Demystifying the Myth
There has been much discussion surrounding the high corporate tax rate that US companies face. The recent GOP tax plan (‘Tax Cuts and Jobs Act’) proposed a reduction in the statutory corporate tax rate from 35% to 21%. However, do companies actually pay the 35% tax rate or do they pay something else?. That is, what is their ‘effective tax rate’? Companies’ effective tax rates can differ significantly from the statutory tax rates for a number of reasons - for example, companies may have tax breaks for investing in R&D, or they may and receive accelerated depreciation on machinery and equipment. Therefore, what they end up paying in reality may be much lower than the often-quoted 35%.Let’s take a look at the recent trends in the effective corporate tax rate:
The above chart shows that the average effective tax rate for all publicly-listed companies varies from year-to-year and this is due to some extreme outliers. For 2016, the average effective tax rate is 12.64%, suggesting that there are some companies with very large ‘negative’ or low tax rates skewing this average downwards. Companies with negative tax rates usually have losses which suggests that the company can carry forward these losses to other years to offset against income. If we ignore firms with losses, then the average effective tax rate in 2016 is 15.09%. If we look at the median effective tax rate, it is fairly stable around 21% for the past five years. Overall, this suggests that companies generally do, in fact, pay much lower taxes than the 35% corporate tax rate by leveraging the ‘tax breaks’ afforded to them.
Let’s take a look at the Fortune 500 companies. Both the mean and median effective tax rates for the Fortune 500 are higher than the overall sample tax rates. The median effective tax rate for the past five years is around 30%. In 2016, the average (median) effective tax rate for Fortune 500 companies is 21% (29%).
What do the largest companies in the U.S. pay in taxes? Let’s take a look at the Dow 30:
In 2016, the average effective tax rate in the past five years has ranged between 26% - 28.5%, and the median has ranged between 25% - 27.4%. Below is the listing of the ten companies within the Dow 30 that have the lowest effective tax rates in 2016.
The Interesting Tidbit
So, how do these companies reduce their effective tax rate?
All ten companies were able to reduce their effective tax rate in 2016 as a result of their foreign operations in lower tax jurisdictions. On average, the ten companies were able to lower their tax rate by 17% as a result of the foreign tax rate differential. Interestingly, Merck was able to completely eliminate any taxes paid by operating in foreign jurisdictions - they were able to reduce their tax rate by 34.8% as a result of their foreign operations. General Electric was able to reduce the tax rate by 23.7%, and Nike Inc was able to reduce it by 20.7%. Of the ten companies, only four companies reduced their taxes as a result of U.S. manufacturing credits, and three companies leveraged the research
So, what does this mean for the GOP tax bill to reduce the statutory corporate tax rate by 14% from 35% to 21%? In 2016, approximately 30% of all public companies had foreign operations that impacted their effective tax rate. Does this mean that for the remaining 70% or so of companies that they simply received a large tax break? For companies like Merck, General Electric and Nike, is it enough to incentivize them to bring some if not all of their profits back to the U.S. given that they already are able to reduce their taxes by more than the 14%? Perhaps so, and only time… and the data will tell.