Corporate Income Taxes: Trends and Forecasts

1
Corporate Income TaxesTrends and Forecasts

• Presentation to the Presidents Advisory Panel on
  Federal Tax Reform
• March 8, 2005
• Douglas A. Shackelford
• University of North Carolina and NBER

2
Overview

• Look back
• Corporate income taxes are in a long decline
• Why have they declined?
• International competition
• Alternative organizational forms
• More effective tax planning
• Tax shelters
• Mobility of income
• Look forward
• Feasibility of the corporate income tax in an
  information economy

3
Corporate Income Tax as a Percentage of Federal
Revenue and GDP

• Source Office Management and Budget,
  Fiscal Year 2005 Budget, as reported by the Tax
  Policy Center.

4
Why Have Corporate Taxes Declined?

• International competition has eroded corporate
  taxes as a revenue source
• Lower rates at home and abroad
• Smaller basee.g., accelerated/bonus
  depreciation, RD deductions and credits
• Other organizational forms (e.g., S corp)
• The corporate income tax is a special levy on
  companies that access capital through the public
  equity markets
• Other techniques to undo two levels of tax
• More effective tax planning

5
International Competitiveness Reducing
Corporate Tax Rates

• Source Gravelle, J. The Corporate Tax
  Where Has it Been and Where is it Going?
  National Tax Journal 57 No. 4 (December, 2004)
  903922.

6
S Corporations Eroding the Corporate Tax Base

• 2004-2010, projected. Source IRS Statistics of
  Income.

7
Business Net Income by Type of Entity

• Source Drew Lyon, PriceWaterhouseCoopers
  , Presentation at the 6th Annual Tax Council
  Policy Institute Symposium, February 11, 2005.
  Underlying data from IRS statistics of Income.

8
Other Ways to Eliminate Double Taxation

• Year-end bonuses in privately-held firms
• Debt shifts business profits to the lenders tax
  return since interest is deductible
• Employee stock options
• Total deductions from stock option exercises were
  10 of total pretax income for the 100 largest
  U.S. companies in 2000. However, total
  deductions exceeded total pretax income for the
  Nasdaq 100. (Graham, Lang, and Shackelford,
  Journal of Finance, 2004)

9
More Effective Tax PlanningBook-Tax Gap

• The gap between accounting earnings and corporate
  taxable income widened during the late 1990s
• e.g., Desai (2002) finds 155 billion of
  unexplained book-tax gap in 1998
• Perhaps book is overstated
• Earnings pressure may have led to inflated,
  fictional earnings in the late 1990s
• Corporate Tax Shelters

10
How about Book-Tax Conformity?

• Argument given for conformity If companies are
  overstating book profits and understating taxable
  income, then require them to report the same
  figure to shareholders and the taxing authority
  and you fix two problems.
• Not a good idea
• Conformity ignores the critically important role
  that accounting information plays in the markets.

11
Corporate Tax Shelters

• Legal noncompliance
• Meet the letter, but not the spirit of the law
• Reduce taxable income but not book income
• Little public data so estimates of their
  magnitude are difficult
• Leasing transactions estimated to cost 4 billion
  for one year (Joint Committee on Taxation, 2004)

12
Shelters Today

• Market has cooled
• Recession reduced demand
• Bad publicity
• IRS has become more aggressive
• Big 4 withdrew partly because shelters threaten
  to undermine the profitable Sarbanes-Oxley audit
  work.
• Market could revive
• Booming economyhigh profits, high taxes
• Recent IRS defeats embolden taxpayers
• Big 4 spin off their tax practices

13
Income Mobility

• The tax system relies on information from the
  historical cost accounting system
• The accounting system is struggling to measure
  income where the primary assets are intangibles.
• As a result, taxable income is becoming
  increasingly difficult to measure.
• These measurement problems provide opportunities
  for tax planners and raise doubts about the
  long-term viability of income taxes
• Problems increase with globalization

14
Old Days

• Factors of production
• Largely immobileheavy industry
• Bricks and Mortar
• Large unskilled/skilled labor force
• Production of goods
• Income
• Primarily sales less production costs
• Biggest accounting questionsinventory,
  depreciation

15
Today

• Factors of production
• Highly mobile--intellectual
• Intangibles and highly technical
• Small, highly educated labor force
• Service-oriented
• Income
• Affected mostly by people and intangibles
• Biggest accounting questionsrealized and
  unrealized intangibles
• What is a brand name worth?
• Where does a telephone call take place?

16
Is an Income Tax Feasible in the Future?

• A tax system built on income can only last as
  long as we can define income with some precision.
• A tax system depends on market frictions that
  make it difficult to undo the tax. In old days
  you could not easily dismantle the plant. Today
  you can move profits around the globe with
  transfer prices or a plane ticket.
• Is it feasible to think that income can be a
  basis for tax measures in the future?

17
Tax Planners Need Differences in Tax Rates

• Tax the Same Income Differently
• At Different Times
• E.g., current tax holiday on repatriated cash
• In Different Places
• U.S. vs. foreign-source
• In Different Organizational Forms
• Flow-through entities, tax-exempt organizations,
  pensions
• Depending on the Savings Vehicle
• Stock held in an 401(k) vs a mutual fund vs
  personal account
• Tax Similar Income Differently
• E.g., new lower rates on U.S. manufacturing