Corporations. $2.5 trillion in sales. Tax liability, zero

_{brought to you by your tax code at work}

Sounds like a slogan to do business in the US doesn't it? Yet assuredly that is not what is happening when corporations line up like the Oklahoma land rush to move to China and India.

Yet, maybe that multinational corporate land rush has something to do with these results?

The Government General Accountability Office just released a report on how many large corporations do not pay taxes yet have strong sales. AP sums it up:

More than 38,000 foreign corporations had no tax liability in 2005 and 1.2 million U.S. companies paid no income tax, the GAO said. Combined, the companies had $2.5 trillion in sales. About 25 percent of the U.S. corporations not paying corporate taxes were considered large corporations, meaning they had at least $250 million in assets or $50 million in receipts

Senators Bryon Dorgan(D-ND) and Carl Levin(D-MI), issued a press release. Within, Senator Dorgan proclaimed:

A shocking indictment of the current tax system. It’s shameful that so many corporations make big profits and pay nothing to support our country. The tax system that allows this wholesale tax avoidance is an embarrassment and unfair to hardworking Americans who pay their fair share of taxes. We need to plug these tax loopholes and put these corporations back on the tax rolls. It’s time for the big corporations to pay their fair share.

and Senator Levin said:

This report makes clear that too many corporations are using tax trickery to send their profits overseas and avoid paying their fair share in the United States.

Here's the question, are corporate taxes avoided simply by moving money offshore?

To that, let's look at the actual GAO report (warning, large pdf!). The time period of this study is from 1998-2005.

FCDCs reported lower tax liabilities than USCCs by most measures shown in this report. A greater percentage of large FCDCs reported no tax liability in a given year from 1998 through 2005. For all corporations, a higher percentage of FCDCs reported no tax liabilities than USCCs through 2001 but differences after 2001 were not statistically significant. Most large FCDCs and USCCs that reported no tax liability in 2005 also reported that they had no current-year income.

Magic Secret Decoder Ring:

• FCDC - Foreign Controlled Domestic Corporation
• USCC - United States Controlled Corporation

When they refer to tax incentives to offshore outsource our jobs, this means corporations use their global subsidiaries to transfer money out of the country and thus avoid US taxes.

Originally the GAO found this occurring much more with foreign owned multinational corporations operating in the United States in 1998. By 2005, there is almost no difference.

What this report is saying United States headquartered multinational corporations have played catch up. US corporations are doing the same damn thing.

Transfer prices are the prices related companies, such as a parent and subsidiary, charge on intercompany transactions. By manipulating transfer prices, multinational companies can shift income from higher to lower tax jurisdictions, reducing the companies’ overall tax liability. As we noted in our previous reports, researchers acknowledge that transfer pricing abuses may explain some of the differences in tax liabilities of foreign-controlled corporations compared to U.S.-controlled corporations. However, researchers have had difficulty determining the exact extent to which transfer pricing abuses explain the differences due to data limitations.

One of the reasons foreign owned domestic corporations are paying less taxes is they were started in the United States more recently and thus have large operating expensive and investment losses to recover before showing a net profit.

So, GAO, how much of this is simply transferring profits out of the country to subsidiaries in other nations to avoid taxes?

That's the big question right?

Here's the bottom line from the GAO:

The researchers have also found that transfer pricing abuses may play a role in explaining the differences. However, measuring the separate effects of these factors on tax liabilities has been difficult due to data limitations

Ouch. So, we don't know if removing tax incentives or ability to move big buck profits offshore is going to have any real effect on offshore outsourcing? Is this a fair assumption?

Or is it a better assumption to say our government is having a tough time even getting an accurate picture on what's happening globally due to the lack of disclosure of raw data from multinational corporations? (or both!)

Ok the GAO is pointing out that corporations are the ones who set the transfer prices of sending money from one subsidiary to another.

They give an example of abuse:

A foreign parent corporation with a subsidiary operating in the United States charges the subsidiary excessive prices for goods and services rendered (for example, $1,000 instead of the going rate of $600). This raises the subsidiary’s expenses (by $400), lowers its profits (by $400), and effectively shifts that income ($400) outside of the United States. At a 35-percent U.S. corporate income tax rate, the subsidiary will pay $140 less in U.S. taxes than it would if the $400 in profits were attributed to it.

Aha, so one is relying on corporations with their divisions of tax specialists, accountants and attorneys to set an accurate price for transferring funds and capital around the globe.

Uh huh! Can I set my own gross income too please?

Look at this folks! The data is so unavailable since the prices are not available, plus the price is determined by the ones who have to pay taxes (or not as we see!), the GAO is resorting to probability and statistics to try to figure it out!

Researchers have used direct and indirect methods to estimate the extent to which transfer pricing abuses explain the differences in reported tax liabilities. Direct methods analyze the transfer prices used by corporations and compare them to arm’s length prices. This method is difficult to apply because price data are often unavailable and determining the price that would be charged between unrelated parties can be difficult. An alternative, indirect method used by researchers analyzes data about the characteristics of corporations in order to test for a statistical relationship between tax rates and subsidiaries’ profitability or tax liability. In some of these studies, statistical methods are used to explain as much of the difference in reported tax liabilities as can be explained by the nontax characteristics and the remaining unexplained difference is identified as the upper limit of the difference that could be explained by transfer pricing abuse.4 However, how close this upper limit estimate is to the actual effect of transfer pricing abuse depends on how many of the important nontax characteristics have been included in the first stage of the analysis. As noted above, data are unavailable for some important nontax characteristics.

So, what is the answer? Well, believe this or not, one thing that came to mind was the flat tax or national sales tax, consumption tax idea in order to capture the true taxes on $2.5 trillion in sales.

The obvious one seems to be reform in corporate accounting methods.

One fact in the report:

3% of large Foreign owned corporations & 1% of large US corporations reported no gross profit on their tax returns. About 4% to 5% reported zero total income.

Anyone believe that these huge corporations had no gross profit? I sure don't.

The GAO didn't make any recommendations. I sure hope there is a follow up on what kind of tax code changes are needed for anyone with a second grade education knows this one sure don't pass the smell test.