Paul L. Caron

Monday, April 18, 2011

Kleinbard Critiques PwC Effective Tax Rate Study

Kleinbard Following up on yesterday's post, PwC: U.S. Companies Pay World’s 6th-Highest Effective Tax Rate: Edward Kleinbard (USC) criticizes the PricewaterhouseCoopers study:
The PwC study is extraordinarily disingenuous, in at least three dimensions:
  1. All of the report's numbers are unweighted simple averages. So a company with $20 billion in profits is weighted as heavily as a company with $200 million in profits (or wherever the bottom cutoff is). This vastly overstates the importance of unimportant companies in low tax jurisdictions. Stateless Income discusses this by comparing statutory rates in the top OECD countries to those of a simple average of all OECD countries.
  2. The report looks at 484 US headquartered companies and 1,336 companies elsewhere in the world. For the USA, that means that it is lumping large amounts of domestic income with foreign income. As a rule of thumb, he further down you go within the population of US firms, the greater the proportion of domestic income, and the fewer resources that are devoted to stateless income planning. So the report is muddling tax on domestic income with tax on foreign income. But again, because the numbers presented are all simple averages, the effective tax rate imposed on US firm # 486 is weighted as heavily as the rate on Firm #1.
  3. The rate used is a GAAP accounting current tax provision. If companies in Country X have small actual tax payments but large deferred tax liabilities, because of accelerated depreciation for example, then they will be treated the same as companies in Country Y that have LARGER actual tax payments but little by way of timing differences (deferred tax liabilities), because Country Y has lower rates but does not give incentives through accelerated depreciation. And hey, whaddaya know, Country X is the USA! Every country that has lowered corporate tax rates has also broadened its base. The reason this is important is that if a company is growing, deferred tax liabilities attributable to accelerated depreciation never ripen into cash liabilities —new equipment is acquired with new accelerated depreciation benefits, sheltering the 'missing' depreciation from the old equipment for which tax depreciation has run out.
I just don't understand why the relatively few thousand dollars that PWC presumably collected for authoring this document justify the erosion of its reputation and goodwill.

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A couple re-critiques, from bottom up. First, deferred tax liabilities almost always do reverse, which is why they are liabilities on the balance sheeet. Notably, DTLs on fixed assets always reverse.

Secondly, why not muddle domestic and foreign income? Don't companies earn both? The implicit critique is that this is not 'US' tax. This is disingenuous in its own way since the US actually does tax foreign income (at the unusually high US tax rates). hence this is actually favourable to the US by assuming that the foreign countries do so too (almost none of the OECD countries effectively tax foreign income).

Thirdly, the apparent rejoinder in the first critique is a non sequitur masquerading as a rejoinder. Comparing statutory average rates is completely besides the point, which is why (even) this PwC study looks at a an alternative measure, being the effective tax rate.

Posted by: Patrick | Apr 18, 2011 2:22:17 PM

The accounting firm's nightmare: a taxprof who knows more than they do. It's like in Star Wars 3, when Yoda fights the Emperor. But even Yoda doesn't always win.

Posted by: Michael A. Livingston | Apr 18, 2011 6:59:46 AM

This is a great critique of a report that when first viewed one's reacton was "that cannot be correct".

It just goes to show that while anyone can mislead, to really have an effective distortion requires statistics.

Posted by: Sid (real one) | Apr 18, 2011 6:59:06 AM