GAO Releases Report on Effective Tax Rates:
Much Ado About Not Much

The GAO recently issued a report entitled “US Multinational Corporations, Effective Tax Rates are Correlated with Where Income is Reported.”  Despite the threatening sounding name, it doesn’t reveal much.

• The headline grabber from the report is that while the statutory corporate tax rate is 35%; GAO found an effective corporate tax rate on the domestic income of large U.S. corporations of 25.2%.  But this is hardly evidence of tax avoidance; GAO recognizes there are many legitimate reasons for the differential, including: 
       o Accounting differences used to compute income for tax and book purposes,     including depreciation deductions;
       o Use of net operating losses from previous years.
       o Tax credits designed to encourage certain investments, such as solar or wind power.

• If anything, the differential highlights the need for broadening the base and reducing the federal corporate tax rate.

• The report notes that foreign investment by U.S. companies has increased disproportionately from 1989 to 2004 as compared to their domestic investment.  However, the report states that over 60 percent of the activity (by all measures in the report) of U.S. companies remained located in the United States.

• In addition, the report does not allege that such change was due to tax-related planning.  There are many non-tax reasons that foreign investment has increased, such as robust economic growth in many countries and improved general foreign investment conditions.

• The effective U.S. tax rate on foreign source income of U.S. corporations is only 4% but, as the report notes, this is also not indicative of tax avoidance:
o Foreign source income is taxed where earned, and appropriately so.  While the U.S. has a worldwide tax system, it does not double-tax income earned abroad, so companies with earnings in high tax countries like Japan would pay little or no tax in the U.S. on that income. 
       o In addition, to promote the competitiveness of U.S. businesses operating abroad, the tax code generally allows companies to defer taxes on foreign-source income until the money is repatriated to the U.S.  Deferral is critical to mitigating the competitive disadvantage faced by U.S. businesses whose foreign competitors are subject to a lower tax rate.  And, as the report notes, such income is subject to tax once it is repatriated to the US.

• As the report notes, tax rates do influence the investment decisions of businesses, such as where to locate jobs.  It is imperative for the U.S. to lower its tax rates in order to compete in the global economy.

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