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January 22, 2007
The Effective Corporate Tax Rate Is Falling
by Martin A. Sullivan — martysullivan@comcast.net

Full Text Published by Tax Analysts®

Document originally published in Tax Notes
on January 22, 2007.

Four years ago, Treasury closed the books on another fiscal year and counted $148 billion in corporate income tax receipts for 2002. At the same time, it bravely predicted corporate receipts would increase to $234 million for fiscal 2006 — a 58 percent increase in four years.

Treasury was wrong, but nobody — least of all Treasury — is complaining. The final numbers are in, and corporate tax receipts for 2006 total a remarkable $354 billion — a 139 percent increase in four years. Figure 1 on the next page depicts this fiscal phenomenon.

After years in the doldrums, the corporate tax is back. It's a moneymaker exceeding all expectations. And its surprising strength is the main reason the Bush administration and Congress are getting a breather before they are again forced to consider the looming long- term federal budget deficit.

Surging profit is the main factor behind this good fiscal news. Figure 2 on the next page shows the latest Commerce Department data on domestic corporate profits. Like income tax receipts, profits are on a rapid upward trajectory. Domestic corporate profits have nearly tripled in the last four years, rising from $554 billion in fiscal 2002 to $1,527 billion in fiscal 2006.

From K Street to the Capitol, the corporate tax windfall is making life easier for official Washington. But before anyone gets too comfortable, it'd be a good idea to pause and consider the facts a little more closely. The data also show that the corporate tax intake per dollar of profit — that is, the effective corporate tax rate — is falling. It now stands at a 10-year low of 22.2 percent — the tail end of the solid line in Figure 3 on p. 282.

This most recent decline appears to be part of a longer-term trend. The five-year average effective corporate tax rate for 1997- 2001 was 29.7 percent. The average for 2002-2006 was 25 percent.

That trend in the national data corroborates the trend seen in other data sources. Large pharmaceutical and high-tech companies have reported declining effective tax rates in their annual reports. (See "Drug Firms Move Profits to Save Billions," Tax Notes, Aug. 7, 2006, p. 472, Doc 2006-14640 or 2006 TNT 152- 5 ; and "High-Tech Companies' Tax Rates Falling," Tax Notes, Sept. 4, 2006, p. 818, Doc 2006-18379 , or 2006 TNT 171-6).)

A Fresh Look

The dashed line in Figure 3 represents what we reported on this topic last summer ("Despite Rapid Growth, Corporate Tax Receipts Fall Short," Tax Notes, July 17, 2006, p. 216, Doc 2006-13336 , 2006 TNT 137-3 ). The difference between the two lines in Figure 3 is attributable to revisions in the official data on corporate profits over the last six months. In July, based on official estimates available at the time, we assumed that corporate tax receipts for fiscal 2006 (which ended on Sept. 30, 2006) would total $330 billion. As noted, the actual amount turned out to be $354 billion.

Standing alone, that change would have resulted in an upward revision in the corporate effective tax rate for 2006. But revisions to domestic corporate profit data (the denominator of the effective tax rate fraction) were even larger. In July the figure for fiscal 2006 was estimated to be $1,312 billion. Now, as shown in Figure 3, we know the actual figure for 2006 is $1,527 billion.

Based on the July estimates, we concluded at the time that "the current burst in corporate receipts should not give us any comfort that the era of corporate tax shelters is coming to a close."

The revised estimates, which show a more pronounced decline in the estimated effective corporate tax rate, require a stronger conclusion: The recent surge in corporate tax revenue has been accompanied by a decline in estimated effective corporate tax rates that is not explained by changes in tax law.


Figure 1. Corporate Income Tax Receipts, Fiscal 1997-2006



Source: Financial Management Service, Treasury Department,
Monthly Treasury Statement, September issues from 1997 through 2006.

Figure 2. U.S. Domestic Corporate Profits, Fiscal 1997-2006



Source: Domestic profits before tax form Table 1.14 (line 32)
of the National Income and Product Accounts, produced by the Commerce
Department's Bureau of Economic Analysis.

Figure 3. U.S. Effective Domestic Corporate Tax Rate (Adjusted),
Fiscal 1997-2006



Source: Data from Figure 1 (adjusted for tax law changes as
described in the July 17 Tax Notes article) divided by data
from Figure 2.

That decline in effective tax rates might be due to any number of relatively benign factors, including increased use of S corporations, increased corporate holdings of tax-exempt bonds, increased deductions for bad debts (not included in the official profit measure), a reduction in capital gains realizations (taxable but not part of official profit data), or increased tax-exempt Federal Reserve Bank profits (included in the official profit totals). And, as I discussed in the July article, there could be flaws in the data. But we must also consider the possibility that aggressive tax planning is on the rise.

Notes

In addition to surging corporate profits, changes in corporate tax laws also explain some of the increase in corporate tax receipts. As explained in the notes at the end of the July 17 Tax Notes article, effective corporate tax rates like those shown in Figure 3 have been adjusted for those changes. So the adjusted effective tax rates presented here may be thought of as the effective corporate tax rates, assuming no changes in the tax laws occurred since 2001.

Other technical data issues are detailed in the notes to the July 17 article. The data revisions included in this article are to (1) the Treasury corporate tax receipts data for fiscal 2006 and (2) the domestic corporate profits before tax (without inventory valuation and capital consumption adjustment) for fiscal 2003 through 2006.


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