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Monday, July 15, 2013

Sullivan: Behind the GAO's 12.6% Effective Corporate Tax Rate

Tax Analysts Martin A. Sullivan (Tax Analysts), Behind the GAO's 12.6 Percent Effective Corporate Rate, 140 Tax Notes 197 (July 15, 2013):

On July 1 the Government Accountability Office made a lot of headlines when it released a study reporting that the average effective corporate tax rate in 2010 was only 12.6%. ... Although it is common knowledge that many U.S. multinationals have used tax planning to substantially reduce their tax bills, the GAO figure is surprisingly low. Other studies typically report average rates in the mid-20s. For example, 40 leading U.S. firms that recently formed a tax reform coalition had an average effective tax rate of 24% over the 2010-2012 period. The GAO itself (p. 28) cites eight prior studies using a variety of data, methods, and time periods, and the average rate of these studies was 28.4%, with a minimum of 22% and a maximum of 31.3%.

So what explains the difference between the GAO's 12.6 percent rate and other studies' rates? Mainly two items. First, the GAO did not include foreign taxes in the widely reported 12.6 percent figure. It did in fact provide a much more conceptually defensible measure that includes foreign taxes in the numerator and arrives at a worldwide rate of 16.9 percent as a result. The table below details the GAO calculation.

Figure 1

The second and more important reason for the GAO's low effective tax rate for 2010 compared with those found in other studies is that the effects of a recession are more dominant in 2010 than they are in other studies, which include both recession and non-recession years or no recession years at all. In 2010 the U.S. economy was still severely hobbled by the Great Recession. Figure 1 shows liability for all corporations from 1997 through 2010, as well as net and gross corporate tax receipts from 1997 through 2012. It shows that in 2010, corporate tax liabilities reported on tax returns used in the numerator of the GAO's effective tax rates were extraordinarily low in that year.

Figure 2

Putting all this together, it seems reasonable not to revise the consensus view that average worldwide effective corporate tax rates are somewhere in the mid- or upper 20s when we are not in the throes of a recession. It is important to keep in mind that these broad averages hide a lot of interesting detail. ...  It is also important to keep on the lookout for misleading effective tax rate calculations from advocacy groups. 

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I disagree with Sullivan. The GAO's methodology dramatically OVERSTATES effective corporate tax rates. Over half a century ago, MIT economist Cary Brown demonstrated that expensing a capital item is equivalent to taxing income from that capital item at a rate of zero -- in other words, that tax deferral matters. The GAO computes effective tax rates by dividing currently reported taxes by current book income. This approach abandons any attempt to quantify the benefits of deferral. To the extent taxes are deferred (stated another way, to the extent taxpayers are permitted to expense capital items more quickly than economic depreciation), today's reported taxes are actually taxes with respect to income earned in prior years. Both Sullivan and the GAO ask us to ignore one of the most fundamental facts in finance in computing effective rates.

Posted by: Theodore Seto | Jul 15, 2013 9:01:07 AM

Massive carryforward/carryback abilities have no practical effect on tax rate? Right.....

Posted by: jimharper | Jul 15, 2013 11:30:50 AM