Boring Report Prompts Sensational Claims on Corporate Tax Avoidance

The Government Accountability Office last week released a report with the scintillating title: “Comparison of the Reported Tax Liabilities of Foreign- and U.S.-Controlled Corporations, 1998-2005.” Summarizing, GAO stated that in 2005 Foreign Controlled Domestic Corporations (FCDCs) reported a lower ratio of tax liabilities to gross receipts and total assets than did U.S.-Controlled Domestic Corporations (USCCs). At play could be abusive transfer pricing transactions. But, GAO also pointed out, FCDCs and USCCs differ by age, size, and industry composition and the agency “did not attempt to determine the extent to which these factors and others, such as transfer pricing abuse, explain differences in tax liabilities.”

Acronym soup laced with numbers is hardly the stuff of great drama. But the study's sponsors found a golden nugget within the mass of statistical tables. “Most corporations doing business in the United States pay no federal income tax to the federal government according to a new GAO study,” the press release proclaimed. It cited GAO's data showing that, between 1998 and 2005, 68 percent of foreign companies doing business in the U.S. and 66 percent of U.S. domestic companies paid no federal income tax.

As anticipated, some journalists and commentators reacted with outrage. The fact that 2/3 of U.S. corporations pay no income tax immediately conjures up the image of large companies like GE, Microsoft, and Boeing engaging in clever and complex schemes to hide their profits in the Cayman Islands or other tax havens.

But, in fact, the vast majority of the 2 million or so U.S. businesses that file corporation income tax returns (schedule C corporations) are small companies. Over half of C corporations have gross receipts less than $250,000—hardly enough to pay the boss and a few employees. It is easy for such companies to arrange their accounts so their owners do not have to pay both corporate and individual income tax and, if they can't avoid reporting corporate profits, they could choose to be partnerships or subchapter S corporations—as most small businesses do—and still pay only individual income tax on their profits. Yes, we do have a separate corporate income tax in the United States—but virtually all the corporate income tax revenue comes from the tiny minority of businesses that are large, publicly-traded corporations.

Much else in the GAO report is interesting and suggestive, though also not conclusive. And steps should be taken to improve our corporate tax system. But let's not get carried away by meaningless statistics, especially when they are contained within a report that reaches no conclusions about tax avoidance.