Bacon's Rebellion

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Random Fact of the Week: Corporate Income Tax

—

by

James A. Bacon
in

Corporate income tax as a percentage of gross revenues reported to the IRS (2008):

United States: 12.9%
Virginia: 17.3%

Source: Internal Revenue Service Data Book (2008), Table 5.

Question: What does this tell us? How do we explain the fact that corporations account for a disproportionately large share of the federal income tax take in Virginia than in the United States as a whole? The same federal tax code applies across the country. Do Virginia certain industries disproportionately benefit from special tax breaks analogous to the oil depletion allowance? Alternatively, do Virginia businesses pay higher taxes because they are more profitable? Or, another theory: Do Virginia businesses pay higher taxes simply because we have more large tax-paying corporations domiciled in the state?

I’d like to see you braniacs out there weigh in on the issue. Perhaps you can bring some relevant data or analysis to bear.

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31 responses to “Random Fact of the Week: Corporate Income Tax”

  1. Anonymous Avatar
    Anonymous

    Given the big role of contracting for the federal government, which in VA is probably more service oriented than manufacturing, does it tell us service companies pay higher taxes than manufacturing or related companies?

    TMT

  2. Groveton Avatar
    Groveton

    Jim's calculation is the percentage of corporate taxes collected as a percentage of total taxes collected (by the IRS). This could be caused by several factors. First, Virginia's people could be considerably less affluent than its companies. Second, Virginia could have more corporations relative to population than other states. Third, individuals in Virginia could have higher tax deductions than elsewhere (think high mortgages). Finally, Virginia's corporations could have lower deductions than corporations elsewhere (true of services firms with limited R&D tax credits.

  3. Larry G Avatar
    Larry G

    http://www.forbes.com/2009/09/23/best-states-for-business-beltway-best-states_table.html

    or

    http://tinyurl.com/yb66vw9

  4. Anonymous Avatar
    Anonymous

    Virginia companies are more profitable due to a high percentage of government contracting.

    They don't have t be out in the real world actually making something, and as a result they have fewer tax sheltering investments generating the money.

    RH

  5. Groveton Avatar
    Groveton

    RH:

    Not quite. The lowest tax rates in the US go to companies which can take accelerated depreciation charges or have large R&D outlays. This includes manufacturing companies and technology companies which make product – like IBM. Services companies (your typical government contractor) have few options to lower their tax rates with various credits and deductions. This is one reason why many US headquartered services companies remain partnerships – McKinsey, Bain, Deloitte.

    The higher percentage of Federal corporate taxes collected in Virginia relative to Federal personal income taxes is likely the result of a disporportionate level of services revenue. The additional taxes have little to do with profitability and a great deal to do with tax credits and deductions.

    An interesting analysis would be to look at the profits (as a percentage fo revenue) vs. Federal taxes paid (as a percent of revenue) for a selection of companies located in Virginia.

  6. Anonymous Avatar
    Anonymous

    "The lowest tax rates in the US go to companies which can take accelerated depreciation charges or have large R&D outlays. This includes manufacturing companies and technology companies which make product – like IBM."

    Yes, but we aren't talking about tax rates, we are talkinga bout profitability. I have a lot of stuff to depreciate on the farm, but I have to buy all that stuff and the reason I am allowed to depreciate it is because it is wearing out.

    My high depreciation makes my taxes low, but it doesn't gurantee a profit.

    I'd prefer to have the profit and pay higher taxes on it.

    RH

  7. Groveton Avatar
    Groveton

    RH:

    I understand your position with the farm. But my reading of Jim's data (including chasing the link) is that he is relating corporate taxes colleted to the Fed to the total tax take by the Fed. He is not relating the tax percentage to the revenue of the company from which the tax is collected. Maybe I don't understand what Jim was saying with his numbers.

  8. James A. Bacon Avatar
    James A. Bacon

    Groveton, Your reading is correct. We're not talking profit margins here — you can't get that from the IRS data. I'm just wondering what accounts for the fact that such a high percentage of the total income tax take from Virginia comes from corporations.

  9. Anonymous Avatar
    Anonymous

    yes, but back to square one.

    Don't you pay tax on profits?

    RH

  10. Anonymous Avatar
    Anonymous

    "Don't you pay tax on profits?"

    Yes and no, a company can report a loss to its investors, but still owe the IRS taxes.

    Also, a company can report a profits to investors, but very little taxable income.

  11. Anonymous Avatar
    Anonymous

    "Yes and no, a company can report a loss to its investors, but still owe the IRS taxes.

    Also, a company can report a profits to investors, but very little taxable income."

    All true, but not germaine to this string. The question is why a high percentage of the total income tax take from Virginia comes from corporations.

    The answer must be that they have a lot of profits, and ones they cannot hide, as with depreciation, depletion credits etc.

    If they owe IRS taxes they are calulated on profits, which as you point out may not have anything to do with what investors see. And if they have little taxable income, Bacon would not have a question.

    RH

  12. Groveton Avatar
    Groveton

    I see the issue now. What are profits? Let's take research and development. You have a group of people, who cost $1M per year, doing R&D. They try to create innovation. They file patents in the company's name. Should their salaries be deducted from the company's revenue in order to calculate profit?

    On the accrual books – definitely. They are employees of the company and their salary, benefits, office space, holiday parties, etc should be deducted from income to calculate profit.

    On the tax books – not completely. While the salary, benefits, etc are deducted, the government allows an R&D tax credit in some cases. If your R&D falls into the tax credit status then your R&D expense is partially an offset to your tax bill.

    If you look at a corporate income statement you'll see a lot of lines of financial information cumulating in a line called "Pre-Tax Income" or "Income Before Taxes" – something like that. Then you'll see a line called "Taxes" or "Income Taxes". Finally, and lastly, you'll see "Net Income".

    The tax calculation is not taking the Pre-Tax Income through a relatively simple tax table – like a personal income tax return. No, it is usually the final line item in a completely separate set of tax books. The separate tax books can come down to a very separate definition of "profit" than the accrual books. The accrual books are maintained with Generally Accepted Accounting Principles or GAAP. The tax books are maintained in alignment with whatever statutes happen to be a matter of law that year.

    The tax law is written partly based on economic logic but largely based on special interest lobbying. Some industries have better lobbyists than others. They get more corporate tax breaks. So, while they can be very profitable on a fair (or accrual or GAAP) basis, they can appear much less profitable when taxes are calculated.

    My suspicion is that Virginia's relatively high take of federal tax dollars from corporations stems from the fact that many of Virginia's industries are not well represented in special interest tax law.

    I'll end with a corollary. On a personal basis (only for federal taxes) – a person making $100,000 per year living in a house would pay a lower percentage of his income in taxes than his neighbor renting the identical house next door. Why? Because mortgage payments are deductible and rental payments are not. Now, multiply that single discrepancy in the tax code 10,000 times and you have the corporate tax structure in the United States.

  13. Larry G Avatar
    Larry G

    I looked at the tables and did some quick mental calculations and I'm not sure Virginia's numbers are that out of line with some other states.

    Before we go off on a wild goose chase here.. might want to generate the top 10 rankings and see how they compare.

    The url I posted previously is worth looking at – it shows Virginia on top of the most business friendly state – but within the sub categories are things that Va did not rank high on…

  14. Anonymous Avatar
    Anonymous

    The comment at 9/26/09 5:35 AM is almost on point with what I was trying to say.

    Earnings Before Taxes is not necessarily what goes on line 1-4 of your 1120. Also, EBT has nothing to do with the Internal Revenue Code. EBT is simply Earning b4 Interest and Taxes less interest expense.

    I also thought VA was on point with most other states. The states that were had a really percent of their IRS collections coming from corporation where DE (~40%) and NV (~30%).

  15. Anonymous Avatar
    Anonymous

    Finally, and lastly, you'll see "Net Income".

    Which is what the shareholder care about.

    RH

  16. Anonymous Avatar
    Anonymous

    Jeez.

    Just because Virginia corporations pay high taxes does not mean virginia is not business friendly.

    Just the opposite. Virginia is business friendly and that allows them to make high profits – on which they pay taxes.

    My take is also that companies in other states that actually produce things have higher expenses than beltway bandits that think and produce paper.

    RH

  17. Anonymous Avatar
    Anonymous

    From the previous posts, it seems like most of the posters are clueless about accounting.

  18. Anonymous Avatar
    Anonymous

    "From the previous posts, it seems like most of the posters are clueless about accounting."

    OK, so clue us in.

    I actually did study accounting, but only for two semesters.

    Despite all the comments above, I hold my position: you don't owe taxes unles you make a profit.

    There are two possible reasons that Virginia coorporations pay a high percenage of total taxes:

    Either their tax rates are much higher than other states, or they make more profit. They might make more profit becuase Virginia is a business friendly state in other ways.

    For example, in Viginia an insurance comapny can cancel your policy for up to two years – retroactively. That helps it make it pretty easy for an insurance company to cull its bad risks, without actually investing in any proactive risk management.

    Pretty easy to make profis that way, and I don't have any sympathy or them if they have to pay taxes – on their profit. Especially sinc they pass th cost on to te customers, anyway.

    If therr is something wrong with my accounting, please let me know.

    RH

  19. Anonymous Avatar
    Anonymous

    For example, some people above have referred to this problem as one of accrual accounting.

    My understanding of accrual accounting is that the same events boil down to expenses or income in the end, but we write them in the books at different times.

    In accrual accounting we accrue the expense of a subcontract when we siiue the contract: in cash accounting we record the expense when we pay it.

    Please clue me in.

    RH

  20. Larry G Avatar
    Larry G

    accrual accounting basically in looking at your cash flow more holistically on a dynamic basis whereas cash accounting is primarily transaction-based.

    In cash account, $1200 "profit" does not recognize that $1300 bill due next month.

    Cash Accounting is how people spend the grocery money because they forgot about the car payment due in two weeks.

  21. Anonymous Avatar
    Anonymous

    "Cash Accounting is how people spend the grocery money because they forgot about the car payment due in two weeks."

    Precisely.

    But however you do that, you still pay taxes on gross profit, and after taxes you are left with net profit (if any). At least that's the way I recall it.

    RH

  22. Larry G Avatar
    Larry G

    it depends WHEN you do the calculation for NET PROFIT and what things you include and exclude.

    That's separate from tax policy because we end up with some businesses who "on paper" look very different than on the tax form.

    this is why, in theory, the government requires you to show an actual "profit" at some point if you are claiming "expenses".

    you can always tell when tax policy changes because the market reflects it.

    For instance, in the last decade or so, does anyone wonder why we have , far, far more wineries than we used to have and yet the wine they sell is still outrageously expensive and apparently immune to competitive markets?

  23. Larry G Avatar
    Larry G

    Here is an interesting article on risk:

    " Taxing Banks to Pay for, and Prevent, Future Bailouts"

    " Both public interventions are justified by negative externalities, which occur when one person’s activity adversely impacts other people. On the highways, each driver slows everyone else, and tolls can speed traffic by keeping price-sensitive drivers off the road."

    In the financial markets, institutional risk-taking creates the risk of failure and federal bailout. The reason to intervene, on either the highways or the Bourse, is to limit the social damage created by people and companies that act without worrying about the costs that they impose upon others."

    http://economix.blogs.nytimes.com/2009/09/29/taxing-banks-to-pay-for-and-prevent-future-bailouts/

  24. Anonymous Avatar
    Anonymous

    Alternate fact of the week:

    "ONCE the toys of rich yuppies, mobile phones have evolved in a few short years to become tools of economic empowerment for the world’s poorest people. These phones compensate for inadequate infrastructure, such as bad roads and slow postal services, allowing information to move more freely, making markets more efficient and unleashing entrepreneurship. All this has a direct impact on economic growth: an extra ten phones per 100 people in a typical developing country boosts GDP growth by 0.8 percentage points, according to the World Bank. More than 4 billion handsets are now in use worldwide, three-quarters of them in the developing world (see our special report). Even in Africa, four in ten people now have a mobile phone."

    The Economist

    RH

  25. Anonymous Avatar
    Anonymous

    "it depends WHEN you do the calculation for NET PROFIT and what things you include and exclude."

    How do you include and exclude things without cheating? Income goes on the plus side and expenses go on the minus side. You don't get to pick and choose. if you pay an expense, that money has to come from somewhere, so how do you not report it, unless you are Bernie Madoff?

    The accrual method defines WHEN you take the income or expense. Same with cash accounting: I can ELECT to pay off debt this year and reduce my profit, but that only increases my profit next year, assuming sales are about the same.

    As you point out, the accrual method does bring some of the foreseeable future into the present, which provides a more balanced picture than just a snapshot in time.

    That is the problem with cost of community services studies: they are based on a snapshot in time when some kind of accrual would provide a different picture.

    RH

  26. Anonymous Avatar
    Anonymous

    "…does anyone wonder why we have , far, far more wineries than we used to have and yet the wine they sell is still outrageously expensive and apparently immune to competitive markets?"

    Same goes with microbreweries.

    The main factor is not taxes, but liberalizing the sales and licensing policies. Wine used to have to be sold through a distributor, but now they can sell direct.

    RH

  27. Anonymous Avatar
    Anonymous

    One Way Uhaul truck rentals:

    Detroit to Fairfax $1,109
    Fairfax to Detroit $ 599

    Providence to Fairfax $532
    Fairfax to Providence $292

    ——————————-

    Fairfax, the new Mecca.

    RH

  28. Larry G Avatar
    Larry G

    whatever direction the rentals have to be dead headed back to will include the deadhead transportation costs.

    so you're actually paying for a roundtrip rental unless a paying customer did the return trip.

  29. Anonymous Avatar
    Anonymous

    Precisely what the data says. More people are going to Farifax from Detroit than the other direction. hence the loser rates, so Uhaul can get more trucks returned withou them having to drive the trucks themselves.

    RH

  30. Larry G Avatar
    Larry G

    or the other way to look at it is that in order for U-Haul to provide available trucks – they have to pay for empty trucks to be delivered to the places that need them to return to the same place where those trucks were driven originally.

    It's a cost of business and if you think about it – they could have just increased the rental costs on all their trucks to cover this aspect of their business but instead they chose to charge those that actually needed the service – a better nexus IMHO.

  31. Anonymous Avatar
    Anonymous

    "they have to pay for empty trucks to be delivered to the places that need them to return to the same place where those trucks were driven originally."

    That is exactly what they are doing by offering lower prices going one direction: they are paying for trucks to be returned to where they need them.

    We are arguing the same point in different ways: but the point is that the data suggests more people want to move to Fairfax from Detroit than the other direction.

    No big surprise there.

    Yes, U-Haul could calculate all their costs and charge a single flat per day plus mile rate, no matter where you go. If they did that then poor people trying to get out of Detroit would not have to pay a premium, as if they had a pre-existing condition.

    Basically U-Haul is making people going from Detroit to Fairfax pay a premium so that U-Haul can subsidize the trip the opposite direction. If u-Haul moves the truck themselves, then the subsidy is 100%. Either way, U-Haul is paying for the delta out of their revenue stream.

    This is preety easy for thenm to maximize: they just lower or increase the rates and see if their revenue goes up or down. It is classic Laffer Curve stuff.

    RH

    RH

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