Corporations based in the United States are paying on average 27 percent of their earnings in taxes, despite a U.S. statutory corporate tax rate of 35 percent, mainly because they have become adept at keeping their earnings offshore in jurisdictions with lower rates. A recent study by the Georgia Tech Financial Analysis Lab found effective tax rates, or the average rates companies actually pay, falls well below corporate rates because companies have moved so much of their operations to offshore locations, where earnings are not subject to U.S. tax until they are returned to U.S. coffers.
“The corporate rate is 35 percent, so if you had a few more percentage points for state and other taxes, we would expect to find rates in the upper 30s,” says Chuck Mulford, director of the research lab at Georgia Tech. Yet we find effective rates tend to be in the range of 27 percent.” And they can vary dramatically from one company to another, the study found. Companies like Merck and Microsoft have effective tax rates lower than 20 percent, and some profitable companies even report negative effective tax rates, including AT&T, Bank of America, Caterpillar, and General Electric.
As Congress and the White House tinker with ideas around how to overhaul the tax code to eliminate loopholes and reduce tax rates, the findings raise concerns about equitable treatment among corporations, says Mulford. “I don't see how you can say our tax code is fair,” he says. “This shows that companies are all over the place in terms of what they pay.” Companies that can't easily move operations abroad, like large retail or health-care organizations, can't take advantage of lower-rate foreign jurisdictions the way large industrial companies are able, he says.
The study examined earnings and tax trends for the 30 companies in the Dow Jones Industrial Average, looking for factors that would cause effective tax rates to fall above or below statutory tax rates. It also looked for differences between effective tax rates and current tax rates, or the taxes that are currently due and payable as a percentage of pre-tax income.
The big contributors to lower effective tax rates included the effects of foreign tax rates being lower than U.S. rates, tax credits, and adjustments related to prior-year accruals. In some cases, foreign rates were actually higher than in the United States, the study found, causing companies like Exxon-Mobil and Chevron to report effective rates of greater than 40 percent, even higher than the U.S. statutory rates.
“Our tax code is set up in such a way that a rational manager trying to maximize share price is going to take steps to move operations, asset ownership, and payment of taxes offshore,” says Mulford. “By lowering corporate rates and making them more competitive with foreign rates, we could move a lot of those taxes back to the U.S.”
The Securities and Exchange Commission has pushed public companies to get more transparent around where they have held earnings offshore with no plans to repatriate them, especially if it appears the company could use the cash at home. The SEC has no authority to require companies to repatriate their foreign earnings, but staff members have said investors deserve to know and understand the company's rationale for keeping foreign earnings invested abroad.