Do Corporations Really Pay No Taxes?

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By most accounts, 2005 was a good year for the U.S. economy. The nation added more than 2 million jobs and the unemployment rate averaged less than 5 percent. Gross Domestic Product grew robustly, and corporate profits soared nearly 18 percent. But few people, including many in the media who regularly report on the economy, understand what happened below the surface to produce those surprisingly good results. Consider, for instance, job growth.

American businesses actually produced 31 million new jobs in 2005, driven by on average some 1.5 million firms every quarter that were expanding, and another 370,000 new businesses that were starting up. On the other hand, firms also eliminated nearly 29 million jobs, including an average of nearly 1.5 million businesses that were contracting each quarter and another 325,000 going out of business, according to the Bureau of Labor Statistics’ Business Employment Dynamics survey. The net result, 2 million additional jobs, is the product of the enormous creation and destruction going on below the surface.

Those startling numbers should remind us that even in a strong economy there are plenty of losers—not just winners. And that should help explain what’s wrong with the press’s coverage of a Government Accountability Office study released last week, which reported that two-thirds of American corporations paid no taxes in 2005—including a quarter of big businesses. The report, commissioned by several labor-friendly Democratic Senators who pretty much knew based on previous studies what it would say, sparked a lot of manufactured outrage in political circles and produced a series of misleading stories, like one by the Associated Press that ran in dozens of newspapers under sensationalistic headlines like “Corporations Pay No Taxes.”

A number of more rational commentators have pointed out some of the ways that the pols have led the media astray on this one. Kevin Hassett, in a Bloomberg commentary, explained that most small businesses are now organized in such a way that many prefer to take their profits as an owner’s salary and pay taxes on the wages. It’s not that they aren’t paying taxes, as the headline incorrectly says, but rather that the money is not flowing to the government through the corporate levy.

Still, the report leaves open the question of larger businesses that paid nothing. The impression one gets from corporate critics is that many are prospering but exploiting loopholes in the tax code and leaving the rest of us to pick up the tab. But that criticism is based on the mistaken notion that in robust years, such as 2005, virtually all businesses do well. Nothing could be further from the truth.

Even in good times, there are plenty of losers in a dynamic economy. The BLS’ Business Dynamics Survey, for instance, shows that in 2005 there were 7.3 businesses that were contracting for every 7.6 that were expanding, including 1.3 that were closing their doors for every 1.5 that were starting up. Large businesses were hardly immune to this kind of tumult. For every 5.8 jobs added by firms with more than 500 employees, other firms that big eliminated 4.9 jobs. Among those hit hard in 2005 was General Motors, which despite $193 billion in revenues wracked up a $10.4 billion loss and cut its workforce.

It shouldn’t be necessary to remind reporters and editors who cover such matters that businesses pay taxes on their profits, not sales. But I often read stories in which a reporter confuses the two, saying that a business “made” $50 million when the writer is referring to the company’s sales. Much of the press that the GAO report received revolves around blurring the distinction between these two. As Michigan Senator Carl Levin, a frequent critic of corporations, said of the study, “Twenty-five percent of the largest U.S. corporations [those with more than $50 million in revenues] had $1.1 trillion in gross sales in 2005 and yet paid no federal income taxes.” That statement suggests that Levin is either trying to mislead us or that he has made it into the world’s most exclusive club, the U.S. Senate, without knowing the difference between earnings and sales.

The difference, of course, can be enormous. For one thing, many industries have extremely small profit margins because as soon as it gets too easy to make a buck in a free-market system, you’re sure to get plenty of competitors crowding in, driving down your margins. The average net margin in the supermarket business is just 1 to 2 percent of sales, for instance, which means that a company with $50 million in sales (to use the study’s definition of large businesses) would earn, on average just $500,000-to-$1 million annually and pay taxes on that money. Many firms in the industry, of course, would be below that average, and some would lose money in any year.

Many businesses we regard as successful operate on small profit margins. After paying $5.8 billion in taxes in 2005, Wal-Mart earned $11.7 billion—a nice chunk of change. But those earnings were on revenues of $312 billion, a mere 3.4 percent net profit margin. Exxon Mobil earned $36 billion in 2005 after paying $23.3 billion in taxes on revenues of $371 billion. Looking at that result you realize that in America today, a ‘windfall’ profit is one that amounts to less than 10 percent of revenues.

The politics behind the GAO report are transparent—to undermine the momentum that’s building to cut corporate tax rates. As I wrote several weeks ago (“In the U.S., Selectively Applied Capitalism,” July 28), the U.S. has the second highest corporate tax rate among 30 countries in the Organisation of Economic Co-Operation and Development. That matters because, as economists for the OECD recently concluded, the corporate tax is the most harmful to economic growth of all the levies most commonly used by member nations. That’s why GOP presidential nominee John McCain favors lowering it, but so does the powerful Democratic Chairmen of the House Ways & Means Committee, Charlie Rangel. The Democratic presidential nominee, Barack Obama, has also said in newspaper interviews that he would consider cutting the corporate tax, but he hasn’t made that an official part of his platform.

Now, however, labor-friendly legislators egged on by union leaders are trying to derail calls for a corporate tax cut by manufacturing outrage against U.S. businesses. That’s not hard to do when you have so many journalists reporting and commenting on these issues who can’t get behind headlines that are spoon fed to them, like the editorial writer at Newsday who found the GAO report “jaw dropping.”

Yes, it’s true that 2005 was a good year for many American companies. As I noted above, corporate profits rose 18 percent, according to the Bureau of Economic Analysis. But taxes on corporate profits that year increased 34 percent, says the BEA. Growing firms, you see, do pay more in taxes. Just don’t imagine that every business is growing whenever the American economy is.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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