President Bush urges cutting taxes on dividends -- while leaving untouched corporate double bookkeeeping, which costs billions in lost tax revenues.

"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.