Get Ready for the Next Assault on Corporate Profits: Followup

One of the things we do for you here at RedState is to cut through the noise and spin so you’ll know what’s really going on. If you were reading the headlines yesterday, you doubtless heard about a new government study showing that a great many business corporations don’t pay any income taxes.

Well, no [excrement], Sherlock. If you don’t make any money in a given year, or if you carry forward losses from prior years, or you have expenses that offset profits, you won’t have a tax liability in that year.

But Senator Byron Dorgan of North Dakota (who along with Sen. Carl Levin of Michigan requested the study from the GAO), made a point of saying that “it’s shameful that so many corporations make big profits and do nothing to support our country.”

Now that the actual GAO report has been published, we can go through it to see what it’s really all about. And I did so.

Senators Dorgan and Levin asked the Government Accountability Office to update a earlier study of the differences in tax payments between foreign-controlled domestic corporations (FCDCs) and US-controlled corporations (USCCs).

What they basically want to know is this: are foreign companies engaging in transfer-pricing abuse, in order to reduce their US tax liability?

What does that mean? Well, I touched on it in my post yesterday. Basically, if you’re a corporation with operations in several different tax jurisdictions (most likely different countries), you might try to contrive sales of goods and services across different business units within the same corporation.

For example, you do final assembly of a product in China and sell it in the US. Your books will show this as a sale by the Chinese business unit and an offsetting purchase by the US unit, which in turn will book the revenue from your eventual customer. Another good example would be a German automaker that ships subassemblies and components to the US and does final assembly here.

The tricky thing is that you can manipulate the value of the intra-company transactions so that they don’t necessarily reflect the true value added at each point in the chain, but rather allocate relatively more value to the locations with lower tax rates or otherwise more-favorable tax treatment.

This is called transfer-pricing abuse, and it’s illegal. It should be illegal, because it defrauds shareholders (by presenting a less-than-true picture of the company’s operations).

Anyway, the point of the report that GAO delivered to Senators Levin and Dorgan on July 24 and published yesterday was this:

GAO discovered that foreign-owned companies operating in the US reported lower tax liabilities overall during the 1998-2005 period than did US-controlled companies.

That’s about it. They basically did a forensic analysis of a large sample of tax returns that they got from the IRS.

What GAO did not do is try to explain the disparity. They didn’t ask whether it was likely caused by transfer-pricing abuse, or instead by the many other factors they note in the report.

So, like any good consultant, they answered the question that was asked but didn’t actually make any policy recommendations or otherwise interpret the results. So we’re no closer to a solution than we were before.

But a solution to what problem? That’s where I have interesting questions.

What are Senators Dorgan and Levin (both Democrats) trying to protect? I think they’re trying to protect the extremely high income tax rate that the US imposes on corporate profits. At 35%, it’s the highest in the world, among large economies.

And such an extreme rate of income tax directly challenges the ability of the US economy to generate growth. The economy would grow much more strongly and generate more good jobs if the corporate income-tax rate were sharply reduced, perhaps to no more than 5%. John McCain has promised to reduce it to 25%, which is at least a good start.

But I think Sens. Dorgan and Levin are looking for talking points they can use to oppose cutting the corporate tax rate. And indeed, Barack Obama has promised to raise corporate taxes rather than lower them, which will be an economic disaster for all Americans.

One of the often-heard objections to the high corporate income-tax rate is that it encourages transfer-pricing abuse, as businesses (presumably) seek to minimize their tax exposure. The EU is constantly hollering about this problem, because they hate the fact that low-tax countries tend to get all the new business sitings, while high-tax countries go begging. (When you hear the pleasant-sounding word “harmonization,” that’s what the Eurocrats are talking about: they want every country to have basically the same tax rates and eliminate competition among them.)

So I think Dorgan and Levin wanted a government report that they could use to say that transfer-pricing abuse (not the too-high US tax rate) is the real problem.

That’s not what they got, but of course they’ll spin it any way they see fit. I thought you should know what was really going on.

-Francis Cianfrocca