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Tax Policies That Will Rip Your Eyes Out

Monday, June 6, 2011 | Ed Pawelec

I hope that headline got your attention, because that's what it's all about: no meat, just flash.  It's certainly no secret that the mainstream media provides little depth, and seldom asks the right questions.

The headlines that got me going last week were those derived from a report by the Citizens for Tax Justice citing a -1.5% effective tax rate for 12 large U.S. corporations. 

Now, I know that my effective tax rate (what I actually pay) is far lower than my statutory tax rate (the most I would pay without any deductions), but I'm still paying something.  This is true for most Americans and U.S. corporations. 

The fact is that, when I am watching the news and politicos are talking about raising or lowering taxes, I have to change the channel because they are missing the point.  Given the complexity of the U.S. tax code -- with deductions, credits, and loop holes -- any real progress must be made through tax reform, not by raising or lowering an arbitrary statutory rate.  To this point, there is an excellent piece from February 2011 from the Center on Budget and Policy Priorities outlining six criteria for reforming the corporate tax code.  Unfortunately, these well reasoned guidelines lacked the headline to grab your attention, and that brings us back to the above mentioned CTJ report.

The 12 corporations that have been "skating" on taxes for the 2008 to 2010 period were, listed in order from a lowest effective tax rate to highest in total for the past three years: General Electric (-61.3%), American Electric Power (-9.2%), DuPont (-3.4%), Verizon Communications (- 2.9%), Boeing (-1.8%), Wells Fargo (-1.4%), FedEx (-0.8%)*, Honeywell (-0.7%), IBM (3.8%), Yahoo (8.7%), United Technologies (10%), and Exxon Mobil (14.2%).

*FedEx will report full year 2010 financials on June 22, 2011.

A headline driven by the outlier

The first thing you should notice in the numbers is the fact that GE's average is dramatically lower than the other 11 firms mentioned.  This was the case in all three years excluding 2009 when GE "lost" $305 million in the U.S. and received $833 million from the Federal government.  But even after you remove GE as an outlier, the average rate paid over the last three years by the remaining 11 companies is still a paltry 1.4% -- nowhere near the 35% statutory corporate tax rate, and well below the effective rate of many individuals.

So the obvious question to me was, what makes GE so special?  One answer comes from the corporate culture at General Electric.  From a March New York Times article:

"At a tax symposium in 2007, a G.E. tax official said the department's 'mission statement' consisted of 19 rules and urged employees to divide their time evenly between ensuring compliance with the law and 'looking to exploit opportunities to reduce tax.'"
 
Essentially, GE looks to its taxation department as a profit center, and it has been mighty effective in manipulating these "opportunities" in the U.S. tax code.  In the table below, comprised of data collected from GE's 2010 10-K, you can see that the tax department really nailed it in last year by getting the U.S. government, and you the taxpayer, to foot nearly all of its international tax bill.

 

In its annual report, GE breaks out both earnings and taxes paid between General Electric, the parent company, and all its divisions excluding General Electric Capital Services (GECS), and GECS.  This handy little division, according to the 10-K:

"... enables GE to use GECS tax deductions and credits to reduce the tax that would otherwise have been payable by GE.

Our consolidated income tax rate is lower than the U.S. statutory rate primarily because of benefits from lower-taxed global operations, including the use of global funding structures, and our 2009 and 2008 decisions to indefinitely reinvest prior year earnings outside the U.S."
 
The point is that the statutory rate is irrelevant when the code is structured to incentivize companies to keep their earnings and investments outside of the U.S.  This is a serious problem.  Republicans claim that simply reducing the statutory rate will bring capital and jobs back into the U.S.  Heck, in GE's case, we might as well make its corporate tax rate zero ... at least then we wouldn't be paying them $3.2 billion!

GE is clearly the worst offender here, but the theme is a common one: we need real tax reform, not just jiggering with some arbitrary rate.  This is particularly true of U.S. multinationals which are capable of exploiting this particular loophole.

U.S. largess expands with indirect subsidies

For fiscal year 2010, General Electric generated 40% of its total earnings in the U.S., and actually received cash back for making $5 billion in profits.  GE's overseas profits will be taxable here in the U.S. as soon as it gets around to bringing them back to the U.S.  According to the current state of the tax code, multinational companies that are domiciled in the U.S. receive a current year tax credit for foreign taxes paid.  In theory, the U.S. will eventually receive tax revenue from these foreign earnings once that money is repatriated, but it's not coming back.

From the above mentioned CFBB article:

"This tilt in the tax code in favor of foreign investments has important revenue implications: the deferral provision will cost the Treasury $212.8 billion over the 2012-2016 period, according to the Office of Management and Budget, making it one of the single largest tax expenditures in the corporate tax code."
 
Not only do we provide the world with billions in direct foreign aid, but we subsidize that figure by giving tax revenues away and incentivizing U.S. companies to build factories and hire workers in other countries.  That makes the $212 billion in lost tax revenue small compared to the positive impact that our faltering economy desperately needs, and which would result from multinational investment and employment in the U.S.

Sarcastic interlude

But I don't want to bash General Electric.  After all, last week they announced that they would be adding 1,000 jobs in Chicago.  Of course, since Jeff Immelt assumed the helm of GE in 2001, the company has laid off or fired as many as 20,000 U.S. workers.  His stellar record on the jobs front was clearly a factor in his selection by President Obama for Chairperson of the Council on Jobs and Competitiveness.  Fox, welcome to the hen house.

I suppose 1,000 jobs is a start.  GE wouldn't make this investment if there wasn't money to be made, so therefore the Treasury can expect some future revenues from U.S. generated income.  Ah but wait ... these jobs are in General Electric Capital Services, the division that GE uses to manipulate its taxes.  The Treasury might want to defer those revenues a bit.

Seriously though ...


You can't make informed decisions from the headlines.  Even if they point you in the right direction, more needs to be known, and the mainstream media does not provide what you need.

The current state of the U.S. tax code is a disaster, and I've touched on only one tiny aspect, albeit a very pricey one.  I'm not interested in taxing the rich or lowering corporate taxes in the current environment. 

Talk has begun in terms of tax reform, but multinationals like GE have a lot of money to spend on lobbying, and will inevitably distort the system to their benefit and your detriment.

This is the time, as the politicians wrangle over the debt ceiling and deficit spending, when real tax reform, particularly at the corporate level, could happen.  We've seen evidence in last week's abysmal economic numbers that monetary stimulus does not work, and there is no room left for political gamesmanship.  While I have little faith in either side of the aisle, anything is possible. 

I encourage you to read "Six Tests for Corporate Tax Reform" and listen, beyond the headlines, for some of those points to show up in discussions on tax reform.  If these issues are not addressed, no progress will be made, and the American economy will continue to languish under its inept political leadership and faulty tax code for years to come.
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Ed Pawelec
Contributing Editor
Price Shock Trader
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