports. Nevertheless, corporate offshore tax sheltering is estimated to cost the U.S. Treasury anywhere from $30 to $70 billion a year, and presumably the effects of these shelters are reflected in the bottom-line results of our study.

Our graph shows that the ratio of corporate taxes relative to corporate profits dropped in the early 1990’s and then increased during the second half of the decade. This effective tax rate combines the 35% Federal statutory rate and the state tax rate, but depends on a variety of factors including how much income is shifted to low-tax havens abroad and how much income gets sheltered in what is often referred to as Delaware Intangible Holding Companies (DIHC). The fall in the effective tax rate for corporations is not only due to falling Federal corporate taxes relative to profits but also an erosion of state corporate tax rates – in part because of the use of DIHC structures.

One of Bill Clinton’s themes during the 1992 campaign was to beef up the enforcement of section 482 of the U.S. tax code, which governs intercompany pricing. The IRS is currently short on resources to enforce section 482, which is something President Bush wishes to address. Rather than bash the Administration, let’s support his efforts to convince the House GOP leadership to provide more funding – especially now that a particular member is in hot water.

Update: the latest from Bruce Bartlett is a must read for anyone who is interested in having an effective Treasury Department . And reader Ken Houghton points us to another gem from Max Sawicky.