A recent government report shows a majority of U.S. corporations avoid paying income taxes each year, prompting Democrats to demand new crackdowns on corporate exploitation of the tax system. A careful study of the report, however, demonstrates the folly of such proposals. Although nearly 75 percent of large corporations pay income taxes each year, these companies account for only 1 percent of all corporations. Smaller start-up enterprises, which comprise the vast majority of all U.S. corporations, fail to pay income taxes simply because they are unprofitable. Therefore, sweeping tax reforms penalizing profitable companies would only make the American business climate more inhospitable and would further discourage new job creation.
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Senior Fellow
Kevin A. Hassett |
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Last week, the Government Accountability Office released a report that revealed why Washington is so broken: Democratic politicians too often act like U.S. businesses are the enemy.
The report had the unassuming title of "Comparison of the Reported Tax Liabilities of Foreign- and U.S.-Controlled Corporations, 1998-2005." It is hard to imagine that such a dry topic could set off a firestorm, but it did.
The problem was the first chart in the report. It showed that 60 percent to 70 percent of companies in the U.S. pay no taxes. That led to an Associated Press story with the startling headline, "Most Companies in U.S. Avoid Federal Income Taxes," and to a frenzy of business bashing by leading Democrats.
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If the GAO added together data for nine hot dog stands and General Electric Co., and found that 90 percent of companies didn't pay any tax, it would be harmless and silly. But if the Democrats then insinuate that 90 percent of companies are tax dodgers, the stakes change. |
Byron Dorgan, the Democratic senator from North Dakota, said in a statement, "It's shameful that so many corporations make big profits and pay nothing to support our country." House Speaker Nancy Pelosi piled on, arguing that the data revealed a fundamental unfairness in the U.S. system, and called for reform.
"When two-thirds of corporations pay no taxes," Pelosi said, "American workers are forced to pay too much in taxes even as they cope with rising prices and falling wages."
The study seemed to play right into the Democratic us-against-them playbook. Evil corporations rake in the cash and then play dirty tricks to avoid taxes. That leaves the little guy with the bill for our government.
The problem is, the study showed no such thing.
No Profit, No Tax
First, while it is true that 60 percent to 70 percent of companies in the study paid no tax in a given year, there was a big qualification. The study focused on an Internal Revenue Service tax database that included millions and millions of companies. The vast majority of firms in the study were tiny mom- and-pop enterprises.
Why did the tiny mom-and-pop enterprises pay no taxes? Because they didn't make any money! The study reported that was the reason about 80 percent of the firms in the sample avoided taxes in a given year. How terrible of them.
If the GAO issued a report that added together data for nine hot dog stands and General Electric Co., and found that 90 percent of companies didn't pay any tax, it would be a harmless and silly thing to do. But if the Democrats then rush to the microphones and insinuate to the general public that 90 percent of companies are tax dodgers, the stakes change.
How can it be that so many small businesses made no money? Companies tended to have no profits because they had large deductions including wages. Hot dog vendors can pay themselves a wage, in which case they have no profits but pay wage taxes, or they can take their money in profits, in which case they pay profits tax. The data suggest they tend to do the former.
Double Taxation
Most of them do this for a simple reason: we still have double taxation of dividends. If you are a hot dog vendor in the top tax bracket and you pay yourself $100, then you pay $35 in taxes. If you keep it as profit and then pay it to yourself as a dividend, you pay a $35 corporate tax, and then a 15 percent dividend tax on top of it. Why would anyone choose the latter? To do so would be to pay more taxes voluntarily.
For big corporations, the story is different, and utterly inconsistent with the Democratic screed. The study found that about 75 percent of large companies (those with sales above $50 million) paid taxes in 2005, about typical for recent U.S. history. And those that didn't pay taxes in 2005 did so earlier, so almost no companies went through the sample period without paying taxes. The latter is, again, typical.
News Hole
In other words, there was virtually no news in the study. But that didn't stop the Democrats, and that's what is so disturbing. Democratic politicians misused and misrepresented the results of this modest GAO study to bash America's corporations and call for sweeping "reforms." If they will do so in response to this minor document, one can only conclude that they will do so on the flimsiest of excuses.
Leaders of the Democratic Party are so eager to portray American business as villainous that they will twist and distort facts in order justify even more punitive taxes than we already have.
The truth is, of course, that we are all in it together. Workers will have better jobs if the U.S. is a more attractive climate for corporations. That means we need to reduce corporate taxes, not increase them.
And that is why Washington is so broken. You can't split the difference when one side is so egregiously wrong.
Kevin A. Hassett is a senior fellow and the director of economic policy studies at AEI.
