Corporate Tax Evasion and Transfer Pricing

The Government Accountability Office (GAO) released a new report [1] today showing that an average of two-thirds of companies operating in the United States paid no federal corporate income tax from 1998 - 2005. That's right, I said none. Zip. Zero. Nada.

The report was requested by Sens. Byron Dorgan (D-ND) and Carl Levin (D-MI) as a follow up to a similar report [2] GAO did in 2004 in which they found similar levels of tax liability reported on corporate tax returns from 1996 through 2000. In fact, in 2004, GAO found that domestically controlled companies and foreign controlled companies "reported tax liabilities of less than 5 percent of their total income, an estimated 94 percent and 89 percent, respectively, in 2000." Wow. Upwards of 90 percent of companies paid at most 5 percent in federal income taxes in 2000, despite the corporate income tax rate being 35 percent.

While you digest that little tidbit (or maybe choke on it), let me tell you about transfer pricing, which is at the heart of these GAO reports and a long time thorn in the side of Sens. Dorgan and Levin, who I guess think corporations should pay taxes. The recently released GAO report defines transfer prices as "the prices related companies, such as a parent and subsidiary, charge on intercompany transactions." So in complex corporate structures, a company can charge itself essentially for goods and services (and even things like trademarks and copyrights). This can lead to a lot of shennanigans by companies to make it look like they have zero tax liability even when they don't.

Yet there isn't very good information about how much of the drastically low tax liability of companies is due to perfectly legal corporate tax credits or operating expenses and loses, and how much is due to fancy accountants' efforts to cook the books. But that didn't stop the Senators from claiming this was all part of the evil corporate plan. A press release [3] from Levin's office quotes him saying that this report makes it clear "that too many corporations are using tax trickery" to avoid paying their fare share.

Unfortunately for Levin, that's not what the report shows. In fact, GAO says explicitly on page two:

As agreed, we did not attempt to determine whether corporations were abusing transfer prices. Nor did we attempt to determine the extent to which this abuse explains any differences in the reported tax liabilities of FCDCs and USCCs.

Instead, Levin should have said what the report does show. Either corporations are breaknig the law to lower their tax liability, OR their actions are perfectly legal and our current tax structure allows for most corporations to pay hardly any taxes. Either way, something needs to be changed - and soon - to hold corporations accountable for paying their fair share.