Media Myths and Corporate Taxes

 

The Government Accountability Office (GAO) in July published a report, Comparison of the Reported Tax Liabilities of Foreign- and U.S.-Controlled Corporations, 1998-2005, GAO-08-957, requested by Sens. Byron Dorgan (D-ND) and Carl Levin (D-MI). The GAO examined a sample of annual IRS data from the Statistics of Income Division (SOI) containing information on corporations that file income tax returns and the number that actually had a tax liability for the years 1998 through 2005.

 

Although the report was fairly antiseptic, the liberal media had a field day publishing stories and headlines that simply did not comport with the underlying facts of the report. The Washington Post's headline blasted "Many Firms Didn't Pay Taxes." The Houston Chronicle claimed that the report by the GAO "found that almost two-thirds of American companies didn't pay corporate income tax annually from 1998 to 2005." The New York Times got in on the propaganda too, publishing an editorial stating that "almost two-thirds of companies in the United States usually pay no corporate income taxes." My personal favorite, though, was the San Francisco Chronicle, whose headline screamed "Most U.S. Firms Paid No Taxes Over 7-Year Span." The study covered an eight-year span, not seven years. The Chronicle couldn't even be bothered to get the length of time right.

 

And did the report scandalously reveal that "almost two-thirds of companies in the United States usually pay no corporate income taxes?" Actually, no. Not even close. The report showed that in each of the years from 1998 through 2005 about 66% of corporate filers had no tax liability. The chart on page 11  shows the percentage of corporations that did not have tax liabilities for multiple years. Let's face it-if 66% of all corporations were paying no taxes for all eight years, we would be reading about a Department of Justice  or IRS investigation into the matter and not some synopsis of a dry GAO report. So let's consider the reasons why this "big" story isn't all it's cracked up to be.

 

Profits Versus Revenues
Some media observed that they found it hard to believe that two-thirds of American companies failed to turn a profit. The news media confused the concept of having a profit for accounting purposes with the concept of making computations resulting in a tax liability under the Internal Revenue Code, a very different animal indeed. Profits can vary widely from year to year, across different sectors and industries, and even within a single industry. Moreover, companies are allowed to average the good years with the bad years through the use of loss "carryforwards" and "carrybacks" to smooth out tax payments in the same way that individuals do. Therefore, in any particular year, a large number of corporations have no taxable income. In fact, the Tax Foundation discovered that of the 25% of large corporations that paid no tax in 2005, 85% of those did not pay tax because they had no profits.

 

And perhaps these media outlets also should have looked at the size of the companies studied in the GAO report.  Kevin A. Hassett of the American Enterprise Institute noted that had they done this, they would have seen that most of the millions of companies examined in the study were small businesses. Businesses tend to structure their affairs to avoid unnecessary taxation. So, for example, a small business owner is likely to pay himself or herself a high salary (and pay individual income taxes), take a wage deduction (and pay wage taxes), and thus reduce his or her profits to zero. Alternatively, if the same small business owner were to keep the profit and then distribute it as a dividend, the owner would be subject to the 35% corporate tax and then a 15% tax on the dividend. So the small business owner isn't
avoiding taxes entirely, but, rather, is arranging his or her affairs to legally reduce taxes.

 

Not Paying Taxes Owed Versus Not Having Tax Liability
Let's clarify another point that these reporters seem to have missed: the difference between not paying taxes owed and not having a tax liability. The GAO report does not say that corporations are not paying taxes they owe. Instead, it says that some corporations did not report tax liabilities, i.e., they did not owe taxes.

So how do corporations avoid having tax liabilities? Most often, they avail themselves of deductions and credits that they are legally entitled to under the Internal Revenue Code. Just "shocking" and "scandalous," isn't it …using deductions and credits they are legally entitled to in order to provide fair rates of return to shareholders and other investors? The media are quick to vilify corporations that reduce shareholder value by paying CEOs too much, but they don't seem to have the same concern if corporations pay Uncle Sam too much.

 

And onto the next equally shocking reason for the lack of tax liability … in the current economic climate, some corporations, gasp, actually haven't been making any money, resulting in losses that may be deducted against income of other tax years. Another reason for the lack of tax liability is that some corporations haven't been making any money, resulting in losses that are allowed to be deducted against income of other tax years. Losing money purposely to avoid taxes is not a good strategy-just ask the auto or airline industries.

 

The tax situation for corporations is not all that different from that of individuals. IRS data show that for 2005-the final year of the GAO study-approximately one-third, or 44 million, of the 134 million individual income tax returns filed showed no income tax liability whatsoever. And this does not even account for all those individuals who had insufficient income to even have to file income tax returns. In addition, IRS data show that individuals making up the bottom half of tax filers (by adjusted gross income) accounted for not quite 3% of total federal personal income tax paid. This data show that corporations are getting no more of a "free ride" than vast numbers of individuals. To be fair, perhaps the GAO should do a study on the number of individuals who utilize exemptions, deductions, and credits like corporations do.

 

In sum, the idea that there is a large pool of corporations not paying taxes that they legally owe is just incorrect. Maybe misrepresenting the data or using it to make deceptive arguments is just the media's way of turning a report that really says nothing into a scintillating, scandalous story. It wouldn't be the first time.