Anything but Avoidance: Citizens for Tax Justice's BlunderingCorporate Tax Report

The nonprofit group Citizens for Tax Justice (CTJ) recently blasted U.S. corporations for increasing their "tax avoidance" behavior during the presidency of George W. Bush. The CTJ report "Corporate Income Taxes in the Bush Years"[1] examines the annual financial reports of a group of large U.S. corporations and purports to show how little these companies paid in taxes from 2001 to 2003. But the report fails to disclose that corporations' tax return data are not publicly available, a fact that makes CTJ's analysis imprecise at best. Because of this shortcoming and other errors, CTJ's conclusion that "loophole seeking-corporations" aren't paying their fair share of taxes falls flat.

Corporations' annual reports can only be used to derive crude estimates of corporate taxable income and taxes paid. The CTJ paper appears to have accounted for some differences between financial reporting rules and tax filing rules, but the paper's discussion of methodology does not provide an adequate explanation of these adjustments. Regardless, it is impossible to account for all of these differences without access to private information.

CTJ also omits other vital details that seriously weaken its conclusions. For example, the paper fails to name any recent tax legislation despite its accusation that Congress and the administration are tweaking tax policy for corporate gain. The following list summarizes the report's major omissions and errors.

• Companies use financial accounting rules to derive the figures in their annual reports. But tax law and financial accounting rules differ significantly, creating legitimate differences between values reported on financial statements and those reported on tax returns. These discrepancies, known as "book-tax differences," cannot be accurately reconciled using only information that is publicly available. The CTJ study ignores this shortcoming in its analysis and, even worse, mischaracterizes book-tax differences as tax avoidance schemes.
• CTJ estimates corporations' average tax rates using figures that almost certainly differ from their true values because tax return data are not publicly disclosed. The CTJ paper does not mention this serious, even crippling, limitation of its analysis. Worse, CTJ misrepresents its estimates of corporations' tax payments as actual tax payments, though these estimates may be grossly inaccurate.
• Certain tax laws reduce a corporation's tax payments in a given year at the expense of limiting future deductions. CTJ ignores this difference between the timing and magnitude of tax benefits. Consequently, CTJ misrepresents the use of accelerated depreciation and net operating losses (NOLs), both of which can reduce a corporation's tax burden in a given year, as illegitimate tax subsidies. But the lower payments that CTJ condemns are only half the story: a corporation that uses accelerated depreciation or NOLs this year trades away the use of these deductions in future years.
• When discussing corporate tax rates, CTJ uses the wrong measure. The CTJ study estimates the average effective tax rates for its sample of companies, but it does not discuss the companies' marginal tax rates. While average tax rates are calculated by dividing taxes paid by total income, marginal tax rates apply to additional increments of income-the next dollar earned. Except by fluke or error, no individual makes decisions based on average tax rates; rather it is marginal rates that govern whether to work another hour or produce one more widget. CTJ's own estimates suggest that companies' marginal tax rates are twice as high as their average rates. By this more appropriate measure, corporations' tax rates are much higher than CTJ implies in its analysis.
• In characterizing the corporate tax benefit from granting stock options to employees as a "tax loophole," CTJ misrepresents the deductibility of salaries and wages as a tax avoidance scheme. But corporations don't pay taxes on wages and stock options because their employees, the recipients of these benefits, pay taxes on them at the individual level. And while there has been controversy over stock option "expensing," it concerns the accounting treatment of these options, which has almost nothing to do with how the options are taxed.
• CTJ bemoans the decline in the relative share of "corporate" taxes collected by the U.S. Treasury without looking at changes in the economy that may account for it. An increasing number of individuals are running their own businesses as non-corporate entities, such as S-corporations and limited liability companies (LLCs). These individuals do pay taxes on their business income but not through the corporate tax system. This trend away from the traditional C-corporation has surely contributed to the decline in the relative share of corporate tax revenues, but CTJ simply ignores it.
• CTJ also overlooks the use of reasonable tax planning strategies that may reduce tax revenues. Unlike most countries, the United States taxes corporate income wherever it is earned, placing U.S. companies at a competitive disadvantage abroad. It is understandable that corporate boards use all legal methods to minimize this disadvantage, including reincorporating in a foreign nation. Indeed, failing to use all legal methods of tax planning would make corporate managers derelict in their responsibility to shareholders. But to CTJ, even playing by the rules is still unjust tax avoidance.
• The CTJ paper does not provide the proper statistical context for its estimates of average tax rates. While the study reports that corporations in its sample paid an average tax rate, over three-years, of 18.4 percent, it neglects to point out that average tax rates ranged from 6.7 percent to 30.14 percent for these companies. This much variation in CTJ's average tax rates, combined with CTJ's imprecise methodology for computing the tax rates, renders any use of the 18.4 percent average rather limited.

Most disturbingly of all, CTJ professes in its report to show the "actual" tax payments of 275 large U.S. corporations, but it never admits that this information is not publicly disclosed and that the report's "actual" payments are merely estimates, and shaky ones at that. Indeed, several companies have publicly taken issue with CTJ's estimates and methodology, and at least one earlier CTJ estimate has been proven grossly inaccurate:

• According to SBC spokeswoman Anne Vincent, "It's just not true that we [SBC] got a half-billion dollar check back from the federal government."[2]
• Pepsi's Kelly McAndrew said, "It is impossible for us to determine how they calculated the tax rate, which is also incorrect."[3]
• In an earlier report, CTJ claimed that Enron received a net refund of $278 million on its federal income taxes in 2000[4]. But Congress's Joint Committee on Taxation reported in 2003 that Enron paid $63.2 million in federal income taxes in 2000, consisting of $21.3 million under the federal income tax and $41.9 million under the corporate alternative minimum tax (AMT).[5]

Finally, CTJ charges that Congress and the Bush administration changed the tax laws to benefit "loophole seeking-corporations." But because the CTJ paper does not list any recent legislation and contains only one page on methodology, which is described with few details, it is difficult to evaluate this specific claim.

The errors and omissions in the Citizens for Tax Justice's study of corporate taxation are myriad. CTJ misrepresents its own error-prone estimates of corporate tax payments as corporations' "actual" payments. It mistakes the differences between tax accounting rules and financial accounting rules as evidence of tax avoidance. It ignores the very significant difference between tax strategies that affect the timing of tax benefits and those that affect how much tax is paid. It trades on the recent "stock option expensing" controversy as justification for branding single-taxation (as opposed to double-taxation) of employee compensation as a "tax loophole." CTJ ignores economic trends that would explain some of the drop in the relative share of corporate tax collections. It implies that playing by the rules in tax planning is somehow unjust. And finally, CTJ uses the wrong measure, the average tax rate, to assess corporations' tax rates even though the marginal tax rate, which is usually much higher, is the more appropriate measure. For these reasons and more (watch for a forthcoming Center for Data Analysis Report from the Heritage Foundation), CTJ's "Corporate Income Taxes in the Bush Years" presents an exceedingly misleading picture of corporate taxation in America.

Norbert Michel, Ph.D., is Policy Analyst in the Center for Data Analysis at The Heritage Foundation.