A new GAO report [PDF] has made some news by reporting that large fractions of both U.S.-controlled and foreign-controlled corporations report no liabilities under the federal corporate income tax. In 2005, 25% of “large” U.S.-controlled corporations and 67% of all U.S.-controlled corporations reported no tax liability; foreign-controlled corporations reported no tax liability at roughly similar rates (slightly higher overall for GAO’s study period).
There can be good reasons for this — some corporations, e.g. startups, may not even manage to earn a gross profit in some periods, and many others may (and do) fail to earn net profits after common deductible expenses such as salaries, depreciation, and interest expenses.
Since the headline results may nevertheless be incendiary, there’s been a fair amount of commentary providing bad reasons why the GAO’s findings might not be problematic. One non-explanation concerns “S” corporations, where corporate income is passed through to shareholders who then pay taxes on the income through the individual tax system:
An outside tax expert, Chris Edwards of the libertarian Cato Institute in Washington, said increasing numbers of limited liability corporations and so-called “S” corporations pay taxes under individual tax codes.
“Half of all business income in the United States now ends up going through the individual tax code,” Edwards said.
The GAO study did not investigate why corporations weren’t paying federal income taxes or corporate taxes and it did not identify any corporations by name. It said companies may escape paying such taxes due to operating losses or because of tax credits. [Via.]
The GAO’s analysis encompasses “S”-corp returns, which not surprisingly rarely show corporate tax liabilities, but the headline figures are for corporations filing returns for non-pass-through corporate forms. (Nor are pass-through forms inherently non-problematic. As David Cay Johnston reported in Perfectly Legal, audit rates for “S”-corps are low, and had been reduced amid the 1990s War on Tax Enforcement; there are ways of turning income into corporate expenses among other things especially when the IRS isn’t looking too closely.)
Another bad explanation in reasonable clothing comes from the a Tax Foundation economist quoted by the NYT:
Joshua Barro, a staff economist at the Tax Foundation, a conservative research group, said that… [t]he vast majority of the large corporations that did not pay taxes had net losses… and thus no income on which to pay taxes. “The notion that there is a large pool of untaxed corporate profits is incorrect.”
The general point that corporations need to have taxable net income to be subject to income tax is correct enough, but not all corporations without taxable income arrive there the same way. Transfer pricing abuse (paying inflated or deflated prices to related entities for tax avoidance purposes) is a widely acknowledged problem that GAO explicitly did not address in its analysis. The extent of the problem would not only encompass firms who eliminated their taxable income through transfer pricing abuse, but also firms seeking “merely” to shave off the tops of their reported income. The amount of untaxed corporate profits also depends on the actual, and seemingly considerable, extent of abusive tax-sheltering practices — also beyond the GAO report’s scope.
What’s most grabbing about the report is that for corporations reporting positive gross income but zero taxable income, an opaque “other deductions” line is the most common one where zero taxable income is established — about 30% across the board of firm sizes and ownership types (the next “culprits” are non-officer employee compensation and interest payments). That line is below the deductions for rank-and-file wages and salaries, officer compensation, rent, interest, depreciation, and many other common deductible expense items. So you might take that as a measure of the extent of esoteric tax preferences, loopholes, and other income-avoidance methods in the corporate tax code or maybe otherwise. It does not obviously help make the case for a healthy corporate tax system.