Corporate Income Taxes: Trends and Forecasts
Presentation to the President’s Advisory Panel on Federal Tax Reform March 8, 2005
Douglas A. Shackelford University of North Carolina and NBER
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Overview
Look back
Corporate income taxes are in a long decline Why have they declined?
International competition Alternative organizational forms More effective tax planning
Tax shelters Mobility of income
Look forward
Feasibility of the corporate income tax in an information economy
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Corporate Income Tax as a Percentage of Federal Revenue and GDP
45.0 40.0 35.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0
% of Revenue
25.0 20.0 15.0 10.0 5.0 0.0
19 34 19 39 19 44 19 49 19 54 19 59 19 64 19 69 19 74 19 79 19 84 19 89 19 94 19 99 20 04
Revenue
GDP
3
Source: Office Management and Budget, Fiscal Year 2005 Budget, as reported by the Tax Policy Center.
% of GDP
30.0
Why Have Corporate Taxes Declined?
International competition has eroded corporate taxes as a revenue source
Lower rates at home and abroad Smaller base—e.g., accelerated/bonus depreciation, R&D deductions and credits The corporate income tax is a special levy on companies that access capital through the public equity markets Other techniques to undo two levels of tax
Other organizational forms (e.g., S corp)
More effective tax planning
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International Competitiveness: Reducing Corporate Tax Rates
65 60 55
Tax Rate %
50 45 40 35 30 25
19 53 19 56 19 59 19 62 19 65 19 68 19 71 19 74 19 77 19 80 19 83 19 86 19 89 19 92 19 95 19 98 20 01
Statutory
Marginal
Source: Gravelle, J. “The Corporate Tax: Where Has it Been and Where is it Going?” National Tax 5 Journal 57 No. 4 (December, 2004): 903:922.
S Corporations: Eroding the Corporate Tax Base
Number of Returns Filed (in Thousands)
5,000 4,000 3,000 2,000 1,000 0
1980 1985 1990 1995 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
C-corp
S-corp
2004-2010, projected. Source: IRS Statistics of Income.
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Business Net Income by Type of Entity
700 600 C corps, excl. RICs and REITs S Corporations Partnerships, excl. LLCs LLCs All Passthroughs
500
400
300
200
100
0 1991 1992 1993 1994 1995 1995 1997 1998 1999 2000 2001
Source: Drew Lyon, PriceWaterhouseCoopers, Presentation at the 6 th Annual Tax Council Policy Institute Symposium, February 11, 2005. Underlying data from IRS statistics of Income. 7
Other Ways to Eliminate Double Taxation
Year-end bonuses in privately-held firms Debt shifts business profits to the lender’s tax return since interest is deductible Employee stock options
Total deductions from stock option exercises were 10% of total pretax income for the 100 largest U.S. companies in 2000. However, total deductions exceeded total pretax income for the Nasdaq 100. (Graham, Lang, and Shackelford, Journal of Finance, 2004)
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More Effective Tax Planning: Book-Tax Gap
The gap between accounting earnings and corporate taxable income widened during the late 1990s
e.g., Desai (2002) finds $155 billion of unexplained book-tax gap in 1998 Earnings pressure may have led to inflated, fictional earnings in the late 1990s
Perhaps book is overstated
Corporate Tax Shelters
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How about Book-Tax Conformity?
Argument given for conformity: If companies are overstating book profits and understating taxable income, then require them to report the same figure to shareholders and the taxing authority and you fix two problems. Not a good idea
Conformity ignores the critically important role that accounting information plays in the markets.
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Corporate Tax Shelters
Legal noncompliance
Meet the letter, but not the spirit of the law
Reduce taxable income but not book income Little public data so estimates of their magnitude are difficult
Leasing transactions estimated to cost $4 billion for one year (Joint Committee on Taxation, 2004)
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Shelters Today
Market has cooled
Recession reduced demand Bad publicity IRS has become more aggressive Big 4 withdrew partly because shelters threaten to undermine the profitable Sarbanes-Oxley audit work.
Market could revive
Booming economy—high profits, high taxes Recent IRS defeats embolden taxpayers Big 4 spin off their tax practices
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Income Mobility
The tax system relies on information from the historical cost accounting system The accounting system is struggling to measure income where the primary assets are intangibles. As a result, taxable income is becoming increasingly difficult to measure. These measurement problems provide opportunities for tax planners and raise doubts about the long-term viability of income taxes Problems increase with globalization
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Old Days
Factors of production
Largely immobile—heavy industry
Bricks and Mortar Large unskilled/skilled labor force Production of goods
Income
Primarily sales less production costs Biggest accounting questions—inventory, depreciation
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Today
Factors of production
Highly mobile--intellectual
Intangibles and highly technical Small, highly educated labor force Service-oriented
Income
Affected mostly by people and intangibles Biggest accounting questions—realized and unrealized intangibles
What is a brand name worth? Where does a telephone call take place?
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Is an Income Tax Feasible in the Future?
A tax system built on income can only last as long as we can define income with some precision. A tax system depends on market frictions that make it difficult to undo the tax. In old days you could not easily dismantle the plant. Today you can move profits around the globe with transfer prices or a plane ticket. Is it feasible to think that income can be a basis for tax measures in the future?
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Tax Planners Need Differences in Tax Rates
Tax the Same Income Differently
At Different Times
E.g., current tax holiday on repatriated cash
U.S. vs. foreign-source
In Different Places
In Different Organizational Forms
Flow-through entities, tax-exempt organizations, pensions
Stock held in an 401(k) vs a mutual fund vs personal account
Depending on the Savings Vehicle
Tax Similar Income Differently
E.g., new lower rates on U.S. manufacturing
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