WHAT WOULD HAPPEN? - University of North Texas

Report
Corporate Income Taxes:
Trends and Forecasts
Presentation to the President’s Advisory
Panel on Federal Tax Reform
March 8, 2005
Douglas A. Shackelford
University of North Carolina and NBER
1
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
2
8.0
40.0
7.0
35.0
6.0
30.0
5.0
25.0
4.0
20.0
3.0
15.0
10.0
2.0
5.0
1.0
0.0
0.0
% of GDP
45.0
19
34
19
39
19
44
19
49
19
54
19
59
19
64
19
69
19
74
19
79
19
84
19
89
19
94
19
99
20
04
% of Revenue
Corporate Income Tax as a Percentage
of Federal Revenue and GDP
Revenue
GDP
Source: Office Management and Budget, Fiscal Year 2005 Budget, as reported by
the Tax Policy Center.
3
Why Have Corporate Taxes Declined?

International competition has eroded
corporate taxes as a revenue source



Other organizational forms (e.g., S corp)



Lower rates at home and abroad
Smaller base—e.g., accelerated/bonus
depreciation, R&D deductions and credits
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
4
International Competitiveness:
Reducing Corporate Tax Rates
65
Tax Rate %
60
55
50
45
40
35
19
53
19
56
19
59
19
62
19
65
19
68
19
71
19
74
19
77
19
80
19
83
19
86
19
89
19
92
19
95
19
98
20
01
30
25
Statutory
Marginal
Source: Gravelle, J. “The Corporate Tax: Where Has it Been and Where is it Going?” National Tax 5
Journal 57 No. 4 (December, 2004): 903:922.
S Corporations:
Eroding the Corporate Tax Base
Number of Returns Filed (in Thousands)
5,000
4,000
3,000
2,000
1,000
C-corp
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1995
1990
1985
1980
0
S-corp
2004-2010, projected. Source: IRS Statistics of Income.
6
Business Net Income by Type of Entity
C corps, excl. RICs and REITs
S Corporations
Partnerships, excl. LLCs
LLCs
All Passthroughs
700
600
500
400
300
200
100
0
1991
1992
1993
1994
1995
1995
1997
1998
1999
2000
2001
Source: Drew Lyon, PriceWaterhouseCoopers, Presentation at the 6 th Annual Tax Council Policy Institute
Symposium, February 11, 2005. Underlying data from IRS statistics of Income.
7
Other Ways to Eliminate Double
Taxation
Year-end bonuses in privately-held firms
 Debt shifts business profits to the lender’s
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)
8
More Effective Tax Planning:
Book-Tax Gap

The gap between accounting earnings and
corporate taxable income widened during
the late 1990s


Perhaps book is overstated


e.g., Desai (2002) finds $155 billion of
unexplained book-tax gap in 1998
Earnings pressure may have led to inflated,
fictional earnings in the late 1990s
Corporate Tax Shelters
9
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.
10
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)
11
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 economy—high profits, high taxes
Recent IRS defeats embolden taxpayers
Big 4 spin off their tax practices
12
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

13
Old Days

Factors of production

Largely immobile—heavy industry




Bricks and Mortar
Large unskilled/skilled labor force
Production of goods
Income


Primarily sales less production costs
Biggest accounting questions—inventory,
depreciation
14
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 questions—realized and
unrealized intangibles


What is a brand name worth?
Where does a telephone call take place?
15
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?

16
Tax Planners Need Differences in Tax
Rates

Tax the Same Income Differently

At Different Times


In Different Places


Flow-through entities, tax-exempt organizations, pensions
Depending on the Savings Vehicle


U.S. vs. foreign-source
In Different Organizational Forms


E.g., current tax holiday on repatriated cash
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
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