Wielding The Corporate Tax Dodge Code Like A Cudgel

I was making coffee this morning when President Obama’s voice ruined it. His words didn’t even sound unreasonable, at first, as I was still half asleep. As many times before, he advocated corporate tax breaks for companies that create jobs in the US, rather than those that create jobs overseas. Presidential candidate Mitt Romney also wants to hand out tax breaks and tax cuts, just different ones.

It’s a popular theme these days: that government can create jobs by encouraging certain corporate behaviors through the deft manipulation of our infamous corporate tax code. A bill to that effect has been sponsored by Michigan Democrat Senator Debbie Stabenow. It would bestow a 20% tax credit on companies that claim to have moved jobs and investments from overseas to the US. Conversely, it would deny a tax deduction for moving investments overseas. Claim because that’s all companies would have to do. The actual mechanics that these intricately structured multinationals use to conduct their business and minimize their taxes may be entirely different.

So, this time around, we get to choose which corporate tax breaks and subsidies we prefer by voting for one or the other candidate, but normally we can only watch as Congress concocts them with bipartisan passion. The mere scent of tax breaks causes lobbyists to salivate, companies to open their checkbooks, and politicians to froth at the mouth with excitement about the desperately needed “campaign contributions” and other forms of support—and the only jobs being created are in the lobbying industry.

Perhaps the two most formidable tax-break jugglers are Boeing and GE. Between 2002 and 2011, Boeing reported $31.8 billion in income to its investors. But the IRS got to see a different story as Boeing didn’t pay income taxes during that period but instead received tax benefits of over $2 billion (CTJ fact sheet). Bailed-out GE, run by crony capitalist par excellence Jeffrey Immelt, who also happened to head President Obama’s Council on Jobs and Competitiveness, earned $10.5 billion, but instead of paying taxes, it received $4.7 billion in tax benefits.

So President Obama’s plan would give Boeing and GE even greater tax benefits if they can claim—which they surely will—that they brought thousands of jobs into the US. But other companies that haven’t been as adept in getting their loopholes into the tax dodge code will pay taxes out of their noses based on corporate tax rates that are among the highest in the world. And after they pay them, they don’t have the capital to invest and create jobs.

This absurdity is due to one fundament flaw: diametrically opposed accounting systems for reporting to investors and to the IRS. GAAP, our ingenious body of Generally Accepted Accounting Principles, is full of rules that companies twist into knots to inflate profits and asset values. The corporate tax code, however, does the opposite. It encourages the same companies to report little or no taxable income to the IRS, and it incentivizes them to invest in economically unproductive activities, such as lobbying or shifting income offshore.

In theory, the solution is simple: throw out the tax code and replace it with GAAP. No special treatment for any particular company. Whatever inflated income CEOs dish out to their investors on a quarterly basis, that’s the income that’s going to be taxed. Because it would be much higher than taxable income according to the tax code, income tax rates should be far, far lower. For example, the top rate, and I’m just making this up for illustration purposes, could be 12%.

Companies would have to choose: either report inflated income to investors and pay more in taxes, or report more realistic numbers to investors and pay less in taxes—in which case financial statements might actually become more reliable. Most of the shenanigans and unproductive activities to avoid taxes would become useless, and companies could focus on maximizing their business rather than minimizing their taxes.

But lawmakers wield the ugly tax code with all its tax breaks and loopholes, with its unfairness, and its confiscatory marginal rates like a cudgel to extract funds and goodies. Entire industries have sprung up in propagating it. So it won’t go away. And listening to the candidates, we can assume that it will get worse. Yet, spending is out of control, and gross national debt will hit $16 trillion in a couple of months, aided and abetted by the Fed, which leaves us in a curious investment environment.

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  4 comments for “Wielding The Corporate Tax Dodge Code Like A Cudgel

  1. Tedbits
    Jul 19, 2012 at 11:53 am

    GAAP being replaced by IFRS (International Financial Reporting Standards). Even so, your point still holds true.

    Taxes are a business expense. No different that your payroll or buying stationery or leasing a building. Every expense is to be minimized for the business to have money left over for reinvestment in growth. Every business owner knows that if you are not growing– you are dying.

    As a business owner, we feel differently about taxes only because it is not clear that taxes are a good return on the investment. If I pay a lease for a building or pay employees, it is clear why I am incurring this expense. When I pay taxes they go into a "general fund" that is used for all sorts of purposes. Perhaps some of those expenditures help my business but I can't help feeling that many do not.

    For this reason, taxes must be a business' first target because they siphon money that could be used to hire more employees, lease more buildings and grow my business.

    It isn't really any more complicated than this.

    I am a new reader to your blog and have been enjoying your articles. I hope this comment adds positively to the discourse.

  2. Wolf Richter
    Jul 19, 2012 at 1:47 pm

    Tedbits – thanks for your perspective. I feel the same way, as you said: "Perhaps some of those expenditures help my business but I can't help feeling that many do not."

    BTW,my understanding is that GAAP will stick around until 2014 (at least). So far, the financial reporting I'm looking at is still done under GAAP. It will be interesting to see how much difference the switch to IFRS will make.

  3. pikosan
    Jul 22, 2012 at 4:07 pm

    It feels somehow wrong that If your business is not growing then it is dying. Even if it is true. Nothing last forever and assuming constant growth seem like speeding faster towards the natural or not end of a company. And I fail to understand why a business should pay less % tax than a ordinary citizen (I mean as a baisic idea. Unfortunetly in practice in today's frame of capitalism it is a neccesity in order to beat the competition).

  4. 4gotnblud
    Oct 6, 2012 at 12:46 pm

    Every time I hear a politician mention tax code reform I become incensed. Reform will always benefit those who fund the reform through lobbying and political donation (the rich get richer). And reform will always mean growing the tax code. Every politician should have to always wear a backpack with the full tax code as cargo.

    I have been a supporter of The Fair Tax but I now believe that would not be advisable in todays depression. What should be implemented is the APT tax system (stand alone – no other taxes, income or otherwise). The APT (automated payment ttransaction tax) would also address the insane wealth the financial movers & shakers have amassed through the ability to design fraudulent financial instruments and schemes. It would bring stability to financial markets and be a boon to idnividuals and small entrepreneurs.

    For those unfamiliar with the APT it is a system whereby all automated transactions, basically all transactions conducted today, are taxed at 0.35%. This percentage is determined to be the current rate necessary to be revenue nuetral at current spending levels. An individual earning $100k in income then spending $100k in purchases (mortgage, groceries, etc.) would incur total tax payments of $700.00 for the year. The vast majority of revenue under this program would fall on the heavy hitters -I wall street with their billions dollars transactions. I will not attempt to fully explain the system but it is easily researched. Of course this system would do away with the IRS, most lobbying, inequalities and political corruption so it will never be implemented. It would also save about 1/2 trillion$ in annual compliance with the current system.

    And the real culprit that is destroying this country is not revenue generation but spending and corruption. We coulld use all those beloved IRS agents who would be riffed by just employing them and our "just us" department to investigate and prosecute Corzine and the other thuusands political and financial crooks.

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