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The New York Times published a four-page cover story on Friday showing how, using a bevy of tax shelters and a legion of lobbyists, General Electric (NYSE: GE ) paid no U.S. income taxes last year.
Predictably, people lost their noodles. The story was especially noxious because GE's CEO Jeff Immelt is President Obama's chairman of the Council on Jobs and Competitiveness. At least 500 media outlets picked up the story within hours of being published, nearly all of them outraged. Jon Stewart of the Daily Show profiled the story on his "I give up" segment, saying, "I know the Supreme Court ruled that corporations are people, but what I didn't realize is that those people are [jerks]."
While enlightening, the Times' story was probably overstated. GE may not have paid any U.S. taxes in 2010, but 2010 wasn't a normal year. Of the hundreds of media outlets covering the story, the most informative take may have come from Washington Post blogger Ezra Klein, who posted an email from a contact at GE:
The Times' story missed the most important part of the story, and I wanted to make sure you have all the facts. The reality is that within the context of the 2008 financial crisis, GE Capital suffered significant losses, which affected taxes. Take out GECapital, and GE's effective corporate tax rate would be 21%.
Here's how it works. General Electric is made up of two major segments: GE Capital and GE. GE Capital is a financing arm; GE makes wind turbines, light bulbs, stoves, and other stuff. GE is a good, profitable business. GE Capital has a knack for losing ungodly amounts of money, particularly over the past few years and particularly in the U.S. Losses from GE Capital's U.S. division offset taxes the GE parent company would have owed the IRS -- so much so that GE's overall tax rate hit zero last year.
Overlooking this stuff is common. A pitchfork-waving website called PayUpNow.org lists several corporations that have paid scant U.S. taxes in recent years. Among the culprits: Citigroup (NYSE: C ) , Bank of America (NYSE: BAC ) , and AIG (NYSE: AIG ) . What do these companies have in common? They've all lost a metric ton of money over the past few years. When you or I lose money on our investments, it's tax-deductible in subsequent years. Similar deal for corporations. Nothing fishy about it.
Still, the Times is quite right about one thing. GE -- and many other large corporations -- employs a small army of tax lawyers whose job is to find every loophole and lobbying mission available to keep the tax bill low. Even before GE Capital was bleeding money, GE's U.S. tax bill was far below the statutory 35% rate, averaging 17% from 2004-2006. It's able to achieve these rates -- comparable to the marginal rate of a person earning less than $700 per month -- by running income through foreign subsidiaries with lower tax rates and running lobbyists through Washington.
You can't blame it for this. It's rational for a company to seek the lowest tax rate possible. This doesn't make them unpatriotic. It makes them capitalists. Part of the problem is the U.S. corporate tax rate is among the highest in the developed world. Countries we often paint with a stigma of high taxation -- France, Norway, Germany -- all have lower corporate tax rates than the U.S. Much more so than individual tax rates, corporate tax rates are competitive across borders. It's a globalized world. So to a certain extent, American corporations like GE have to run circles around our tax code just to stay competitive.
I don't think GE should be demonized in light of the Times' story. It's acting like any rational, profit-seeking company should.
It's the tax code itself that's the problem, and it's damaging to the economy in a couple ways. One, it makes it hard for small companies to compete with the big boys who can afford in-house tax departments. President Obama pointed this out in his State of the Union speech this year: "Those with accountants or lawyers to work the system can end up paying no taxes at all. But all the rest are hit with one of the highest corporate tax rates in the world. It makes no sense, and it has to change."
Why it might have to change is because, even though our corporate tax rate is among the highest in the world, its contribution to tax revenue is nearing irrelevancy:
Sources: U.S. Treasury, author's calculations.
There are several explanations for why this charts nosedives, not the least of which are lower tax rates. But there's more to the story. Corporate taxes as a percentage of the total tax pot has steadily plunged:
Sources: U.S. Treasury, author's calculations.
This chart, I think, shows a broken tax system. The corporate tax code is so inefficient, both in its rate compared with other nations and its ability to exploit, that companies like GE effectively avoid it. Unfortunately, these large corporations are the ones capable of making a dent in tax revenue. The poor schmucks that end up actually paying the 35% corporate tax aren't large enough to make much of a difference. The result is a corporate tax code that favors the large, punishes the small, and puts an outsized burden on individuals to pay the country's debts. If corporate tax revenue as a percentage of GDP were the same today as in 1962, today's deficit would be almost a third smaller.
What's the solution? Some have suggested switching to a territorial tax system. Others have proposed lowering the corporate tax rate but gutting exemptions and credits. Others still say leave it alone.
What about you? I want your take. Share your thoughts in the comment section below.