Imagine that you took your car to the repair shop for a pervasive rattle. And let’s say that the mechanic took a good look under the hood and said that your best bet was to completely replace the engine. You know how much that’s going to cost. And you know that means you’ll be out of commission for a bit. And you know that it’s probably the best thing for the car. But you balk. Instead, you ask, what if I just replace the spark plug? Or the oil filter?
That, in a nutshell, sums up Congress’ latest approach to corporate tax reform.
Earlier this year, the Government Accountability Office (GAO) released a report (downloads as a pdf) ordered by Congress as part of their efforts to explore corporate tax reform. Specifically, GAO was asked to examine issues related to certain tax expenditures:
(1) the deferral of income for controlled foreign corporations;
(2) deferred taxes for certain financial firms on income earned overseas; and
(3) the graduated corporate income tax rate.
For purposes of the study, the GAO defined tax expenditures as “special exemptions and exclusions, credits, deductions, deferrals, and preferential tax rates—support federal policy goals, but result in revenue forgone by the federal government.” An example of a tax expenditure that you can point to you on your personal income tax return would be the home mortgage interest deduction or the child tax credit. Put another way, it’s a tax break.
We love our tax breaks. That’s what makes tax expenditures so tough to tackle. They are a huge drain on revenue but taxpayers, including individuals and corporations, have come to love them. The GAO report indicates that those three tax expenditures cost the Treasury almost $49 billion in lost revenue in fiscal year 2012 alone.
Of the three tax breaks identified for purposes of the study, two of them focused on income earned overseas – a fairly politically charged issue of late. The United States taxes domestic corporations on their worldwide income, regardless of where it is earned, a system often referred to as global taxation; this is in contrast to a territorial system that imposes tax only on dollars earned inside of a country’s borders. However, as a nod to the pain of paying taxes for money that might not be readily accessible and/or usable, some income earned by foreign subsidiaries of domestic companies is eligible for tax deferral. That’s deferral, not avoidance, which means that it will be taxed when it makes its way back to the U.S. – usually in the form of dividends to the parent companies. But since you don’t have to pay are repatriated, there’s no rush to bring the funds back: this system of deferral often results in U.S. companies like Apple “parking” funds abroad for years.
The third expenditure focuses on tax rates. The United States taxes all foreign and domestic corporate income using a graduated corporate income tax rate structure.
The GAO considers the rate structure a tax expenditure because “it is an exception to the normal structure of a flat corporate income tax rate.”
The impact of expenditure is measured with the assumption that taxpayer behavior otherwise remains constant. That’s a pretty big assumption, which, of course, necessarily means that some of the study is flawed (sorry, GAO).
Here’s what the study concludes:
1, Deferral isn’t always tax efficient. In fact, “deferral provides no benefit to these purely domestic or exporting U.S. corporations. Rather than leveling the playing field, deferral benefits U.S. multinationals over other types of U.S. corporations.” In fact, “differences in tax burden do affect corporations’ real investment decisions, which could lead to these efficiency losses.”
and
2, The graduated corporate income tax rate, which was originally designed to benefit small businesses, doesn’t actually do that at all. In fact, it may do just the opposite: since so many big companies are able to take advantage of tax breaks to lower their overall tax burden, they tend to pay a smaller rate. In other words, as the GAO noted, “big” companies may have significant assets but limited taxable income as a result of tax techniques that allow for shaving dollars off of the bottom line.
This means what? A serious wake-up call for corporate tax reform?
Not so much.
The report points out that the economics involved are complicated. And while the complexity of the Tax Code is a monster of our own creation, it may be nearly impossible to determine which piece needs the most attention. For example, while deferral is expensive, the tax benefit might (cough) “be passed on to consumers through lower prices,” (cough again) “to employees through higher wages,” or “to investors through higher returns” (much more likely). Exactly what would happen by making a change is hard to figure, concludes the GAO.
As to who exactly the current system benefits? We may not know that either, according to the GAO. The report concludes that “[a]lthough the ultimate beneficiaries are unknown, there is some evidence that certain industries benefit more from deferral than others.” Those industries might be (cough, cough) “those involved in pharmaceutical manufacturing and computer and electronic equipment manufacturing,” according to evidence offered by IRS from the 2004 repatriation holiday. In case you’re having a hard time figuring out who they’re fingering, I’ll help you out: Apple, Google, Microsoft, Pfizer, and Dell. Allegedly.
The long and short of it is that there’s way too much supposition – and not enough solid data – to say, with certainty, that any particular piece of the Tax Code, as written, can be plucked out on its own to be “fixed.” In its analysis, for example, the GAO offers up that the foreign tax credit – which may potentially impact both deferral and corporate tax rates – as well as other related provisions as necessarily “complex.” In fact, the GAO uses the word “complex” or “complexity” 18 times in the report – nearly once for every two pages of text (not including appendices).
In other words, it’s not just a spark plug or a piston that needs replacing. The whole thing needs a good once over – and perhaps a complete overhaul is in order. Sadly, that’s not where our Congress is focused. A number of individual bills sit in committee poking holes at perceived tax breaks but despite the chatter about fixing what’s broken, the scope of these bills tends to be quite narrow.
Maybe Congress needs some direction. Perhaps a word or two from an agency tasked with studying these problems? What about, say, the GAO? After this study – which took five months to put together – the GAO has to have some sense of direction, some suggestions for improving the current system, right? From their own report: GAO made no recommendations.