GAO Points to Problems with Corporate Tax Deferral

A new report from the Government Accountability Office examines corporate tax deferral, highlighting the distortionary impact on the economy.

Corporate tax deferral expenditure confers the benefit of effectively reducing a multinational corporation’s taxes by delaying the taxation of certain income of foreign subsidiaries of U.S. corporations until it is repatriated to the U.S. parent as dividends. The GAO was asked by Congress to examine issues related to tax expenditures for corporate tax deferral. The report uses GAO's tax expenditures evaluation guide to determine what is known about the deferral of income for controlled foreign corporations; deferred taxes for certain financial firms on income earned overseas; and the graduated corporate income tax rate. The GAO combined the two deferral provisions for evaluation purposes.

“While views on the purpose of deferral have changed over time, currently, it is often viewed by experts as promoting the competitiveness of U.S. multinational corporations,” said the report. “Some experts argue that this view is too narrow. For example, this definition of competitiveness ignores the effect on other corporations that cannot use deferral, such as those that are purely domestic or export without foreign subsidiaries. Further, it ignores impacts on the wider economy.”

The GAO acknowledged that good tax policy has several dimensions. “By delaying the tax on foreign source income, deferral could distort corporate investment and location decisions in a way that lower taxes, but favor less productive activities over more productive ones,” said the report. “Informed judgments about deferral's effect on the fairness of the tax system cannot be made because who benefits from deferral, after accounting for such factors as changes in prices and wages, has not been determined. However, there is widespread agreement among experts and the Internal Revenue Service that deferral adds complexity to the tax code.”

The GAO said it did not identify other federal spending programs that provide similar support to U.S. multinational corporations. The GAO made no recommendations in the report.

Congressman Lloyd Doggett, D-Texas, a senior member of the House Ways and Means Committee, pointed out that the GAO study is important for two reasons.  It is the very first to use GAO’s newly developed tax expenditures evaluation guide. The guide suggests using five questions to evaluate a tax expenditure: (1) what is its purpose and is the purpose being achieved; (2) does it meet the criteria for good tax policy; (3) how is it related to other federal programs; (4) what are its consequences for the federal budget; and (5) how is its evaluation being managed? To address these questions, the GAO reviewed the legislative history and relevant academic and government studies, analyzed 2010 IRS data, and interviewed agency officials and tax experts.

“Controlling the deficit means controlling tax expenditures,” Doggett said in a statement Wednesday. We need to scrutinize these barnacles on the tax code because they can sink our efforts to achieve a reasonable budget.”

He pointed out that the GAO makes important findings about tax deferral’s impact on competitiveness and efficiency. The GAO wrote, “Deferral provides no benefit to these purely domestic or exporting U.S. corporations. Rather than leveling the playing field, deferral benefits U.S. multinationals over other types of U.S. corporations.”  The report also emphasizes research that shows “that differences in tax burden do affect corporations’ real investment decisions, which could lead to these efficiency losses.” 

The GAO specifically compared economic efficiency under a “full inclusion” system, under which all foreign-source income would be taxed immediately, and a territorial system, under which companies would pay no U.S. income tax on foreign income.

“Under a territorial system, these investment location distortions may increase relative to the current system because the tax incentive to invest in low-tax countries may be enhanced when the differences in tax rates are made permanent,”  said the report.

The GAO also notes that the graduated corporate income tax rate, which was designed to benefit small businesses, is not well targeted to that purpose. The report finds that because many large companies are able to take advantage of tax loopholes to lower their taxable income, large corporations have also been able to take advantage of this tax break.

“This report is another reminder that any serious budget agreement must control tax expenditures,” said Doggett. “Multinationals are already advantaged over domestic businesses. Eliminating even more taxes on their profits abroad will only promote shipping more jobs abroad. Tax deferrals benefit only a narrow slice of the business community, are expensive, and discourage investment in America. ”

Corporate Tax Legislation

To address international corporate tax avoidance, Doggett has introduced a package of three bills that would close loopholes and ask multinationals to pay a more fair share in federal taxes—the Stop Tax Haven Abuse Act, the International Tax Competitiveness Act, and the Fairness in International Taxation Act.  

The Stop Tax Haven Abuse Act (H.R. 1554) aims to close several different loopholes by deterring the use of tax havens for tax evasion and strengthening the enforcement of our tax laws.  One provision would prevent U.S.-run corporations from avoiding U.S. taxes by filing a piece of paper abroad and pretending to be foreign. The bill would also require SEC-registered corporations to report annually on the number of employees, sales, financing, tax obligations, and tax payments on a country-by-country basis, shedding more light on the extent of use of tax havens. This bill also provides for additional penalties for failing to disclose offshore holdings and for promoting abusive tax shelters.

The International Tax Competitiveness Act (H.R. 1555) addresses the practice of developing a trademark, patent, or copyright in the U.S. and then transferring that intellectual property abroad to avoid taxes on the massive amounts of income generated by it. This bill would treat income from the U.S. intellectual property as U.S. income and tax it accordingly.   

The Fairness in International Taxation Act (H.R. 1556) would end the current practice of treaty shopping to avoid U.S. taxes. The United States has tax treaties with a number of trading partners that reduce the amount of taxes that a U.S. based entity owes on interest and royalties paid to a foreign parent. Since many of these foreign parent companies are set up in tax havens, these companies now bypass U.S. tax by routing the payment through a tax-treaty country that then just transfers the funds to the tax-haven parent. This bill would end that legal fiction and say that you only get the tax-treaty discount if the parent company is actually located in a tax-treaty country.