Arguments Have Loopholes, Too

The hue and cry over GE's nonexistent tax bill obscures important realities about corporate taxation.
Randy MyersApril 18, 2011

By statute, the federal government levies a 35% income tax on corporate profits. In reality, critics counter, companies pay less — often far, far less. The truth lies somewhere in the middle — but not in the part of the middle that companies would prefer.

This was brought home last month when it came to light that General Electric paid no federal income taxes last year, despite earning $12 billion on $150 billion in sales. Much of the media coverage noted that GE generates a substantial portion of its profits overseas, where it typically pays lower tax rates than those levied by the United States. Finger-waggers also noted that the company reinvests much of those profits offshore, avoiding U.S. taxes on those amounts until and if it repatriates them.

What was made less clear is that GE’s tax bill, or lack thereof, was largely determined by the fact that it sustained nearly $32 billion in losses at its GE Capital subsidiary between 2008 and 2010.

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“Nobody wants to lower their taxes by having real losses, and frankly that’s what happened to GE,” observes Mark Weinberger, global vice chairman of Big Four accounting firm Ernst & Young.

GE also noted that its effective tax rate of 7.4% — a figure reflecting what it paid at home and abroad — would have been about 15% absent the GE Capital losses.

A related media outcry was unleashed recently in response to research by New York University finance professor Aswath Damodaran showing that companies in some industries had astonishingly low effective income-tax rates in 2009: 4.5% for biotechnology companies, 5.6% for pharmaceutical companies, and 5.9% for Internet companies, to cite some examples. Damodaran’s data, in fact, indicated that the average tax rate across all industries was just 14.7%.

But a fuller review of Damodaran’s research reveals that the eye-popping numbers aren’t as damning as they appear. As Damodaran tells CFO, those numbers reflect the average effective tax rate for every company in each industry he studied, including those that had posted losses and thus paid no taxes at all.

Throw out the losers, Damodaran explains, and the numbers are dramatically different. Updated for 2010, for example, his data shows that while the effective tax rate for all biotech companies was 5.7% last year, the average rate for those that actually made money was a much more substantial 26.9%. The effective rate for all 5,928 companies he studied was 15.3%, but for companies that finished in the black it was 29.8%.

As for the claim that big companies have the resources needed to exploit every loophole and drive their tax rates down whether they make a profit or not, a CFO analysis of companies in the S&P 100 found that those companies had an average effective tax rate of 28.5% last year.

As the push for reform intensifies (watch for a related story in CFO magazine in May), critics on both sides will have valid arguments to make. Here’s hoping that when data is trotted out to support a point, it’s presented in its full context.