Thursday, August 14, 2008

Tempest in a teapot

Speaker Pelosi is saying that the GAO report that came out this week, indicating that two-thirds of all U.S. corporations pay no tax at all, "highlights the need to revisit tax reform to ensure that U.S. companies pay their fair share of taxes."

Now, I certainly agree about the need for tax reform, and for addressing corporate-level tax avoidance, but not based on the GAO report, which was truly a non-event. The fact that lots of corporations pay no taxes means next to nothing when lots of them may be small companies without significant profits. Even the fact that, according to the report, 25% of fairly large companies paid no taxes, while a bit more interesting, does not immediately make one excited given that we have recently had a bit of a recession.

The finding in the report that foreign-controlled U.S. corporations report lower profits than those that are U.S. owned is a bit interesting, and suggests (as the report notes) that the foreign companies may be using transfer pricing to shift profits out of the U.S. (Or perhaps they haven't been doing well here lately.) But I believe the comparison in the report is to U.S.-owned companies generally. A more interesting comparison would be to U.S.-owned multinationals, since they have roughly the same transfer pricing incentives and opportunities as the foreign firms. In other words, the key here may be multinational enterprise, not whether a company is treated as a U.S. resident or not.

Readers should also keep in mind that, insofar as transfer pricing is hurting U.S. revenues, one of its possible policy implications is that the U.S. corporate tax rate should be lower so the incentive to engage in it will be less. Tougher enforcement is also an option, but transfer pricing is notoriously difficult to do right - since there is no underlying there there - and it also leads to very costly compliance and litigation.

So let's have tax reform by all means (not that I expect it by any means), but intellectual honesty suggests not basing it on the GAO report's supposed findings.

1 comment:

Anonymous said...

There has been much written about this in the past few days and I must say that you are the first person to truly understand the issue. TP is difficult to enforce, the IRS will catch some abusers but most will never get caught, and 2nd, the only way to reduce the number of abusers is to reduce the corporate tax rate. Lower rate will most likely result in higher tax dollars as companies will stop putting profits in lower tax jurisdictions.

Good post.