"Corporate
Tax Evasion on an Enormous Scale"
February 28, 2003
Huck Gutman
President Bush has told the nation
he is worried about what he calls a ‘double taxation’ on dividends.
As a consequence he has proposed to Congress that taxes on dividends be eliminated.
The effrontery of the proposal is stunning.
First, last year President Bush decided
the nation might need to go a war. Then, instead of asking citizens
to pay for its costs, he announced he would ask Congress to reduce taxes
-- just when the government’s expenses are set to rise dramatically.
(That is not, of course, even taking account of the projected $300 billion
deficit for next year, a deficit predicted even before war costs are calculated.)
Second, with unemployment
almost 50 percent higher than when he took office, with almost ten percent
of America’s manufacturing jobs lost in the past two years, George W. Bush
decided to press for a tax cut that will go overwhelmingly to the nation’s
wealthiest citizens – those in the top one percent, whose annual incomes
are over $374,000 a year. This small group of Americans, according
to computations run by Citizens for Tax Justice, would get 48.9 percent of
the total benefits this year should the President’s plan to eliminate dividend
taxes be approved.
Third, there is the hypocrisy of President
Bush recommending the elimination of the tax on dividends on the basis that
tens of millions of Americans own stock – when he knows that the great majority
of the stock owned by most of those Americans is in pension funds, which
makes them immune from dividend taxes anyway. While he claims he is
helping everyone, the benefits of his proposed cuts go overwhelmingly to
the wealthy.
Surely this is effrontery. But
there’s more.
A current system of double accounting
is the shame of the nation, yet Mr. Bush does nothing about it. Never
mentions it. Won’t acknowledge that it exists. As readers might
imagine, this double accounting is not available to working Americans.
But it is available to corporations, who use this double accounting to avoid
paying the taxes they legitimately owe the government.
The Joint Committee on Taxation of
the U.S. Congress has concluded that corporations use differences between
tax rules and accounting rules to avoid paying taxes on their profits.
Take Enron, for example. Enron reported to its shareholders that it
earned $3.625 billion in profit between 1996 and 2000. It then turned
around and reported to the IRS that it had only earned $76 millions in profit
during those years. This double accounting defrauded tens of thousands
of shareholders and pensioners out of billions of dollars, for the cooked
books were discovered to have masked questionable investment procedures.
What is not widely known, however,
is that Enron’s reported profits should have generated $1.142 billion in
taxes – yet the corporation paid only $63million in those years.
This is a scandal that is in no way
limited to Enron alone, or to a handful of rogue companies who keep double
books and in the process defraud the government of money owed for taxes.
In a remarkable study, Harvard University
economist Mihir A. Desai has calculated the difference between the profits
that corporations reported to the Internal Revenue Service in 1998, and the
profits that accountants certified in the annual reports the companies issued
to their stockholders. The difference between them is staggering: $154
billion in 1998. The result of almost one-sixth of a trillion dollars
hidden by accountants’ sleight-of-hand from the IRS? The federal government
did not collect $54 billion that should have been paid in taxes.
How do these corporations get away
with two sets of books? How can they tell their stockholders they are
raking in profits, and then turn around and tell the IRS that they had such
a bad year that they will pay little or nothing in taxes?
Don’t ask President Bush. He
is, all too obviously, more concerned with reducing taxes on the wealthy
than with collecting taxes owed by wealthy corporations. Eliminating
double bookkeeping – requiring corporations to use similar accounting in
both their corporate reports and the IRS filings – is truly sensible tax
reform, but will not be forthcoming from those in power.
According to the New York Times, the
IRS has recently reported that while small corporations bear their fair share
of taxes, large corporations don’t. Though the corporate tax rate is
35 percent, the IRS found that the 10,000 largest corporations paid only
20.3 percent of their 1999 profits in federal income taxes. The second
tier of companies, good sized but not large, paid taxes at a rate almost
50 percent greater, 30.9 percent. And here’s the kicker: the
10,000 largest corporations had over 25 times the total profits that the
second tier generated – and got away with paying at a lesser rate even though
they earned a lot more. That is not progressive taxation – it is regressive
taxation.
By what means do corporations evade
paying taxes on their profits? Tax shelters allow fake losses (think
of all Enron’s ‘deals’), deductions are double accounted, and cash is transferred
internally. Corporations claim excess depreciation or reinvest earnings
abroad to shield them from domestic taxation.
But the largest single contributor
to this evasion of taxes is the lavish awarding of the stock options to corporate
executives. According to Professor Desai, “the proliferation of option
instruments to compensate employees has had a significant role in creating
a large and growing gap between tax income and book income and in changing
the corporate tax base.” Desai found that for the nation’s largest
corporations, option exercises consumed over a quarter – 27 percent – of
operating cash flow in a five-year period covering 1996 through 2000.
(“Operating cash flow” is a term used by accountants to indicate the money
made by a company; it is a more accurate measure of what is going on than
earnings, and is one way of considering a company’s profitability.)
All those stock options we have been
reading about? They not only weaken corporations and bilk stockholders,
it turns out they divert a huge amount of tax revenue away from the IRS and
into the pockets of wealthy corporate executives. CEOs get rich not
only at the expense of stockholders, but at the expense of taxpayers: when
corporations do not pay what they owe, the bill comes due to the rest of
us, either in higher taxes or in a mounting national debt that our children
will have to repay.
The problem is getting worse.
Professor Desai found that in those same years, 1996 through 2000, the value
of stock options awarded more than sextupled, from $32 billion to more than
$199 billion. The value of stock options that were exercised – actually
used – more than tripled, to $106 billion. $78 billion in options were
exercised in the nation’s 150 largest firms alone, with a resulting ratio
of options exercised to operating cash flow of over 29 percent. Corporate
profits, and the taxes that should be paid on those profits, are flooding
into the investment portfolios and bank accounts of corporate executives.
There are solutions to the problem
of stock options and double book-keeping. The first is simple.
Require every corporation, and its accountants, to publish the income accounting
it provides the IRS alongside the accounting it has traditionally provided
in the company’s annual report to stockholders. If there are going
to be two sets of books, at least let everyone know this is the case, and
open any fancy bookkeeping to the light and fresh air of public scrutiny.
The second solution is almost as simple.
Change accounting rules so that stock options, the largest single contributor
to the disparity between book accounting and tax accounting, are expensed
on corporate balance sheets.
The third is radical, and hence harder
to legislate – the special interests will never allow it. Require corporations
to keep only one set of books. If they report a small profit or a loss
to the government, then make sure they report that same earnings results
to their shareholders and their bankers. If they claim they are profitable
to their stockholders, let them pay taxes on those profits.
One solution or another, it is time
to do something about double bookkeeping.
Huck Gutman is a columnist for The Statesman in Kolkata,
India and writes regularly for Dawn in Karachi, Pakistan. He teaches at the
University of Vermont.