The Gap Between Statutory and Real Corporate Tax Rates

Actual taxes paid by consistently profitable Fortune 500 companies now is less than half the statutory rate

By Robert McIntyre and T.D. Coo Nguyen
First published by the Multinational Monitor, Vol 25, No. 11

Ostensibly, the U.S. federal tax code requires corporations to pay 35 percent of their profits in income taxes.

But of the 275 Fortune 500 companies that made a profit each year from 2001 to 2003 and for which adequate information to draw conclusions is publicly available, only a small proportion paid federal income taxes anywhere near that statutory 35 percent tax rate. The vast majority paid considerably less.

In fact, in 2002 and 2003, the average effective tax rate for all of these 275 companies was less than half the statutory 35 percent rate. Over the 2001-2003 period, effective tax rates ranged from a low of -59.6 percent for Pepco Holdings to a high of 34.5 percent for CVS.

Over the three-year period, the average effective rate for all 275 companies dropped by a fifth, from 21.4 percent in 2001 to 17.2 percent in 2002-2003.

The statistics are startling:

  • Eighty-two of the 275 companies, almost a third of the total, paid zero or less in federal income taxes in at least one year from 2001 to 2003. In the years they paid no income tax, these companies earned $102 billion in pretax U.S. profits. But instead of paying $35.6 billion in income taxes as the statutory 35 percent corporate tax rate seems to require, these companies generated so many excess tax breaks that they received outright tax rebate checks from the U.S. Treasury, totaling $12.6 billion. These companies’ “negative tax rates” meant that they made more after taxes than before taxes in those no-tax years.
  • Twenty-eight corporations enjoyed negative federal income tax rates over the entire 2001-2003 period. These companies, whose pretax U.S. profits totaled $44.9 billion over the three years, included, among others: Pepco Holdings (-59.6 percent tax rate), Prudential Financial (-46.2 percent), ITT Industries (-22.3 percent), Boeing (-18.8 percent), Unisys (-16.0 percent), Fluor (-9.2 percent) and CSX (-7.5 percent), the company previously headed by current Secretary of the Treasury John Snow.
  • In 2003 alone, 46 companies paid zero or less in federal income taxes. These 46 companies told their shareholders they earned U.S. pretax profits in 2003 of $42.6 billion, yet they received tax rebates totaling $5.4 billion. Almost as many companies, 42, paid no tax in 2002, reporting $43.5 billion in pretax profits, yet receiving $4.9 billion in tax rebates. From 2001 to 2003, the number of no-tax companies jumped from 33 to 46, an increase of 40 percent.
  • In 2001, the Treasury paid corporations $40 billion in tax refunds, a third more than the 1998-2000 average.
  • Then in 2002 and 2003, after the law was changed to expand tax subsidies and make it easier for corporations to carry back excess tax breaks to earlier years, corporate tax refunds skyrocketed to an average of $63 billion a year – more than double the 1998-2000 average.

Corporations are now paying the lowest levels of taxes in the post-World War II era. In fiscal 2002 and 2003, federal corporate incomes taxes dropped to their lowest sustained level as a share of the economy since World War II. Only a single year during the early Reagan administration was lower.
In 1986, President Ronald Reagan fully abandoned his earlier policy of showering tax breaks on corporations. The Tax Reform Act of 1986 closed tens of billions of dollars in corporate loopholes, so that by 1988, the overall effective corporate tax rate for large corporations was up to 26.5 percent. That improvement occurred even though the statutory corporate tax rate was cut from 46 percent to 34 percent as part of the 1986 reforms.

In the 1990s, however, many corporations began to find ways around the 1986 reforms, abetted by tax-shelter schemes devised by major accounting firms.

Effective corporate tax rates then plummeted, thanks to Bush administration-backed tax breaks passed in 2002 and 2003, continued corporate offshore tax-sheltering, and the refusal of the Congress and White House to crack down on even the most abusive inherited corporate tax-sheltering activities.

Corporate taxes paid for more than a quarter of federal outlays in the 1950s and a fifth in the 1960s. They began to decline during the Nixon administration, yet even by the second half of the 1990s, corporate taxes still covered 11 percent of the cost of federal programs. But in fiscal years 2002 and 2003, corporate taxes paid for a mere 6 percent of federal expenses.

Billions and billions

Over the 2001-2003 period, the 275 Fortune 500 companies that were profitable each year and for which adequate information is publicly available earned almost $1.1 trillion in pretax profits in the United States. Had all of those profits been reported to the Internal Revenue Service (IRS) and taxed at the statutory 35 percent corporate tax rate, then the 275 companies would have paid $370 billion in income taxes over the three years. But instead, the companies reported only about half of their profits – $557 billion – to the IRS. Instead of a 35 percent tax rate, the companies as a group paid a three-year effective tax rate of only 18.4 percent.

In 2002 and 2003, the 275 companies sheltered more than half of their profits from tax. They told their shareholders they earned $739 billion in those two years, but they paid taxes on less than half of that, only $363 billion.

Loopholes and other tax subsidies cut taxes for the 275 companies by $43.4 billion in 2001, $60.8 billion in 2002 and $71.0 billion in 2003, for a total of $175.2 billion in tax breaks over the three years.

Half of the total tax-break dollars over the three years – $87.1 billion – went to just 25 companies, each with more than a billion-and-a-half dollars in tax breaks.

General Electric topped the list of corporate tax break recipients, with $9.5 billion in tax breaks over the three years.

Industrial divide

Effective tax rates varied widely by industry. Over the 2001-2003 period, industry effective tax rates for the 275 corporations ranged from a low of 1.6 percent to a high of 27.7 percent.

In 2003, the range of industry tax rates was even greater, ranging from a low of -30.0 percent (a negative rate) up to a high of 27.9 percent.

  • Aerospace and defense companies enjoyed the lowest effective tax rate over the three years, paying only 1.6 percent of their profits in federal income taxes. This industry’s taxes declined sharply over the three years, falling to -30.0 percent of profits in 2003.
  • Other very low-tax industries, paying less than half the statutory 35 percent tax rate over the entire 2001-2003 period, included: transportation (4.3 percent), industrial and farm equipment (6.2 percent), telecommunications (7.5 percent), electronics and electrical equipment (10.8 percent), petroleum and pipelines (13.3 percent), miscellaneous services (14.4 percent), gas and electric utilities (14.4 percent), computers, office equipment, software and data (16.0 percent), and metals & metal products (17.4 percent).
  • Not a single industry paid an effective tax rate of more than 29 percent, either for the entire three-year period or in any given year.

Within industries, effective tax rates also varied widely. For example, over the three-year period, average tax rates on oil companies ranged from 3.0 percent for Devon Energy up to 31.4 percent on Marathon Oil. Among aerospace and defense companies, three-year effective tax rates ranged from a low of -18.8 percent for Boeing up to a high of 25.0 percent for General Dynamics.

How they do it

There are myriad reasons why particular corporations paid low taxes. The key major tax-lowering items revealed in the companies’ annual reports – plus some that are not disclosed – include:

Accelerated depreciation. The tax laws generally allow companies to write off their capital investments considerably faster than the assets actually wear out. This “accelerated depreciation” is technically a tax deferral, but so long as a company continues to invest, the tax deferral tends to be indefinite. In 2002 and again in 2003, Congress passed and President Bush signed new business tax breaks totaling $175 billion over the 2002-2004 period. These new tax subsidies centered on a huge expansion in accelerated depreciation, coupled with rules making it easier for companies with an excess of tax breaks to get tax rebate checks from the Treasury by applying their excess tax deductions to earlier years and still other new tax subsidies.

Atop the list of accelerated depreciation beneficiaries are SBC Communications, with $5.8 billion in accelerated depreciation tax savings, Verizon (with $4.5 billion), Devon Energy ($4.4 billion), ExxonMobil ($2.9 billion) and Wachovia ($2.8 billion).

Stock options. Most big corporations give their executives and other employees options to buy the company’s stock at a favorable price in the future. When those options are exercised, corporations can take a tax deduction for the difference between what the employees pay for the stock and what it is worth. But in reporting profits to shareholders, companies do not treat the effects of stock-option transactions as business expenses – based on the arguable theory that issuing stock at a discount doesn’t really reduce profits because the market value of a company’s stock often has only a very attenuated relation to earnings.

The corporate tax benefits from stock option write-offs are quite large. Of the 275 corporations, 269 received stock-option tax benefits over the 2001-2003 period, which lowered their taxes by a total of $32 billion over three years. The benefits ranged from as high as $5 billion for Microsoft over the three years to tiny amounts for a few companies.

Overall, tax benefits from stock options cut the average effective corporate tax rate for the 275 companies by 3 percentage points over the 2001-2003 period.

The benefits declined after 2001, however, falling from $13 billion in 2001 to about $9.5 billion a year in 2002 and 2003. The tax-rate effects of stock options are likely to continue to decline as accounting standards are changed to reduce the disparity between the book and tax treatment of options.

Tax credits. The federal tax code also provides tax credits for companies that engage in certain activities – for example, research (on top of allowing immediate expensing of research investments), certain kinds of oil drilling, exporting, hiring low-wage workers, affordable housing and supposedly enhanced coal (alternative fuel). As credits, these directly reduce a company’s taxes.

Some credits have unexpected beneficiaries. For instance, Bank of America cut its taxes by $580 million over the 2001-2003 period by purchasing affordable-housing tax credits. Clorox saved $36 million, Kimberly-Clark, $115 million, and Illinois Tool Works, an unspecified amount, from those same credits. Bank of New York obtained $100 million in alternative fuel credits over that period. Marriot International operates four coal-based synthetic fuel facilities solely for the tax benefits, which cut Marriot’s taxes by $233 million in 2003 and $159 million in 2002.

Offshore tax sheltering. Over the past decade, corporations and their accounting firms have become increasingly aggressive in seeking ways to shift their profits, on paper, into offshore tax havens, in order to avoid their tax obligations. Some companies have gone so far as to renounce their U.S. “citizenship” and reincorporate in Bermuda or other tax-haven countries to facilitate tax sheltering activity.

Not surprisingly, corporations do not explicitly disclose their abusive tax sheltering in their annual reports. For example, Wachovia’s extensive schemes to shelter its U.S. profits from tax are cryptically described in the notes to its annual reports merely as “leasing.” It took extensive digging by PBS’s Frontline researchers to discover that Wachovia’s tax shelter involved pretending to own and lease back municipal assets in Germany, such as sewers and rail tracks, a practice heavily promoted by some accounting firms. Other tax shelter devices, such as abuses of “transfer pricing,” also go unspecified in corporate annual reports. Nevertheless, corporate offshore tax sheltering is estimated to cost the U.S. Treasury anywhere from $30 billion to $70 billion a year, and presumably the effects of these shelters are reflected in the bottom-line results of what companies pay in tax.

Tax Reform (& Deform) Options

Almost two decades after the major corporate tax reforms under Ronald Reagan in 1986, many of the problems that those reforms were designed to address have re-emerged, along with an array of new corporate tax-avoidance techniques.

If policymakers wanted to reform the corporate income tax to curb tax subsidies and make the taxation of different industries and companies more equal, they certainly could do so. They could focus on the long list of corporate tax breaks, or as they are officially called, “corporate tax expenditures” produced each year by the Joint Committee on Taxation and the U.S. Treasury. They could reinstate a stronger corporate Alternative Minimum Tax that really does the job it was originally designed to do. They could rethink the way the corporate income tax currently treats stock options. They could adopt restrictions on abusive corporate tax sheltering, as the Clinton Treasury Department proposed. They could reform the way multinational corporations allocate their profits between the United States and foreign countries, so that U.S. taxable profits are not artificially shifted offshore.

But all signs point to movement in the opposite direction. In October, Congress adopted legislation to comply with a World Trade Organization (WTO) ruling that an export tax subsidy violates certain WTO obligations. The legislation closed some heavily criticized corporate loopholes that almost everyone agrees are unwarranted. But at the same time, the bill expanded existing and created new tax breaks – to the tune of $210 billion, mostly for corporations. They even include measures that would make it easier (and more lucrative) for companies to shift taxable profits, and potentially jobs, overseas.

The tax bill will further reduce corporate taxes substantially over time. In fact, one of the biggest winners under the bill will be General Electric, the company that already enjoys more tax subsidies under existing law than any among the 275 Fortune 500 firms making a consistent profit from 2001 to 2003.

Robert McIntyre is Director of the Citizens for Tax Justice. T. D. Coo Nguyen works with the Institute on Taxation and Economic Policy. This article is based on the two organizations’ report, “Corporate Income Taxes in the Bush Years,” published in September 2004.

© 2005 Multinational Monitor

See our index of articles on corporate welfare and tax evasion