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March 19, 2012
Tax Reform Goals Differ for Corporate Coalitions

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By Martin A. Sullivan --

When it comes to taxes, corporate America is divided into two parts. First, there are companies that pay full freight. Their effective tax rates are close to the statutory 35 percent rate. They tend to be low-tech and labor-intensive, and -- most of all -- they have most of their profits in the United States. Then there are those companies that collectively save tens of billions of dollars each year by taking advantage of loopholes in the transfer pricing and anti-deferral rules. Their effective tax rates are significantly less than 35 percent. They are technology-intensive and pack a lot of their profits in tax havens.

As the drumbeat for tax reform grows louder, the priority for members of the first group is easy to understand. Existing tax breaks don't do much for them, so a tax reform that cleaned up the code and lowered the rate could be a big plus. The membership of the RATE Coalition, a group dedicated to reducing the corporate tax rate, is made up mostly of this type of company. Its membership includes AT&T, Home Depot, Disney, and Macy's.

The tantamount concern of members of the second group is international taxation. That manifests itself in three general policy thrusts: (1) thwarting President Obama's perennial proposals to raise taxes on foreign profits; (2) securing a repeat of the 2004 tax holiday for repatriated foreign profits; and (3) moving the United States from a worldwide to a territorial system of international taxation. For territorial taxation, the proposal must be devoid of any significant expense allocation, thin capitalization, and anti-deferral rules to get the support of this group. (The revenue-neutral territorial proposal by House Ways and Means Committee Chair Dave Camp, R-Mich., does not make the grade.) Companies with this profile can be found among the members of the WIN America Campaign, a coalition dedicated to securing tax relief for repatriated foreign profits, and they include Apple, Microsoft, Pfizer, and Cisco Systems.

Figure 1 shows the share of foreign profits as a percentage of worldwide profits for the coalitions' members that are publicly traded corporations. These are three-year figures from each company's latest SEC Form 10-K. The difference between the two coalitions is striking. Of the 21 RATE members, only one, Nike, has more than half of its pretax profits outside the United States. Of the 19 WIN America members, 11 have more foreign than domestic profits. Four companies -- Brocade, Autodesk, Pfizer, and Broadcom -- reported losses in the United States even though they were profitable on a worldwide basis.

Figure 2 shows all companies in both coalitions with foreign effective tax rates less than 20 percent. Twelve of those 14 are in the WIN America coalition.

Figure 3 shows all companies from both coalitions with more than $10 billion of accumulated foreign profits (with no associated U.S. tax liability booked on the companies' financial statements). Seven of the eight companies are in the WIN America coalition.

Finally, Figure 4 shows the member companies' worldwide effective tax rates reported to shareholders. After removing unusual cases, the average for the RATE Coalition is 32.4 percent, and the average for the WIN America companies is 26.6 percent -- a difference of 5.8 percentage points. If we remove energy companies (which are always plagued with high foreign tax rates) from the average, the computed difference grows to 7.6 percentage points.

There is no open dispute yet between the two coalitions, but the data show that the potential for conflict is there. WIN America members want to preserve and extend tax rules that allow them to shift profits out of the United States and into low-tax countries. But most RATE Coalition members will get little or no benefit if Congress takes that route. Money is tight. They would prefer that any funds earmarked for the relaxation of international rules be redirected to a cut in the corporate rate.

That "end tax breaks to pay for a rate cut" approach is nothing new. Several groups adopted it during passage of the Tax Reform Act of 1986, even though most businesses opposed the legislation, which raised corporate taxes. (See Jeffrey Birnbaum and Alan Murray, Showdown at Gucci Gulch 151, 178 (1987).) If corporate tax reform is revenue neutral, the proportion of companies favoring this approach will be larger than in 1986.

Timid Titans

The deep division of interests in corporate America is a headache for the broad business coalitions like the U.S. Chamber of Commerce and the Business Roundtable (BRT), whose members are in both groups. Obama and Camp both have said that they want corporate tax reform to be revenue neutral. And that kind of reform means one group must suffer at the expense of the other.

The big four corporate tax expenditures that could be scaled back to pay for corporate tax reform are the research credit, the section 199 manufacturing deduction, accelerated depreciation, and deferral of U.S. tax on foreign profits. The Chamber opposes repeal of all four and, in fact, favors significant expansion of the last two. On February 22 chamber President and CEO Thomas Donohue released a statement saying, "We will be forced to vigorously oppose pay-fors that pit one industry against another or lavish favors on some while punishing others."

That does not leave a lot of room to maneuver. In fact, the Chamber seems a little lukewarm about rate reduction. Commenting on Camp's draft plan to lower the rate to 25 percent, the group stated that it "reserves further comments on the proposed rate reductions until additional details are provided with respect to the corresponding base broadening measures that will be proposed." Putting that all together, the Chamber in effect is saying it opposes corporate tax reform that is not a corporate tax cut. Without any base broadening, that's about $10 billion per year for each percentage point reduction in the corporate rate.

The BRT has stated that it favors ("fiscally responsible") tax reform that would be revenue neutral across the entire tax system. It also favors a 25 percent corporate rate, extension of the research credit, and a territorial system without expense allocation rules or anti-deferral rules that apply to active income. So how would the BRT pay for the rate cut to 25 percent with a price tag of $100 billion per year? Its answer is vague. And instead of tackling the central problem of tax reform -- how to pay for lower rates -- it has sidestepped the issue: "BRT CEOs believe that these reforms can be undertaken in a fair and fiscally responsible manner, with the cost of these reforms to be offset as much as possible through appropriate base broadening."

Given the options it has taken off the table, the BRT would be lucky if "appropriate" base broadening paid for a 30 percent rate. And even still, such a tax reform must include repeal of accelerated depreciation and the section 199 deduction for domestic manufacturing -- changes that groups like the Chamber would vigorously oppose.

The motto of the BRT is "Not Just Leaders. Leadership." More than anybody else, business leaders should appreciate that the enormous sums of money needed to pay for rate cuts they seek must come from somewhere. Until they are explicit about those sources, until they are willing to take the heat from those who are going to pay, are they really providing leadership?

Notes on the Data

WIN America Campaign. As of March 12, the WIN America Campaign had 50 entries on its list of "supporters." Twenty-six were business groups, the overwhelming majority of which were technology related (such as the Silicon Valley Tax Directors Group and the Consumer Electronics Association). The Chamber was also in that group. The remaining 24 entities were companies. Two of those companies, Virgin America and Serious Energy, were dropped because they were not publicly traded and detailed financial information is not available. A third, Kodak, was dropped because it had large losses in all three years and filed for bankruptcy on January 11. Cadence Design Systems was also dropped because over the three-year period it had significant losses that made interpretation of its statistics (such as effective tax rates) problematic (although it should be noted that like several other WIN America supporters, all its losses in those three years were domestic; it showed foreign profit in all three years).

That leaves 20 companies included in the statistical analysis. They are listed here with the end of the month and year of the companies' latest reported fiscal year in parentheses: [1] Adobe (Nov. 2011), [2] Apple (Sept. 2011), [3] Autodesk (Mar. 2011), [4] Broadcom (Dec. 2011), [5] Brocade (Oct. 2011), [6] Brown-Forman (Apr. 2011), [7] CA Inc. (Mar. 2011), [8] Cisco (July 2011), [9] Devon Energy (Dec. 2011), [10] Duke Energy (Dec. 2011), [11] EMC (Dec. 2011), [12] Google Inc. (Dec. 2011), [13] Intersil (Dec. 2011), [14] Loews Corp. (Dec. 2011), [15] Microsoft (June 2011), [16] NASDAQ OMX (Dec. 2011), [17] Oracle (May 2011), [18] Pfizer (Dec. 2011), [19] Qualcomm (Sept. 2011), and [20] Varian Medical Systems (Sept. 2011).

RATE Coalition. As of March 12, the RATE Coalition had 25 entities on its list of members. Two were trade associations: the Association of American Railroads and the National Retail Federation. The remaining 23 entities were companies. Cox Enterprises (not a publicly traded company) and T-Mobile (the U.S. wireless operation of Deutsche Telekom) do not publish detailed financial information.

That leaves 21 RATE Coalition companies included in this analysis: [1] AT&T (Dec. 2011), [2] Altria (Dec. 2011), [3] Boeing (Dec. 2011), [4] Capital One (Dec. 2011), [5] CVS Caremark (Dec. 2011), [6] Disney (Sept. 2011), [7] FedEx (Dec. 2011), [8] Ford Motor Co. (Dec. 2011), [9] General Dynamics (Dec. 2011), [10] Home Depot (Jan. 2011), [11] Intel (Dec. 2011), [12] Kimberly-Clark (Dec. 2011), [13] Lockheed Martin (Dec. 2011), [14] Macy's (Jan. 2011), [15] Nike (May 2011), [16] Raytheon (Dec. 2011), [17] Texas Instruments (Dec. 2011), [18] Time Warner (Dec. 2011), [19] UPS (Dec. 2011), [20] Verizon (Dec. 2011), and [21] Viacom (Sept. 2011).

For AT&T, only 2009 and 2011 data were used in figures 1 and 4 because of a huge tax benefit booked in 2010 relating to a settlement with the IRS as a result of a restructuring of its wireless business in 2008. Including 2010 data would reduce its average effective tax rate from 34.2 percent to 21.4 percent. Similarly, for Macy's, figures 1 and 4 include only 2010 and 2011 data because huge losses booked in 2009 distort the picture from what most likely will be the company's future tax situation. Including 2009 data would reduce the company's average effective tax rate from 39.1 percent to 24.7 percent.

Ford (effective tax rate equal to -64 percent) is not included in the average shown in Figure 4. In 2011 it released a $9.8 billion valuation allowance against deferred tax assets because the company now believes it can use net operating losses and tax credits generated during crisis years. Thus, huge tax benefits do not reflect the company's long-term tax situation. Verizon (effective tax rate of 13 percent) also is not included in the average because it uses the equity method of accounting, in which little or no tax is paid on income from some affiliates' income (itself reported after-tax). That gives the company an effective tax rate that does not reflect the burden it actually bears and makes its effective tax rate not comparable with those of other companies included.

Devon Energy is not included in Figure 1 because it does not provide sufficiently detailed information about its significant foreign operations (entirely in Canada) to calculate the split of foreign and domestic profit. Several members of the RATE Coalition did not separately report any foreign income or foreign taxes, and so it was assumed for those calculations that foreign income and taxes were zero.

Figure 1. Foreign Share of Worldwide Profits
(RATE Coalition vs. WIN America Campaign)

Source: Author's calculations using publicly available data.

Figure 2. Foreign Effective Tax Rates Less Than 20 Percent

Source: Author's calculations using publicly available data.

Figure 3. Coalition Members With More Than
$10 Billion of Unrepatriated Foreign Profits

Note: Totals do not include unrepatriated foreign profits for which U.S. tax liabilities have not been booked.

Source: Author's calculations using publicly available data.

Figure 4. Worldwide Effective Tax Rate
(RATE Coalition vs. WIN America Campaign)

Source: Author's calculations using publicly available data.

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