Hunting tax dodgers

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It is August in a US election year, so we are due some moral outrage from Washington. Senators Byron Dorgan and Carl Levin are up in arms following a report from government watchdogs indicating that two-thirds of domestic and foreign companies doing business in the US don’t pay a dime in federal income tax. Mr Levin says the report “makes clear” that “tax trickery” is rife and denying the Treasury its fair share of profits.

The report does nothing of the sort – as its author points out on the first page. Internal Revenue Service data show that in 2006, of 2.3m companies filing returns – excluding pass-through entities such as Reits, which pay little or no federal tax anyway – 69 per cent had assets of less than $1m. It is not surprising that many small companies, which will often be lossmaking or barely profitable, pay little or no tax. The report shows that the proportion of large companies – which pay the overwhelming majority of tax receipts – reporting no tax liability peaked in 2001 and 2002. This was during a recession so, again, little surprise there.

The fact that a bigger proportion of foreign-owned corporations reported no liability at this time is also telling. Foreign ownership of US companies increased markedly in the acquisition boom of the late 1990s. Foreign buyers accounted for 32 per cent of US deals in 2000 compared with 12 per cent in 1996, according to Dealogic. This is important because foreign companies tend to earn lower profits on US purchases in the early years owing to upfront costs. Interest costs on debt financing for deals also reduce taxable profits. Use of deferred tax assets complicates the picture further. Global supply chains and capital flows do increase the risk of tax abuse, so vigilance is paramount. But sweeping judgments serve little purpose, other than political grandstanding.

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