Federal corporate tax expenditures—special exclusions, exemptions, deductions, credits, deferrals, or tax rates—totaled more than $76 billion in fiscal year 1999, according to conservative estimates by the Office of Management and Budget. For the five-year period 2000-2004, the government will spend more than $394 billion on corporate tax subsidies.45
The notion of tax “expenditure” expresses the idea that revenue losses due to preferential tax provisions such as special exclusions, exemptions, deductions, credits, deferrals, or tax rates have the same budgetary implication as a giveaway of government resources. When the government does not collect certain taxes due to tax expenditures, it is spending money. And when the government fails to collect taxes from corporations due to various legal preferences, it is subsidizing those companies as surely as if it were making direct payments to them. The issue here is not tax rates, but tax preferences for particular categories of corporations or corporate behavior.
The special insidiousness of corporate tax expenditures is that they are hidden subsidies. They do not appear as budget expenditures, and because they represent money not collected (rather than payments doled out) they do not generate even the felt-outrage of off-budget giveaways. Generally, once they have been included in the Internal Revenue Code, corporate tax expenditures remain on the books unless Congress affirmatively acts to remove them. This situation contrasts to on-budget programs, which require continuing Congressional approval and authorizations to continue, and therefore are automatically subject to ongoing Congressional review, if not action.
The 1974 Budget Act requires that a list of tax expenditures, corporate and individual, be included in the budget. This budgetary requirement at least makes it possible to identify the cost of most corporate tax expenditures, and it is a model for what should be done in other corporate welfare areas.
Many of the corporate tax breaks merit special attention because they actually encourage undesirable activity, including environmentally destructive activity. The oil and gas industry, for example, wins major subsidies through the tax code. When the need to encourage a transition to renewable fuels is clear, why does the Internal Revenue Code encourage more aggressive oil drilling, with its associated environmental harms, than even market demand would induce? What rationale is there for artificially biasing the market against conservation and efficiency? Tax escapes and credits to the oil and gas industry take more than $500 million from taxpayers annually.46
Similarly, several tax rules encourage wanton mining, beyond that which is justified even on market terms, by providing tax incentives for mining operations. The effect is to bias the market against recycling interests.47 The percentage depletion allowance for mining allows mining companies to deduct a certain percentage from their gross income that exceeds the actual loss of value. (These vary by mineral, with sulfur, uranium, and lead given the high percentage of 22 percent.) Rules that allow immediate expensing of exploration and development, rather than a write-off as mines are depleted, plus other mining tax escapes, cost the Treasury an estimated $300 million a year.48
Then there are the specially targeted loopholes, such as the Amway example mentioned in the introduction. The Amway case is typical in the shady fashion in which it transpired, but it is somewhat atypical in that the exact beneficiaries were identifiable. Anonymity works as a protective shield for the corporate tax renegades. Removing that anonymity would make preservation of the tax advantages much more difficult politically. The President’s Office of Management and Budget (OMB) should be required to compile a list of the top 50 beneficiaries of each corporate tax expenditure.
A second critical issue involves the intended effect of each tax expenditure. Aside from serving as payoffs to politically well-connected companies, tax expenditures are designed to encourage specific kinds of behavior. Do they do so?49 For example, the Work Opportunity Tax Credit is designed to encourage firms to hire certain groups of people (such as recent welfare or food stamp recipients) for low-skilled jobs. The FY 1999 cost of this corporate tax expenditure is $285 million.50 But it may be that the tax credit also provides an incentive for churning of these employees, so that employers can repeatedly recoup the tax incentive. (Employers can claim a credit of up to $2,400 for the first $6,000 of a workers earnings; workers must be employed for at least 400 hours for the credit to be claimed.) The tax credit may also provide an incentive for employers to replace existing employees with new employees from the targeted groups. Determining whether or not these unintended and undesirable outcomes occur requires more data gathering and close scrutiny. And because of the nature of tax expenditures—they are effectively “administered” by the IRS rather than agencies with expertise in the relevant field—scrutiny will come from Congress, the media and citizens, or not at all.
One way to facilitate that scrutiny is to have sunset provisions for corporate tax expenditures (as for other corporate welfare programs), which would require Congressional renewal of tax breaks. The Work Opportunity Tax Credit is indeed scheduled to be phased out by 2004, but an unproven tax expenditure of this sort should have a shorter first life, say two years. At the least, a short initial period for tax expenditures would allow testing and review of whether they achieved their desired effects, and whether they had any harmful consequences. Generally, and without regard to the Work Opportunity Tax Credit, such a standard seems particularly appropriate given the harsh time limitations applied to welfare for poor people in the 1996 “welfare reforms.”
Another area deserving of immediate and priority Congressional investigation is the apparent underpayment of federal income tax by foreign corporations. A recent General Accounting Office (GAO, a Congressional research agency) report concluded that foreign-controlled corporations doing business in the United States pay approximately half the taxes that U.S. companies pay.51 The report found that the approximately 15,000 large U.S. companies paid an average of $8.1 million in federal income taxes in 1995. The approximately 2,700 large foreign-controlled corporations in the United States paid an average of $4.2 million in the same year. Foreign-controlled companies paid taxes as a percentage of sales at just over half the rate of U.S. companies. Senator Byron Dorgan and Citizens for Tax Justice attribute the differential payments in large part to manipulative transfer pricing by foreign multinationals—this practice of dubious legality involves paying too little or charging too much in paper transactions between U.S. and foreign affiliates, so that the income of the U.S. affiliate is artificially lowered. Citizens for Tax Justice points out that the growing number of foreign corporate takeovers of U.S. companies (Daimler’s purchase of Chrysler, Deutche Bank’s takeover of Bankers Trust and BP’s buyout of Amoco and possibly Arco prominent among them) may accentuate the tax avoidance problem.52
A second, growing source of multinational tax avoidance, according to Citizens for Tax Justice, involves financial transactions. In one, newly invented shell game, companies pay interest to non-taxable offshore subsidiaries and deduct the interest payments against their worldwide taxable income. But they claim an exemption from U.S. anti-tax haven laws by contending that, for U.S. tax purposes, the interest earned by the offshore subsidiaries does not exist. The Treasury Department has tried to clamp down on this tax-avoidance scheme, but has been blocked by Congress.