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United States Government Accountability Office: 
GAO: 

Report to Congressional Requesters: 

September 2013: 

Corporate Tax Expenditures: 

Evaluations of Tax Deferrals and Graduated Tax Rates: 

GAO-13-789: 

GAO Highlights: 

Highlights of GAO-13-789, a report to congressional requesters. 

Why GAO Did This Study: 

Congress and the administration are reexamining tax expenditures used 
by corporations as part of corporate tax reform. These tax 
expenditures—special exemptions and exclusions, credits, deductions, 
deferrals, and preferential tax rates—support federal policy goals, 
but result in revenue forgone by the federal government. 

GAO was asked to examine issues related to certain tax expenditures.
This report uses GAO’s tax expenditures evaluation guide to determine 
what is known about: (1) the deferral of income for controlled foreign 
corporations; (2) deferred taxes for certain financial firms on income 
earned overseas; and (3) the graduated corporate income tax rate. GAO 
combined the two deferral provisions for evaluation purposes. 

GAO’s guide suggests using five questions to evaluate a tax 
expenditure: (1) what is its purpose and is the purpose being 
achieved; (2) does it meet the criteria for good tax policy; (3) how 
is it related to other federal programs; (4) what are its consequences 
for the federal budget; and (5) how is its evaluation being managed? 
To address these questions, GAO reviewed the legislative history and 
relevant academic and government studies, analyzed 2010 Internal 
Revenue Service (IRS) data, and interviewed agency officials and tax 
experts. 

What GAO Found: 

Deferral: Both deferral tax expenditures confer the benefit of 
effectively reducing taxes by delaying the taxation of certain income 
of foreign subsidiaries of U.S. corporations until it is repatriated 
to the U.S. parent as dividends. 

1. While views on the purpose of deferral have changed over time, 
currently, it is often viewed by experts as promoting the 
competitiveness of U.S. multinational corporations. Some experts argue 
that this view is too narrow. For example, this definition of 
competitiveness ignores the effect on other corporations that cannot 
use deferral, such as those that are purely domestic or export without 
foreign subsidiaries. Further, it ignores impacts on the wider economy. 

2. Good tax policy has several dimensions. By delaying the tax on 
foreign source income, deferral could distort corporate investment and 
location decisions in a way that lower taxes, but favor less 
productive activities over more productive ones. Informed judgments 
about deferral’s effect on the fairness of the tax system cannot be 
made because who benefits from deferral, after accounting for such 
factors as changes in prices and wages, has not been determined. 
However, there is widespread agreement among experts and the Internal 
Revenue Service (IRS) that deferral adds complexity to the tax code. 

3. GAO did not identify other federal spending programs that provide 
similar support to U.S. multinational corporations. 

4. Joint Committee on Taxation (JCT) 2011 estimates show relatively 
modest consequences for the federal budget. 

5. No federal agency has been tasked with evaluating deferral. 

Graduated corporate income tax rate schedule: The graduated tax rates 
lower tax rates for corporations with less than $10 million in taxable 
income. 

1. The purpose of the graduated corporate income tax rate schedule is 
viewed by the sources GAO reviewed as supporting small businesses. 
However, evidence is mixed on whether it achieves this purpose. The 
tax rates may not be well targeted toward supporting small businesses 
because corporations that are large in terms of assets and gross 
receipts may have taxable income that is small enough to qualify for 
the rates. 

2. The economic efficiency of the graduated rates depends on whether 
they correct for a market failure. This includes too few small 
businesses forming, given their potential for profit and innovation, 
which offsets the possible distortions from its advantaging one type 
of business organization over others. GAO did not identify any studies 
of the efficiency effects or those that specifically estimate the 
distribution of the benefits from the graduated rates. According to 
IRS staff, while the graduated rates present little complexity, some 
evidence of tax planning to avoid higher rates has been found. 

3. The graduated rates may be related to a number of federal spending 
programs also targeted to small businesses. 

4. JCT 2011 estimates also show modest consequences for the federal 
budget. 

5. No federal agency has been tasked with evaluating the graduated 
rates. 

What GAO Recommends: 

GAO made no recommendations. Treasury, IRS, the Joint Committee on 
Taxation, and external experts provided technical comments that were 
incorporated, as appropriate. 

View [hyperlink, http://www.gao.gov/products/GAO-13-789]. For more 
information, contact James R.White at (202) 512-9110 or whitej@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

Evaluation of Tax Deferrals: 

Evaluation of Graduated Corporate Income Tax Rate Schedule: 

Agency and Third Party Comments and Our Evaluation: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Comparison of Territorial and Worldwide Corporate Income 
Tax Systems: 

Appendix III: IRS Statistics of Income Data on the Number of C 
Corporations by Taxable Income and Size of Business Receipts, 2010: 

Appendix IV: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: Corporate Income Tax Rate Schedule: 

Table 2: Percentage of Corporations with Positive Taxable Income by 
Taxable Income and Size of Business Receipts, 2010: 

Table 3: Number of Corporate Taxpayers by Taxable Income and Size of 
Business Receipts, 2010: 

Table 4: Coefficient of Variation Calculations for Totals in Table 3: 

Figures: 

Figure 1: Example of Deferral under the U.S. Worldwide Corporate 
Income Tax System: 

Figure 2: Ratio of U.S. Corporate Profits Earned Abroad to Total U.S. 
Corporate Profits, 1987-2012: 

Figure 3: Number of Returns by Form of Business, Tax Year 1986-2008: 

Figure 4: Estimated Federal Tax Revenue Losses Due to Graduated 
Corporate Income Tax Rate Schedule, Reported by Treasury, 1998-2012: 

Figure 5: Example of Worldwide and Territorial Corporate Income Tax 
Systems: 

Abbreviations: 

BEA: Bureau of Economic Analysis: 

CBO: Congressional Budget Office: 

CRS: Congressional Research Service: 

FTC: Foreign Tax Credit: 

IRC: Internal Revenue Code: 

IRS: Internal Revenue Service: 

JCT: Joint Committee on Taxation: 

OMB: Office of Management and Budget: 

SOI: Statistics of Income: 

Treasury: Department of the Treasury: 

[End of section] 

GAO:
United States Government Accountability Office: 
441 G St. N.W. 
Washington, DC 20548: 

September 16, 2013: 

The Honorable John Lewis: 
Ranking Member: 
Committee on Ways and Means Subcommittee on Oversight: 
United States House of Representatives: 

The Honorable Lloyd Doggett: 
United States House of Representatives: 

In the past few years, both Congress and the administration have 
proposed reforming the corporate income tax system. A key component of 
discussions about reform is determining how the income of U.S. 
multinational corporations should be taxed--in particular, whether the 
federal government should continue or modify the current deferral of 
taxes on certain income until it is repatriated back to the United 
States. Currently, there are two provisions that relate to the 
deferral of U.S. taxation of foreign-source income: a general 
provision that applies to all controlled foreign corporations and a 
special provision applicable to active financial-services income. 
Another key component of reform discussions is the appropriate 
corporate income tax rate and structure. The current structure 
includes a set of graduated tax rates. The Department of the Treasury 
(Treasury) identifies both deferral provisions and the graduated rates 
as corporate tax expenditures because they are reductions in the 
federal corporate income tax liability that result from special 
provisions of the tax code. As our prior work pointed out, these tax 
expenditures are among the largest utilized only by corporate 
taxpayers.[Footnote 1] According to Treasury's estimates, the amount 
of corporate tax revenue forgone from these three tax expenditures 
totaled almost $49 billion in fiscal year 2012.[Footnote 2] Modifying 
or eliminating these tax expenditures as part of corporate tax reform 
will likely involve tradeoffs between various objectives pursued by 
the federal government, such as tax revenue and corporate investment. 

Because of your ongoing interest in whether and how well these tax 
expenditures are achieving their purposes, you requested that we apply 
the guide that we recently developed for evaluating the performance of 
tax expenditures to certain corporate ones.[Footnote 3] This report 
uses our guide to determine what is known about the following three 
tax expenditures: (1) the deferral of income for controlled foreign 
corporations; (2) deferred taxes for certain financial firms on income 
earned overseas; and (3) the graduated corporate income tax rate. 

Because the two deferral provisions are so similar, we combine them 
for evaluation purposes, and then evaluate the graduated rates 
separately. 

Our tax expenditure evaluation guide outlines a series of questions 
and criteria that can be used to evaluate tax expenditures. The five 
primary questions outlined in the guide are: 

1. What is the tax expenditure's purpose and is it being achieved? 

2. Even if its purpose is achieved, is the tax expenditure good policy? 

a. Does it generate net economic benefits for society? 

b. Is it fair? 

c. Is it simple, transparent, and administrable? 

3. How does the tax expenditure relate to other federal programs? 

4. What are the consequences for the federal budget of the tax 
expenditure? 

5. How should evaluation of the tax expenditure be managed? 

The guide's questions cover a number of different policy objectives, 
which sometimes compete with one another. This report provides 
information in response to the questions, but does not attempt to 
balance the different objectives or make recommendations. Rather, 
policymakers are in the best position to judge how competing policy 
objectives should be weighed. 

As we note in our tax expenditure evaluation guide, the guide is not a 
"one size fits all" framework for evaluating tax expenditures. We used 
reasonable judgment in applying the guide's questions and concepts to 
evaluate the three tax expenditures. In some instances, we focused our 
discussion on certain questions in the guide because they were more 
relevant to the tax expenditures we were evaluating. At the same time, 
we devoted less discussion to other questions that were more technical 
in nature. See appendix I for the guide's full list of questions. 

To determine what is known with respect to the deferral tax 
expenditures and the graduated corporate income tax rate schedule, we 
reviewed a variety of sources. These sources included studies by GAO, 
the Congressional Research Service (CRS), the Congressional Budget 
Office (CBO), the Joint Committee on Taxation (JCT), and other federal 
agencies; legislation, statutes, and regulations related to each of 
the tax expenditures; and academic research. We also interviewed 
officials at Treasury, the Internal Revenue Service (IRS), and three 
external experts, one from CRS and two from universities, who have 
researched and written extensively on the U.S. corporate income tax 
system. The results from these interviews are not generalizable. When 
no consensus existed among our sources for the answer to a question, 
we summarized the debate and provided citations for the various views. 
We analyzed Treasury's tax expenditure estimates from 1998 to 2012, 
and 2011 estimates by JCT on the revenue effects of changing tax 
expenditures. We also analyzed 2010 data from the IRS Statistics of 
Income (SOI), the most recent year available at the time of our work, 
and data from the Bureau of Economic Analysis (BEA) that covered 1987 
to 2012. To assess the reliability of the data and estimates, we 
reviewed agency documentation, interviewed agency officials, and 
reviewed our prior reports that have used them. We determined that the 
Treasury, BEA, JCT, and IRS data and estimates were sufficiently 
reliable for our purposes.[Footnote 4] 

We conducted our work from April to September 2013 in accordance with 
all sections of GAO's Quality Assurance Framework that are relevant to 
our objectives. The framework requires that we plan and perform the 
engagement to obtain sufficient and appropriate evidence to meet our 
stated objectives, and to discuss any limitations in our work. We 
believe that the information and data obtained, and the analysis 
conducted, provide a reasonable basis for any findings and conclusions 
in this product. 

Background: 

The United States taxes domestic corporations on their worldwide 
income, regardless of where it is earned, and provides credits for 
foreign income taxes paid. A U.S. parent corporation may directly or 
indirectly own multiple corporations, including both domestic and 
foreign subsidiaries. The U.S. taxes the worldwide income of U.S. 
corporations, whether earned domestically or abroad. However, the 
active business income earned by foreign subsidiaries is generally 
eligible for deferral from U.S. tax until it is distributed, usually 
in the form of dividends, to the U.S. parent corporation or other U.S. 
shareholders.[Footnote 5] When income is repatriated in this way, it 
may have already been taxed in the foreign country where it was 
earned. To avoid taxing foreign source income twice, the federal tax 
code allows U.S. parent corporations a foreign tax credit (FTC) for 
taxes paid to other countries. A U.S. corporation would pay U.S. tax 
on foreign-source income only to the extent that the U.S. tax on that 
income exceeds the FTC. Figure 1 shows how deferral affects how a 
dividend payment from a foreign subsidiary to its U.S. parent 
corporation is generally taxed under the U.S. worldwide tax approach. 

Figure 1: Example of Deferral under the U.S. Worldwide Corporate 
Income Tax System: 

[Refer to PDF for image: illustration] 

Foreign: 
Foreign subsidiary: 
Net income $100; 
Taxes paid = $20; 
After-tax income = $80; 
Amount repatriated now to parent as dividend = $40; 
Dividend distributed now: $40 to U.S. parent corporation; 
Amount deferred and not repatriated = $40. 

Income tax: $20; 
Foreign government: 20% corporate Income tax. 

U.S.: 
U.S. parent corporation: 
Dividend income received now = $40; 
Reported foreign taxes paid = $10; 
Taxable income = $50; 
U.S. tax liability = $17.50; 
Foreign tax credit claimed = $10; 
After-tax income = $32.50. 

Income tax: $7.50; 
U.S. government: 35% corporate Income tax. 

Source: GAO analysis. 

[End of figure] 

Passive income, such as dividends, interest, rental income, and 
royalties received by controlled foreign corporations, and certain 
types of easily manipulated active income, is not subject to deferral. 
[Footnote 6] Income ineligible for deferral is defined under Subpart F 
of the Internal Revenue Code (IRC). 

Unlike the United States, most developed countries do not tax 
corporations on their worldwide income. Instead, these countries use a 
territorial tax system that taxes only the income earned within a 
country's physical borders, and exempts from tax dividends received 
from foreign subsidiaries on their foreign earnings as well as gains 
realized on the sale of foreign subsidiaries. There has been a trend 
of developed countries moving towards territorial tax systems. As of 
2012, 28 of the 34 current member countries of the Organisation for 
Economic Co-operation and Development have adopted some form of a 
territorial tax system.[Footnote 7] However, most countries generally 
do not use a pure form of either the worldwide (also known as a full-
inclusion system) or territorial tax system. Rather, countries tend to 
use a hybrid system that contains some features of both systems. For 
example, the deferral provisions in the U.S. worldwide system delay 
the taxation of foreign source income, whereas a purer form of the 
worldwide system would tax this income as it is earned. As we have 
previously found, countries using the territorial approach do not 
exempt all foreign source income from taxation, but have exceptions 
for certain types of passive income.[Footnote 8] 

The income of controlled foreign corporations that is generated 
through the primary business activities related to financial-services 
is excepted from Subpart F's anti-deferral regime. Interest income, 
for example, which would typically fall under the Subpart F 
definition, and thus would be taxed currently whether or not it is 
repatriated to a U.S. parent corporation, is permitted to be deferred 
under this active financial-services income provision. This tax 
expenditure is an exception to Subpart F because it treats what would 
otherwise be considered passive income as active business income that 
can be deferred since it was earned through the primary business 
activities of financial-services companies. The effect of the 
exception is to include financial-services companies among the U.S. 
corporations that can defer taxation on their business income earned 
abroad. 

The United States taxes all foreign and domestic corporate income 
using a graduated corporate income tax rate structure. Corporations 
with less than $10 million in net taxable corporate income are subject 
to different tax rates, depending on the amount of income earned. As 
seen in table 1, income is taxed at graduated rates of 15, 25, 39, and 
34 percent for various income levels up to $10 million, and 35 and 38 
percent for income up to $18,333,333. The 38-and 39-percent rates 
reduce the benefits provided by the lower graduated rates.[Footnote 9] 
Finally, for corporations with taxable income higher than $18,333,333, 
a flat rate of 35 percent applies to all taxable income. 

Table 1: Corporate Income Tax Rate Schedule: 

Taxable Income over: $0; But not over: $50,000; 
Tax rate: 15%; 
Of the amount over: $0. 

Taxable Income over: $50,000; But not over: $75,000; 
Tax rate: $7,500 + 25%; 
Of the amount over: $50,000. 

Taxable Income over: $75,000; But not over: $100,000; 
Tax rate: $13,750 + 34%; 
Of the amount over: $75,000. 

Taxable Income over: $100,000; But not over: $355,000; 
Tax rate: $22,250 + 39%; 
Of the amount over: $100,000. 

Taxable Income over: $335,000; But not over: $10,000,000; 
Tax rate: $113,900 + 34%; 
Of the amount over: $335,000. 

Taxable Income over: $10,000,000; But not over: $15,000,000; 
Tax rate: $3,400,000 + 35%; 
Of the amount over: $10,000,000. 

Taxable Income over: $15,000,000; But not over: $18,333,333; 
Tax rate: $5,150,000 + 38%; 
Of the amount over: $15,000,000. 

Taxable Income over: $18,333,333; 
Tax rate: 35%; 
Of the amount over: $0. 

Source: Internal Revenue Service. 

[End of table] 

Treasury and JCT designate the two deferral provisions and the 
graduated corporate income tax rate schedule as tax expenditures 
because they are special tax provisions that are exceptions to the 
normal structure of the corporate income tax system.[Footnote 10] The 
deferral provisions are designated as tax expenditures because they 
deviate from the baseline case of a pure worldwide tax system in which 
U.S. corporations would be taxed on their worldwide income whether or 
not the income is repatriated to the United States. The graduated rate 
provision is designated a tax expenditure because it is an exception 
to the normal structure of a flat corporate income tax rate. All three 
tax expenditures reduce revenue received by the federal government 
below what it would be under the normal structure established by 
Treasury and JCT.[Footnote 11] 

Treasury and JCT each compile an annual list of tax expenditures by 
budget function with estimates of the corporate and individual income 
tax revenue losses, also known as tax expenditure estimates.[Footnote 
12] They separately calculate the estimated revenue losses for each 
tax expenditure under the assumptions that all other tax expenditures 
remain in the tax code, and taxpayer behavior remains constant. 
[Footnote 13] Thus, the tax expenditure estimates do not represent the 
amount of revenue that would be gained if a particular tax expenditure 
was repealed, since repeal would probably change taxpayer behavior in 
some way that would affect revenue. 

Evaluation of Tax Deferrals: 

1. What is the tax expenditure’s purpose and is it being achieved? 

Deferral Is Viewed by Many as Promoting Competitiveness: 

Deferral has long been a part of the tax code, and views of its 
purpose have changed over time. Currently, it is often viewed by tax 
experts and in the research that we reviewed as promoting 
competitiveness.[Footnote 14] However, deferral's effect on 
competitiveness depends on how competitiveness is defined. If 
competitiveness refers to the ability of U.S. multinational 
corporations to operate successfully in foreign markets through their 
subsidiaries, then deferral, which increases after tax returns by 
delaying tax payments, provides a benefit that may enhance 
competitiveness.[Footnote 15] In foreign markets, U.S. corporations 
face competitors that, operating under a territorial tax system in 
their own countries, pay tax only in the foreign country. U.S. 
corporations under the worldwide system must pay the foreign tax plus 
any U.S. tax on the same income. By delaying this U.S. tax, deferral 
is said to move U.S. corporations closer to having a "level playing 
field" with their foreign competitors. 

Whether the tax benefit provided by deferral results in net positive 
economic effects for the United States is the subject of debate. Some 
research has found that investments U.S. multinationals make abroad, 
due in part to the incentives provided by deferral, lead to positive 
economic effects for employment and wages in the United States, while 
others have questioned the magnitude of these effects.[Footnote 16] 
Treasury officials noted that in some instances U.S. foreign direct 
investment may be associated with increased investment in the United 
States. In other instances, it may be associated with decreased U.S. 
investment, meaning that the effect on employment and wages in the 
United States would be uncertain. 

However, whether this definition of competitiveness that focuses on 
multinationals is appropriate has been a subject of debate among 
experts.[Footnote 17] Competitiveness has also been defined as the 
ability of U.S. corporations to operate successfully in domestic 
markets, and to export products into foreign markets. Deferral 
provides no benefit to these purely domestic or exporting U.S 
corporations. Rather than leveling the playing field, deferral 
benefits U.S. multinationals over other types of U.S. 
corporations.[Footnote 18] Our prior work has shown that deferral and 
other aspects of U.S. international corporate taxation allow U.S. 
multinational corporations to pay a much smaller U.S. effective tax 
rate on foreign source income than domestic income.[Footnote 19] If 
these multinationals earn income in countries that, on average, have 
lower corporate tax rates than the United States, they have an 
advantage over purely domestic U.S. corporations because the average 
effective tax rate on the multinationals' worldwide income may be 
lower than the rate paid by the purely domestic corporations on their 
U.S. income. However, there is some research that has found that 
multinationals and domestic-only firms face similar effective tax 
rates.[Footnote 20] 

Other tax experts argue that the appropriate definition of 
competitiveness should focus on broader industry or national purposes 
rather than corporations.[Footnote 21] For example, a U.S. industry is 
said to be more competitive by attracting more investment and 
resources than foreign industries.[Footnote 22] For others, 
competitiveness is a more general concept, referring to the set of 
institutions, policies, and human and natural endowments that make a 
country productive. A tax policy that promotes competitiveness under 
this definition would try to assure that the tax system does not 
prevent a country's resources from being put to their most productive 
uses.[Footnote 23] Countries that meet this standard can engage most 
effectively in international trade that can be mutually beneficial. 
Tax benefits for only certain corporations or industries may not meet 
this criterion. Finally, some experts note that the concept of 
competitiveness is the wrong concept to focus on when formulating tax 
policy and that efficiency, which we discuss in the following section, 
is the appropriate concept. They argue that simply using the wrong 
concept in this way leads to bad policy outcomes.[Footnote 24] 

2. Even if its purpose is achieved, is the tax expenditure good policy? 
* Does the tax expenditure generate net economic benefits for society? 

Numerous Business Decisions Are Affected by Deferral and Each Has 
Consequences for Efficiency: 

Tax differences between countries can affect decisions made by 
multinational corporations, including where to invest in operations, 
where to locate their corporate residences, when to repatriate income 
from foreign subsidiaries, and whether to acquire foreign or domestic 
corporations. Their decisions are said to be distorted when the 
corporations respond to tax differences by putting resources into less 
productive activities because these activities are taxed less heavily 
than more productive uses. As we stated in our guide, when this 
happens, the economy is not as productive as it could be, and society 
does not achieve as high a standard of living as it would if the 
distortion did not exist.[Footnote 25] 

As mentioned above, the United States uses a hybrid form of the 
worldwide tax system where deferral delays but does not eliminate the 
U.S. tax on foreign source income. In this way, the U.S. worldwide 
system has some features less like a pure worldwide system and more 
like a territorial system. Moving in either direction would affect 
deferral. On one hand, the United States could eliminate deferral if 
it moved towards a more pure worldwide system by adopting a full 
inclusion system where foreign source income is taxed by the United 
States as it is earned rather than when it is repatriated. On the 
other hand, the United States could move towards a more territorial 
system by exempting foreign source income from U.S. taxation, or, in 
effect, making deferral permanent.[Footnote 26] The effect on 
corporations' decision making and ultimately on efficiency will depend 
on which way of ending deferral is adopted. The following discusses 
some of the decisions that have been identified in the literature 
where deferral could increase or decrease distortions. 

Some tax experts argue that deferral may distort decisions about where 
U.S. corporations invest, compared to a full-inclusion system, if the 
U.S. tax rate is higher than foreign tax rates, as is often the case. 
This difference in tax rates, combined with the ability to defer 
paying the higher U.S. tax until income is repatriated, could mean 
that a U.S. corporation earns more after taxes from a less productive 
investment abroad than from a more productive investment at home. The 
efficiency loss is the loss of income (or product) that results when 
the corporation chooses the less productive foreign investment because 
it produces a higher after-tax return. Some research has shown that 
differences in tax burden do affect corporations' real investment 
decisions, which could lead to these efficiency losses.[Footnote 27] 
If the United States adopted a full inclusion system, this distortion 
affecting the allocation of investment domestically or abroad could 
potentially be reduced because the tax incentive to invest abroad 
would be eliminated, since corporations would pay the same U.S. tax on 
their worldwide income, whether it comes from foreign or domestic 
investments. Under a territorial system, these investment location 
distortions may increase relative to the current system because the 
tax incentive to invest in low-tax countries may be enhanced when the 
differences in tax rates are made permanent. However, the 
responsiveness of investment decisions to tax rate differences 
indicates that U.S. corporations could be at a disadvantage under a 
full inclusion system as they could be competing against foreign 
companies which would likely be taxed under a territorial tax system 
and at a lower tax rate. This disadvantage would be removed under a 
territorial system where U.S. corporations would face the same tax 
rate as foreign competitors also operating in those countries. 

Some experts and research that we reviewed argue that deferral may 
reduce distortions, compared to a full inclusion system, about where 
businesses decide to incorporate, and whether U.S. corporations choose 
to change their country of incorporation to a foreign country (so-
called corporate inversions). By choosing not to have its corporate 
residence in the U.S., a corporation could permanently avoid U.S. tax 
on income earned abroad, and whatever income it is able to shift out 
of the U.S. Deferral may somewhat reduce this distortion by allowing 
corporations to defer from tax income earned abroad. Some research has 
indicated that taxing income, once it is repatriated, affects 
decisions of where to incorporate, or to change incorporation from one 
country to another.[Footnote 28] Some research has also shown that 
most inversions that occur for tax reasons are to avoid U.S. tax on 
income earned in the U.S. by increasing the scope for income shifting 
rather than to avoid U.S. tax on foreign-source income.[Footnote 29] 
However, recent research has found mixed results on trends in the 
number of inversions. Some have found that only a small number of U.S. 
corporations that conduct initial public offerings have reincorporated 
in low-tax countries, while others have recently highlighted an 
increase in inversions.[Footnote 30] In 2004, legislation was passed 
to limit the ability of U.S. corporations to change their country of 
incorporation to a foreign country.[Footnote 31] This corporate 
residence distortion could be increased by full inclusion, which would 
raise the effective U.S. tax on income earned abroad, and encourage 
companies to avoid this tax by moving their residence abroad. A 
territorial system would eliminate this incentive by removing the U.S. 
tax on foreign source income. 

It is also argued that deferral, compared to a full inclusion system, 
improves economic efficiency by removing distortions that affect 
decisions about which subsidiaries and other assets corporations own. 
[Footnote 32] Some corporate groups may be able to use foreign 
subsidiaries and assets more productively because of synergies that 
result from ownership within the corporate group, while another 
corporate group that acquired these subsidiaries and assets would not 
have these synergies and therefore would not be able to use them as 
productively. For this reason, tax differences could lead to 
productivity loss when a corporation without those synergies, but with 
more favorable tax treatment is able to outbid for ownership of those 
assets a corporation with those synergies. In this case, the use of 
deferral or a territorial system makes inefficiency less likely and 
the move to full inclusion makes it more likely. However, others argue 
that ownership synergies do not have significant effects on 
productivity because there are numerous ways for corporations to use 
assets as productively without owning them, such as leasing, contract 
manufacturing, or licensing of trademarks or technology.[Footnote 33] 
In this case, deferral or a move to a territorial system would not 
produce significant efficiency gains. 

Some research has also shown that deferral can distort decision making 
by affecting the timing of repatriations, referred to as the "lockout" 
effect. The distortion would happen if deferral incentivizes 
corporations to keep income abroad rather than repatriating it to the 
higher tax country. This income may be more productive if repatriated 
and reinvested at home rather than retained (or "locked out") abroad 
for tax reasons. Although estimates have varied over time, they 
consistently show that the lockout effect does have efficiency costs. 
Estimates from 2001 of the efficiency cost of U.S. multinational 
corporations from the lockout effect put the size of the loss at about 
1 percent of foreign pretax income.[Footnote 34] However, the large 
repatriations under the 2004 tax holiday have suggested to some 
researchers that these earlier estimates may be too small.[Footnote 
35] More recent estimates have shown that the efficiency loss 
increases with the amount of earnings accumulated abroad, and could be 
as high as 7 percent of foreign pretax income by 2015.[Footnote 36] 
Both the territorial and full inclusion systems eliminate the lockout 
effect. The territorial system makes foreign earnings tax free whether 
or not they are repatriated, and the full inclusion system makes 
foreign earnings taxable without repatriation. 

The extensive literature on deferral disagrees on its overall impact 
on efficiency, or whether a movement toward a full inclusion or 
territorial system would improve efficiency. Deferral's effect on the 
decisions just discussed, where to invest, where to locate 
headquarters, whether to make an acquisition, and when to repatriate 
income can depend on factors such as the location of the market 
(domestic or foreign) and the source of investment capital (again, 
domestic or foreign). In addition, there may be empirical disagreement 
about the size of an effect. Without agreement on the separate effects 
on efficiency, there is no agreement about how to add them up to get 
an overall effect. 

2. Even if its purpose is achieved, is the tax expenditure good policy? 
* Is the tax expenditure fair? 

Informed Judgments about Deferral's Equity Require Information about 
Ultimate Beneficiaries: 

We were unable to find any studies that specifically estimate the 
distribution of the benefits from the two deferral tax expenditures. 
Treasury, CBO, and the Tax Policy Center have developed estimates of 
the distribution of the corporate tax burden as a whole. However, 
these studies may not indicate who ultimately benefits from deferral 
and, further, whether deferral is fair and equitable. 

The distribution of ultimate beneficiaries, referred to as the 
economic incidence of the tax benefit, depends on the extent that the 
tax provision leads to changes in the prices of goods or services. For 
example, the tax benefit for corporations from deferral may be passed 
on to consumers through lower prices, to employees through higher 
wages, or to investors through higher returns. Economic incidence is 
difficult to determine due to the complexity of the interactions that 
produce these price and income changes. Studies of the distribution of 
burdens and benefits usually base their estimates of economic 
incidence on empirical studies of how prices in relevant markets, 
including markets for goods and services or labor and capital markets, 
respond to changes in certain tax provisions. The studies of the 
corporate tax burden that we identified did not estimate the effect of 
deferral and their methods may require adjustments before such an 
estimate can be made. Without these estimates, informed judgments 
about deferral's fairness will be hard to draw because such judgments 
depend on knowing who receives the benefit of the tax expenditure. 
Equally, the distributional effects of the territorial and full 
inclusion alternatives to deferral are also unknown, and informed 
judgments about the fairness of the alternatives cannot be made. 

Although the ultimate beneficiaries are unknown, there is some 
evidence that certain industries benefit more from deferral than 
others. An IRS study found that during the one-time U.S. repatriation 
tax holiday in 2004, certain industries, such as companies involved in 
pharmaceutical manufacturing and computer and electronic equipment 
manufacturing, benefited disproportionately, as they repatriated 
significantly more income in the form of dividends relative to the 
size of the tax filers.[Footnote 37] 

2. Even if its purpose is achieved, is the tax expenditure good policy? 
* Is the tax expenditure simple, transparent, and administrable? 

Deferral Adds Complexity to the Tax Code: 

There is widespread agreement among tax experts that the U.S. system 
for taxing foreign source income is complex and adds burden for IRS 
and taxpayers. Deferral contributes to this complex system by 
enhancing the incentive for corporations to shift income abroad to be 
taxed at lower rates. Deferral further adds complexity by interacting 
with a number of tax provisions designed to limit income shifting. 
[Footnote 38] One of those provisions, Subpart F of the IRC, creates 
an exception to the general rule of deferral by defining certain types 
of passive income, such as interest and royalties, as well as certain 
other easily manipulated income, as ineligible for deferral. These 
types of income are viewed as subject to greater manipulation to 
reduce taxes because they can be artificially shifted between related 
parties.[Footnote 39] Moreover, there are also exceptions to Subpart 
F. As noted previously, interest income that is generated through the 
primary business activities of financial-services companies of 
controlled foreign corporations is eligible for deferral. These 
various provisions add complexity as taxpayers must determine which 
income can be deferred. 

Deferral also affects complexity by interacting with the foreign tax 
credit and transfer pricing. Our prior work has highlighted these 
areas as major sources of compliance risk and burden.[Footnote 40] 
Deferral allows corporations to time their repatriations of foreign 
source income for periods when they have excess foreign tax credits, 
which can be used to lower the amount of U.S. tax they pay. In these 
cases, complex rules for determining the source of income are required 
to ensure that the foreign tax credits are applied only against the 
portion of the corporation's worldwide taxable income attributable to 
foreign sources.[Footnote 41] Transfer pricing rules attempt to limit 
income shifting by requiring that related corporations charge prices 
for the goods and services they sell to each other that are comparable 
to market prices. Identifying and evaluating these transfer prices can 
be difficult for IRS and taxpayers when, as often is the case with 
intangible property, limited information exists on comparable market 
prices. 

3. How does the tax expenditure relate to other federal programs? 

Deferral Does Not Overlap Directly with Other Federal Programs: 

Our prior work on corporate tax expenditures identified no related 
federal activities sharing the same reported purpose as the two 
deferral tax expenditures.[Footnote 42] Although we have highlighted 
export promotion programs as an area of potential duplication and 
overlap, these programs are focused primarily on small companies 
rather than U.S. multinational corporations.[Footnote 43] Deferral is 
integral to the way the United States taxes multinational 
corporations, and interacts with a number of other tax provisions, 
such as Subpart F. When considering reform to this system, changes to 
deferral would need to be coordinated with changes to other tax 
provisions. 

4. What are the consequences of the federal budget of the tax 
expenditure? 

Deferral May Have Relatively Modest Consequences for the Federal 
Budget but Estimates Vary: 

According to JCT estimates produced in 2011 and reported by CBO, 
ending deferral by moving to a full inclusion worldwide system, where 
foreign source income is taxed whether or not repatriated, would 
increase federal revenues by $4.7 billion in 2012. According to the 
same estimates, exempting active foreign dividends from U.S. tax, 
similar to that of a territorial tax system, and changing the tax 
treatment of overhead expenses would increase revenues by $3.3 billion 
in 2012.[Footnote 44] These estimates are based on specific proposals 
to change the tax code, and include behavioral responses by taxpayers 
to the tax change.[Footnote 45] The revenue estimate for exempting 
active foreign dividends shows an increase in revenue chiefly because 
the expense allocation rules under this option reduced the expenses 
that can be deducted from U.S. income relative to the current system's 
expense allocation rules.[Footnote 46] 

The effect on U.S. tax revenue of full inclusion and territoriality 
depends on the incentives the alternatives provide to shift income out 
of the United States and its taxing authority and the specifics of the 
alternatives' design. The incentive to locate income in low-tax 
countries may be less under full inclusion and higher under the 
territorial system, thereby eroding the U.S. corporate tax base. 
[Footnote 47] However, territorial systems in practice include design 
features, such as a minimum tax on foreign source income, that are 
intended to limit these losses. 

JCT and Treasury also make tax expenditure estimates on a regular 
basis that do not account for how taxpayer behavior may change when a 
tax expenditure is altered. Although these estimates do not represent 
the amount of revenue that would be gained if deferral were 
eliminated, they can indicate how revenue losses may be changing over 
time. The tax expenditure estimates show that revenue losses from the 
general deferral tax expenditure have increased significantly. 
[Footnote 48] These estimates of increasing tax revenue losses are 
consistent with changes in the location of earnings of U.S. 
corporations. During this period, U.S. corporations were earning an 
increasing share of their profits from foreign sources, likely 
increasing the amount of income deferred abroad. As seen in figure 2, 
U.S. corporate profits earned abroad, compared to total U.S. corporate 
profits, have increased moderately since 1997. 

Figure 2: Ratio of U.S. Corporate Profits Earned Abroad to Total U.S. 
Corporate Profits, 1987-2012: 

[Refer to PDF for image: line graph] 

Ratio of U.S. corporate profits earned abroad to total corporate 
profits: 

Year: 1987; 
Ratio: 0.13. 

Year: 1988; 
Ratio: 0.13. 

Year: 1989; 
Ratio: 0.16. 

[1990-1991: U.S. economic recession] 

Year: 1990; 
Ratio: 0.18. 

Year: 1991; 
Ratio: 0.17. 

Year: 1992; 
Ratio: 0.15. 

Year: 1993; 
Ratio: 0.14. 

Year: 1994; 
Ratio: 0.12. 

Year: 1995; 
Ratio: 0.13. 

Year: 1996; 
Ratio: 0.13. 

Year: 1997; 
Ratio: 0.12. 

Year: 1998; 
Ratio: 0.13. 

Year: 1999; 
Ratio: 0.14. 

Year: 2000; 
Ratio: 0.18. 

[2001: U.S. economic recession] 

Year: 2001; 
Ratio: 0.22. 

Year: 2002; 
Ratio: 0.18. 

Year: 2003; 
Ratio: 0.17. 

Year: 2004; 
Ratio: 0.16. 

Year: 2005; 
Ratio: 0.16. 

Year: 2006; 
Ratio: 0.16. 

Year: 2007; 
Ratio: 0.23. 

[2008-2009: U.S. economic recession] 

Year: 2008; 
Ratio: 0.33. 

Year: 2009; 
Ratio: 0.26. 

Year: 2010; 
Ratio: 0.24. 

Year: 2011; 
Ratio: 0.24. 

Year: 2012; 
Ratio: 0.22. 

Source: GAO analysis of Bureau of Economic Analysis data. 

[End of figure] 

In addition, a number of legislative changes may have affected the 
revenue losses from deferral by making it easier to shift or keep 
income abroad. These include the look-through rule exception from 
Subpart F. This rule provides that dividends, interest, rents, and 
royalties received or accrued by one controlled foreign corporation 
from a related controlled foreign corporation are not treated as 
Subpart F income, and are eligible for deferral.[Footnote 49] Finally, 
some have suggested that in light of the U.S. tax repatriation holiday 
in 2004, which allowed U.S. corporations to exempt most dividends from 
tax on a one-time basis, U.S. multinational corporations may have 
accumulated foreign earnings abroad in anticipation of another 
repatriation holiday.[Footnote 50] 

5. How should evaluation of the tax expenditures be managed? 

No Consensus Exists on Which Agency Should Evaluate Deferral: 

No federal agency has been tasked to evaluate deferral. Since 1994, we 
have recommended greater scrutiny of tax expenditures, as periodic 
reviews could help determine how well specific tax expenditures work 
to achieve their goals, and how their benefits and costs compare to 
those of programs with similar goals.[Footnote 51] However, as we 
reported in June 2013, the Office of Management and Budget (OMB) has 
not developed a framework for reviewing tax expenditure 
performance.[Footnote 52] We made a number of recommendations to OMB, 
including that it provide guidance to agencies to identify tax 
expenditures that contribute to each appropriate agency goal. In July 
2013, OMB released guidance that directs agencies to identify tax 
expenditures that contribute to their goals.[Footnote 53] 

Evaluation of Graduated Corporate Income Tax Rate Schedule: 

1. What is the tax expenditure’s purpose and is it being achieved? 

The Graduated Corporate Income Tax Rate Schedule's Purpose Is Viewed 
as Supporting Small Businesses, but It May Not Be Well Targeted to 
That Purpose: 

The purpose of the graduated corporate income tax rate schedule has 
generally been described in the academic literature and by tax experts 
as supporting small businesses by reducing their tax burden. The tax 
expenditure benefits businesses that organize under Subchapter C of 
the IRC, "C corporations," by taxing their income at reduced tax rates 
when the income falls beneath certain limits. To the extent that small 
corporations have income beneath these limits, they could benefit from 
the reduced rates.[Footnote 54] 

Some rationales for providing this tax benefit to smaller businesses 
include encouraging entrepreneurship, innovation, and small business 
growth and employment. It has been argued in some academic literature 
that the greater after-tax income may make the small businesses more 
attractive to investors, and may alleviate a lack of access to capital 
that small businesses experience due to limited information on their 
business model or profit potential. Similar justifications have been 
made for providing benefits through other federal programs, such as 
federal small business loan programs. CRS' tax expenditure compendium 
details how the graduated corporate income tax rate schedule has 
developed and changed legislatively over time.[Footnote 55] 

Evidence is mixed on whether the lower corporate tax rates provided by 
the graduated rate schedule increases business formation.[Footnote 56] 
Some research shows that, although only a small number of start-up 
companies initially form as C corporations, when and if these 
businesses generate profits, they have an incentive to incorporate so 
that these profits are taxed at lower corporate tax rates. However, 
other research has also indicated that incentives can produce the 
opposite effect. Businesses are less likely to incorporate if 
corporate tax rates are high, compared to individual tax rates, and 
instead may choose another form of business entity that is taxed under 
the individual tax rates.[Footnote 57] In contrast, businesses with 
losses will typically prefer not to incorporate so that these losses 
can be deducted from other higher taxed personal income. Research has 
also shown that in 2007 a majority of unincorporated small businesses 
faced a marginal tax rate of 10 to 25 percent, making the rates they 
paid comparable to those of the graduated corporate income tax 
rates.[Footnote 58] IRS data have also shown that the number of 
businesses that organize themselves as C corporations has declined, 
while those organizing as S corporations and partnerships have been 
rising in the past decade. See figure 3. 

Figure 3: Number of Returns by Form of Business, Tax Year 1986-2008: 

[Refer to PDF for image: multiple line graph] 

Number of returns: 

Tax Year: 1986; 
S Corporation: 826,214; 
Partnerships: 1,702,950; 
C Corporation: 2,598,270. 

Tax Year: 1987; 
S Corporation: 1,127,910; 
Partnerships: 1,648,030; 
C Corporation: 2,480,440. 

Tax Year: 1988; 
S Corporation: 1,257,190; 
Partnerships: 1,654,250; 
C Corporation: 2,299,900. 

Tax Year: 1989; 
S Corporation: 1,422,970; 
Partnerships: 1,635,160; 
C Corporation: 2,199,080. 

Tax Year: 1990; 
S Corporation: 1,575,090; 
Partnerships: 1,553,530; 
C Corporation: 2,136,030. 

Tax Year: 1991; 
S Corporation: 1,698,270; 
Partnerships: 1,515,350; 
C Corporation: 2,098,640. 

Tax Year: 1992; 
S Corporation: 1,785,370; 
Partnerships: 1,484,750; 
C Corporation: 2,077,520. 

Tax Year: 1993; 
S Corporation: 1,901,510; 
Partnerships: 1,467,570; 
C Corporation: 2,055,980. 

Tax Year: 1994; 
S Corporation: 2,023,750; 
Partnerships: 1,493,960; 
C Corporation: 2,310,700. 

Tax Year: 1995; 
S Corporation: 2,153,120; 
Partnerships: 1,580,900; 
C Corporation: 2,312,380. 

Tax Year: 1996; 
S Corporation: 2,304,420; 
Partnerships: 1,654,260; 
C Corporation: 2,317,890. 

Tax Year: 1997; 
S Corporation: 2,452,250; 
Partnerships: 1,758,630; 
C Corporation: 2,248,060. 

Tax Year: 1998; 
S Corporation: 2,588,090; 
Partnerships: 1,855,350; 
C Corporation: 2,249,970. 

Tax Year: 1999; 
S Corporation: 2,725,780; 
Partnerships: 1,936,920; 
C Corporation: 2,198,740. 

Tax Year: 2000; 
S Corporation: 2,860,480; 
Partnerships: 2,057,500; 
C Corporation: 2,172,710. 

Tax Year: 2001; 
S Corporation: 2,986,490; 
Partnerships: 2,132,120; 
C Corporation: 2,136,760. 

Tax Year: 2002; 
S Corporation: 3,154,380; 
Partnerships: 2,242,170; 
C Corporation: 2,100,070. 

Tax Year: 2003; 
S Corporation: 3,341,610; 
Partnerships: 2,375,370; 
C Corporation: 2,047,590. 

Tax Year: 2004; 
S Corporation: 3,518,330; 
Partnerships: 2,546,880; 
C Corporation: 2,027,610. 

Tax Year: 2005; 
S Corporation: 3,684,090; 
Partnerships: 2,763,630; 
C Corporation: 1,974,960. 

Tax Year: 2006; 
S Corporation: 3,872,770; 
Partnerships: 2,947,120; 
C Corporation: 1,955,150. 

Tax Year: 2007; 
S Corporation: 3,989,890; 
Partnerships: 3,096,330; 
C Corporation: 1,865,230. 

Tax Year: 2008; 
S Corporation: 4,049,940; 
Partnerships: 3,146,010; 
C Corporation: 1,782,480. 

Source: GAO analysis of IRS data. 

[End of figure] 

Evidence from aggregated corporate tax return data suggests that the 
graduated corporate income tax rate schedule may not be well targeted 
at supporting small businesses. As table 2 indicates, some 
corporations that may not be considered small businesses claimed one 
of the graduated rates and received the tax benefit. For example, as 
table 2 shows, about 23 percent of corporations with positive taxable 
income that had business receipts from between $10 million and $50 
million had less than $75,000 in taxable income, and benefited from 
the two lowest graduated rates.[Footnote 59] The use of taxable income 
as an indicator of the size of a business may include businesses that 
are large by other indicators, such as total assets. 

Table 2: Percentage of Corporations with Positive Taxable Income by 
Taxable Income and Size of Business Receipts, 2010: 

Size of business receipts: Under $25,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 90.5%; 
$50,000 - $75,000 (25 percent): 3.3%; 
$75,000 - $100,000 (34 percent): 1.3%; 
Over $100,000 (34 percent or more): 4.9%. 

Size of business receipts: $25,000 under $100,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 95.3%; 
$50,000 - $75,000 (25 percent): 3.3%; 
$75,000 - $100,000 (34 percent): 0.6%; 
Over $100,000 (34 percent or more): 0.9%. 

Size of business receipts: $100,000 under $250,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 89.4%; 
$50,000 - $75,000 (25 percent): 5.6%; 
$75,000 - $100,000 (34 percent): 2.6%; 
Over $100,000 (34 percent or more): 2.4%. 

Size of business receipts: $250,000 under $500,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 83.6%; 
$50,000 - $75,000 (25 percent): 6.5%; 
$75,000 - $100,000 (34 percent): 5.0%; 
Over $100,000 (34 percent or more): 4.9%. 

Size of business receipts: $500,000 under $1,000,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 79.5%; 
$50,000 - $75,000 (25 percent): 10.0%; 
$75,000 - $100,000 (34 percent): 3.2%; 
Over $100,000 (34 percent or more): 7.2%. 

Size of business receipts: $1,000,000 under $2,500,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 68.8%; 
$50,000 - $75,000 (25 percent): 12.2%; 
$75,000 - $100,000 (34 percent): 5.9%; 
Over $100,000 (34 percent or more): 13.1%. 

Size of business receipts: $2,500,000 under $5,000,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 52.4%; 
$50,000 - $75,000 (25 percent): 13.0%; 
$75,000 - $100,000 (34 percent): 6.7%; 
Over $100,000 (34 percent or more): 28.0%. 

Size of business receipts: $5,000,000 under $10,000,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 31.0%; 
$50,000 - $75,000 (25 percent): 13.1%; 
$75,000 - $100,000 (34 percent): 7.6%; 
Over $100,000 (34 percent or more): 48.2%. 

Size of business receipts: $10,000,000 under $50,000,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 16.3%; 
$50,000 - $75,000 (25 percent): 6.2%; 
$75,000 - $100,000 (34 percent): 5.2%; 
Over $100,000 (34 percent or more): 72.4%. 

Size of business receipts: $50,000,000 under $100,000,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 4.4%; 
$50,000 - $75,000 (25 percent): 1.7%; 
$75,000 - $100,000 (34 percent): 2.2%; 
Over $100,000 (34 percent or more): 91.8%. 

Size of business receipts: $100,000,000 under $250,000,000; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 0.9%; 
$50,000 - $75,000 (25 percent): 0.9%; 
$75,000 - $100,000 (34 percent): 0.7%; 
Over $100,000 (34 percent or more): 97.5%. 

Size of business receipts: $250,000,000 and over; 
Corporate income tax rate bracket: 
First $50,000 (15 percent): 0.2%; 
$50,000 - $75,000 (25 percent): 0.2%; 
$75,000 - $100,000 (34 percent): 0.0%; 
Over $100,000 (34 percent or more): 99.7%. 

Source: GAO analysis of Internal Revenue Service Statistics of Income 
Corporate Tax File Data estimates, 2010. 

Notes: Data on the number of corporations are from IRS SOI corporate 
file and include active corporations that filed a return on forms 
1120, 1120-F, 1120-L, and 1120-PC, but not forms 1120S, 1120-REIT, and 
1120-RIC. The coefficient of variation for the estimates can be found 
in table 4, see appendix III. 

[End of table] 

Neither Treasury nor IRS has established performance measures for the 
graduated corporate income tax rate schedule to measure its effect, 
and whether it is achieving its purpose. As we previously found, most 
agencies have not focused on identifying the contributions tax 
expenditures make towards agency goals.[Footnote 60] 

2. Even if its purpose is achieved, is the tax expenditure good policy? 
* Does the tax expenditure generate net economic benefits for society? 

Efficiency Effects of the Graduated Rates Are Disputed: 

Some academic literature has suggested that the graduated rates can 
cause inefficiency by providing relief to some corporations and not 
others depending on their taxable income. The economy is less 
efficient if the rates divert resources from one type of corporation 
to another based on tax considerations, rather than how productively 
the corporations use the resources. Other sources of potential 
inefficiency include the incentive provided by the graduated rates for 
small businesses to form as C corporations to take advantage of lower 
corporate rates, compared to those of individual tax rates. A Treasury 
study found that higher differentials between corporate and non-
corporate tax rates increased the likelihood that a firm will convert 
from C to S corporation status after the Tax Reform Act of 1986. 
[Footnote 61] In this case, small businesses may choose an 
organizational form that they would not have selected without the tax 
incentive, suggesting that this may not be the most productive way for 
them to organize their operations.[Footnote 62] 

The graduated rates could be justified on efficiency grounds if, from 
society's point of view, without the incentive too few small 
businesses are formed given their potential for profit and innovation. 
It has been argued by some research that small businesses need support 
because they provide a disproportionate share of innovation and net 
job creation. However, more recent research has shown that a small 
number of new businesses may generate most of the innovation and net 
job creation. If this is the case, targeted federal support for 
certain small businesses may be more effective than graduated rates 
that apply to all corporations with less than a certain amount taxable 
income.[Footnote 63] 

The magnitude of the efficiency effects of the graduated rates has not 
been estimated, but experts agree that the effect of reducing or 
eliminating the rates will depend on how the change is implemented. 
For example, reducing or eliminating the rates without making similar 
changes to individual tax rates may motivate companies to change 
organizational form--from C corporations to "pass-through" entities 
like S corporations and partnerships--to take advantage of the 
differences between corporate and individual income tax rates. 

2. Even if its purpose is achieved, is the tax expenditure good policy? 
* Is the tax expenditure fair? 

Informed Judgments about the Graduated Rates' Equity Require 
Information about Ultimate Beneficiaries: 

As with the deferral tax expenditures, studies that specifically 
estimate the distribution of the benefits from the graduated corporate 
income tax rate schedule are unavailable. Without these estimates, 
conclusions about the fairness of the tax expenditures will be hard to 
draw because such judgments depend on who bears the burden of the tax 
or receives the benefit of the tax expenditure. The ultimate 
beneficiaries depend on the extent that the tax provision leads people 
to make decisions that change the prices of goods or services. Just as 
in the case of the deferral tax benefit, the benefit of graduated 
rates may be passed on to consumers through lower prices, employees 
through higher wages, or to investors through higher returns.[Footnote 
64] 

2. Even if its purpose is achieved, is the tax expenditure good policy? 
* Is the tax expenditure simple, transparent, and administrable? 

The Graduated Rates Likely Add Little Complexity to Determining Tax 
Liability But Some Evidence of Tax Planning Has Been Found: 

Although we did not find any estimates that isolate the compliance and 
administrative costs associated with the graduated rates, both costs 
are likely to be relatively low. IRS officials could not highlight any 
administrative or compliance issues involved with administering the 
graduated corporate income tax rate schedule. They said that applying 
the graduated corporate income rate schedule for a particular taxpayer 
is primarily a computational issue, and does not present much 
uncertainty to taxpayers in determining their tax liabilities. 
However, IRS research has found some evidence that corporations' 
taxable income tends to cluster below rate changes introduced by the 
tax rate brackets. The research found that if the tax net income of 
corporations in their sample of Schedule M-3 filers (generally those 
with assets of at least $10 million) from tax years 2004 through 2008 
rose 5 percent, a substantial number of corporations would face higher 
marginal tax rates.[Footnote 65] This clustering of filers around 
certain tax rates may be the result of tax planning that increases 
compliance costs. 

The compliance and administrative costs of the graduated rates have 
not been estimated separately from the costs of complying with and 
administering all the provisions of the corporate income tax. However, 
estimates of the total compliance burden of small businesses may give 
some context to the compliance costs associated with graduated rates. 
A 2007 study of businesses with assets of less than $10 million in 
2002 found that small businesses initially face significant fixed 
compliance costs, which increase at a decreasing rate as the business 
grows.[Footnote 66] However, the specific administrative and 
compliance costs of the graduated rates may not be a large part of 
these costs compared with other, more complicated provisions of the 
tax code. 

3. How does the tax expenditure relate to other federal programs? 

Graduated Rates Are Related to a Number of Spending Programs but the 
Relative Effectiveness of the Tax Expenditure Has Not Been Assessed: 

Our prior work on corporate tax expenditures found no related federal 
spending program sharing the same reported purpose as the graduated 
rates of supporting small businesses that adopt the corporate form of 
legal organization.[Footnote 67] However, there are federal spending 
programs that share, at least in part, the similar purpose of 
supporting entrepreneurs and small businesses. In prior work, we 
identified 52 programs at the U.S. Departments of Agriculture, 
Commerce, and Housing and Urban Development, and the Small Business 
Administration, which all overlap with at least one other program in 
terms of the type of assistance they are authorized to offer, and the 
type of entrepreneur they are authorized to serve.[Footnote 68] 

Changes in the graduated rates are generally part of proposals to 
reduce the overall corporate tax rate which are discussed in the 
context of tax reform. The issue of whether the tax expenditure could 
be better designed to target small business or spending or non-tax 
policies that support small businesses may be preferable but has not 
been part of the discussion. 

4. What are the consequences of the federal budget of the tax 
expenditure? 

Moving to a Flat Corporate Income Tax Rate of 35 Percent Would Have 
Relatively Modest Consequences for the Federal Budget: 

According to JCT estimates produced in 2011 and reported by CBO, 
moving to a single corporate rate of 35 percent would have raised $1.5 
billion in 2012.[Footnote 69] This estimate is based on a specific 
proposal to change the tax code, and includes behavioral responses by 
taxpayers to the tax change. JCT and Treasury also annually calculate 
tax expenditure estimates that do not account for how taxpayer 
behavior may change when a tax expenditure is altered. Because they do 
not account for these behavioral changes or interactions with other 
tax provisions, the tax expenditure estimates available for the 
graduated rates do not represent the amount of revenue that would be 
gained if these rates were repealed. However, as mentioned above in 
the case of deferral, these estimates can indicate how revenue losses 
may be changing over time. As shown in figure 4, estimated tax revenue 
losses from the graduated corporate income tax rate schedule have 
decreased in the past decade. From 1998 through 2012, estimated tax 
revenue losses fell from $7.3 billion to $4.3 billion in constant 2012 
dollars. The estimated fiscal year 2012 loss was 3 percent of all 
estimated revenue losses from corporate tax expenditures ($147 
billion). The estimate was equal to 1.8 percent of corporate tax 
revenue in 2012. 

Figure 4: Estimated Federal Tax Revenue Losses Due to Graduated 
Corporate Income Tax Rate Schedule, Reported by Treasury, 1998-2012: 

[Refer to PDF for image: line graph] 

[Billions in constant 2012 dollars] 

Fiscal year: 1998; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $7.27 billion. 

Fiscal year: 1999; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $8.45 billion. 

Fiscal year: 2000; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $8.44 billion. 

Fiscal year: 2001; [U.S. economic recession] 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $6.29 billion. 

Fiscal year: 2002; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $6.1 billion. 

Fiscal year: 2003; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $3.72 billion. 

Fiscal year: 2004; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $2.93 billion. 

Fiscal year: 2005; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $3.66 billion. 

Fiscal year: 2006; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $4.54 billion. 

Fiscal year: 2007; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $5.88 billion. 

Fiscal year: 2008; [U.S. economic recession] 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $2.62 billion. 

Fiscal year: 2009; [U.S. economic recession] 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $2.86 billion. 

Fiscal year: 2010; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $3.12 billion. 

Fiscal year: 2011; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $3.34 billion. 

Fiscal year: 2002; 
Graduated Corporate Income Tax Rate tax expenditure revenue loss 
estimates: $4.27 billion. 

Source: GAO analysis of OMB budget, fiscal years 2000-2014. 

[End of figure] 

The decrease in figure 4 may be due, in part, to less companies 
incorporating as C corporations, which we highlighted above. 

5. How should evaluation of the tax expenditures be managed? 

No Consensus Exists on Which Agency Should Evaluate the Graduated 
Corporate Tax Rate Schedule: 

As in the case of the deferral tax expenditures, no agency has been 
tasked with evaluating the graduated corporate income tax rate 
schedule. In June 2013, we made a number of recommendations to OMB, 
including that it should provide guidance to agencies to identify tax 
expenditures that contribute to each appropriate agency goal.[Footnote 
70] In July 2013, OMB released guidance that directs agencies to 
identify tax expenditures that contribute to their goals.[Footnote 71] 

Agency and Third Party Comments and Our Evaluation: 

We provided a draft of this report to the Secretary of the Treasury 
and the Commissioner of Internal Revenue for comment. We also asked 
the Joint Committee on Taxation (JCT) and all external experts we 
interviewed to review a draft of this report. Treasury, IRS, JCT, and 
external experts provided technical comments that were incorporated, 
as appropriate. 

We sent copies of this report to the Secretary of the Treasury, to the 
Commissioner of Internal Revenue, and other interested parties. This 
report will also be available at no charge on GAO's website at 
[hyperlink, http://www.gao.gov]. 

If you have any questions on this report, please contact me at (202) 
512-9110 or whitej@gao.gov. Contact points for our offices of 
Congressional Relations and Public Affairs may be found on the last 
page of this report. Key contributors to this are listed in appendix 
IV. 

Signed by: 

James R. White: 
Director, Tax Issues Strategic Issues: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

This report uses our tax expenditures evaluation guide to determine 
what is known about following three tax expenditures: (1) the deferral 
of income for controlled foreign corporations; (2) deferred taxes for 
certain financial firms on income earned overseas; and (3) the 
graduated corporate income tax rate. Because deferred taxes for 
certain financial firms on income earned overseas is a special case of 
the treatment of foreign source income of all controlled foreign 
corporations, our first section of the report focuses our discussion 
on the more general case of all controlled foreign corporations using 
deferral. Our second section of the report covers the graduated 
corporate income tax rate schedule. For both sections of the report, 
we cover the five questions outlined in our guide and listed below to 
determine what is known about each tax expenditure. We highlight what 
questions we are answering for each tax expenditure at the beginning 
of each section of the report. 

GAO Tax Expenditure Evaluation Guide: 

To evaluate the three tax expenditures above, we applied our tax 
expenditure evaluation guide, which was issued in November 2012. 
[Footnote 72] The guide outlines a series of questions and sub-
questions that can be used to evaluate tax expenditures. The five 
primary questions and sub-questions outlined in the guide are: 

1. What is the tax expenditure's purpose and is being achieved? 

* What is the tax expenditure's intended purpose? 

* Have performance measures been established to monitor success in 
achieving the tax expenditure's intended purpose? 

* Does the tax expenditure succeed in achieving its intended purpose? 

2. Even if its purpose is achieved, is the tax expenditure good policy? 

* Does the tax expenditure generate net economic benefits for society? 

* Is the tax expenditure fair? 

* Is the tax expenditure simple, transparent, and administrable? 

3. How does the tax expenditure relate to other federal programs? 

* Does the tax expenditure contribute to a designated cross-agency 
priority goal? 

* Does the tax expenditure duplicate or overlap with another federal 
effort? 

* Is the tax expenditure being coordinated with other federal 
activities? 

* Would an alternative to the tax expenditure more effectively achieve 
its intended purpose? 

4. What are the consequences for the federal budget of the tax 
expenditure? 

* Are there budget effects not captured by Treasury's or the Joint 
Committee on Taxation's tax expenditure estimates? 

* Are there options for limiting the tax expenditure's revenue loss? 

5. How should evaluation of the tax expenditure be managed? 

* What agency or agencies should evaluate the tax expenditure? 

* When should the tax expenditure be evaluated? 

* What data are needed to evaluate the tax expenditure? 

The guide's questions cover a number of different policy objectives. 
Sometimes, these objectives compete. This report provides information 
responsive to the questions, but does not attempt to balance the 
different objectives or make recommendations. Rather, policymakers are 
better positioned to judge how competing policy objectives should be 
weighed. As we note in our tax expenditure evaluation guide, it is not 
a "one size fits all" framework for evaluating tax expenditures. We 
used reasonable judgment in applying the guide's questions and 
concepts to evaluate the three tax expenditures. In some instances, we 
focused our discussion on certain questions in the guide because they 
were more relevant to the tax expenditures we were evaluating, while 
devoting less discussion to others that were more technical in nature. 

* Question 1 above covers the tax expenditure's intended purpose and 
if it is being achieved. Since the purpose of the deferral tax 
expenditures is unclear, we did not address the sub-questions related 
to whether the deferral tax expenditures achieve their intended 
purpose, and if performance measures have been established. 

* For question 2 above, our discussion of the deferral tax 
expenditures and criteria for good policy also includes question 3 
above which covers alternatives to the tax expenditures, as there is a 
natural relation to alternative proposals and how they may affect the 
criteria outlined in question 2. 

To the extent that we use our tax expenditure evaluation guide in the 
future on other tax expenditures, the structure and focus of future 
reports may differ from how it is presented in this report. To 
determine what is known about the deferral tax expenditures and the 
graduated corporate income tax rate schedule by answering the five 
questions listed above, we reviewed the following sources: 

* Our previous work on tax expenditures, tax reform, tax policy and 
administration, duplication, overlap, and fragmentation, and results-
oriented government and program evaluation. 

* Previous work by the Congressional Research Service (CRS), the 
Congressional Budget Office (CBO), the Joint Committee on Taxation 
(JCT), the Department of the Treasury (Treasury), and the Internal 
Revenue Service (IRS). 

* Legislation, statutes, and regulations. 

* Academic and scholarly research on the tax expenditures and 
corporate taxation. To identify academic literature, we searched terms 
and certain authors in a number of academic literature databases, such 
as ProQuest, Econlit, and Social SciSearch. We reviewed and identified 
academic literature cited in CRS' tax expenditure compendium, and a 
comprehensive study by JCT on foreign direct investment.[Footnote 73] 
We reviewed articles published in the National Tax Journal and asked 
Treasury, IRS, and the external experts we interviewed for 
recommendations on articles to review. We also interviewed Treasury 
and IRS officials, and external experts affiliated with CRS and two 
universities, who specialize in the U.S. corporate income tax system. 
The results from these interviews are not generalizable. 

* Treasury tax expenditure estimates for fiscal years 1998 through 
2012, and estimates by JCT on the revenue effects of making changes to 
the tax expenditures in our scope.[Footnote 74] To identify how the 
deferral and graduated corporate income tax rate schedule tax 
expenditures have changed in terms of their aggregate estimated 
revenue losses, we analyzed tax expenditure estimates developed by the 
Treasury and reported by the Office of Management and Budget in the 
Federal Budget's Analytical Perspectives for fiscal years 1998 through 
2012.[Footnote 75] We converted all tax expenditure estimates for each 
fiscal year into 2012 constant dollars to adjust for inflation. We did 
so by using the chain price indexes reported in the fiscal year 2014 
federal budget. While sufficiently reliable as a gauge of general 
magnitude, summing tax expenditure estimates do not take into account 
any interactions between tax expenditures. In addition, tax 
expenditure estimates do not incorporate any behavioral responses. 
Thus, they do not represent the revenue amount that would be gained if 
a specific tax expenditure was repealed. To identify JCT estimates of 
the revenue effects of making changes to the tax expenditures in our 
scope, we reviewed CBO's latest report that outlines spending and 
revenue options. These options outline a number of changes to the tax 
expenditures in our scope with accompanying estimates from JCT. 
[Footnote 76] Its revenue-effect estimates take into account a number 
of behavioral changes, unlike the tax expenditure estimates that 
Treasury and JCT complete. These include possible behavioral changes 
in: (1) corporate dividends and retained earnings; (2) the corporate 
capital structure; (3) corporate equity valuations; (4) repatriations 
of deferred foreign income; and (5) business entity choice.[Footnote 
77] 

* Data estimates from IRS Statistics of Income (SOI) Corporate Tax 
File, 2010, the most recent year available at the time of our work, 
and Bureau of Economic Analysis (BEA) data on corporate profits from 
1987 through 2012. We requested estimates from the IRS SOI 2010 
Corporate Tax File on the number of C corporations by their corporate 
income tax bracket, and a measurement of their size--in this case--
business receipts. Data compiled by IRS SOI are based on a stratified 
random sample of 63,630 corporate income tax returns for 2010 from 
corporations that end their corporate year from July 1, 2010, through 
June 30, 2011. These estimates are subject to sampling errors. The 
margin of error is based on a 95-percent confidence interval. For our 
report, IRS SOI provided data on C corporations, which include active 
corporations filing tax forms 1120, 1120-F, 1120-L, and 1120-PC. Data 
are not included for "pass-through" entities, which file on forms 
1120S, 1120-REIT, and 1120-RIC. We used business receipts as our 
measurement of size and used IRS' breakout for the different sizes of 
business receipts. We also obtained data from IRS on the number of 
different types of business form entities (C corporations, S 
corporations, and partnerships) from 1986 to 2008. We also analyzed 
data from BEA on corporate profits by industry from 1987 to 2012. To 
determine how the composition of U.S. corporate profits have changed 
over time, we took a ratio of the amount of profit earned by U.S. 
corporations abroad compared to the total amount of profits earned by 
U.S. corporations. This analysis was based on a similar analysis used 
in academic literature.[Footnote 78] 

To assess the reliability of the data and estimates, we reviewed 
agency documentation, interviewed agency officials, and reviewed our 
prior reports that have used the data and estimates. We determined 
that Treasury, JCT, BEA, and IRS data and estimates were sufficiently 
reliable for our purposes. However, the IRS SOI corporate sample may 
not provide a precise estimate of the number of taxpayers claiming a 
tax expenditure when the number of taxpayers is very small. We 
conducted our work from April to September 2013 in accordance with all 
sections of GAO's Quality Assurance Framework that are relevant to our 
objectives. The framework requires that we plan and perform the 
engagement to obtain sufficient and appropriate evidence to meet our 
stated objectives, and to discuss any limitations in our work. We 
believe that the information and data obtained and the analysis 
conducted provide a reasonable basis for any findings and conclusions 
in this product. 

[End of section] 

Appendix II: Comparison of Territorial and Worldwide Corporate Income 
Tax Systems: 

Many proposals for changing the way the current U.S. system taxes 
foreign source income are detailed and complex.[Footnote 79] In 
general, however, they involve redesigning the current system to more 
resemble a pure worldwide or a pure territorial system. The basic 
designs of the three systems being considered as alternatives are the 
following: 

* The current worldwide system with deferral. Foreign active business 
income is taxed when repatriated as dividends to the U.S. This system 
has a foreign tax credit limited to the U.S. tax liability on foreign 
source income, and certain anti-deferral provisions like Subpart F. 

* A territorial system that uses a dividend exemption. The dividends 
derived from foreign active business income can be repatriated without 
U.S. tax. This system would continue to tax Subpart F income as do 
most countries with territorial systems. 

* A worldwide system with full inclusion. The current worldwide system 
is retained, but deferral of foreign active business income is 
eliminated. 

The current system serves as a benchmark against which to compare the 
alternatives. When applying the criteria of a good tax system, the 
territorial and worldwide systems with full inclusion are examined for 
their effect on efficiency, equity, and complexity, and their 
relativity to the effects of the current system. Figure 5 illustrates 
how the basic design of the full inclusion worldwide system and the 
territorial system affects the taxes that corporations pay. 

Figure 5: Example of Worldwide and Territorial Corporate Income Tax 
Systems: 

[Refer to PDF for image: illustration] 

Country A: 
(Worldwide Corporate Income Tax System): 35% corporate income tax rate 
on domestic and foreign source income. 

Domestic corporation in country A: 
Domestic Income: $100; 
Tax liability (A): $35; 
After tax income: $65; 
Income tax: $35. 

Foreign subsidiary of country B corporation in country A: 
Foreign source Income: $100; 
Tax liability (A): $35; 
Tax liability (B): $0; 
After tax income: $65; 
Income tax: $35. 

Country B: 
(Territorial Corporate Income Tax System): 15% corporate income tax 
rate on domestic income. 

Foreign subsidiary of country A corporation in country B: 
Foreign source Income: $100; 
Tax liability (A): $35; 
Tax liability (B): $0; 
Foreign tax credit: $15; 
After tax income: $65; 
Income tax to Country A: $20; 
Income tax to Country B: $15; 
Foreign tax credit to Country A: $15. 

Domestic corporation in country B: 
Domestic Income: $100; 
Tax liability (B): $15; 
After tax income: $85; 
Income tax to Country B: $15. 

Source: GAO analysis. 

[End of figure] 

As shown in figure 5, Country A has a worldwide tax system that taxes 
income of its domestic corporations, and that of foreign corporations 
earned within its borders at the same 35-percent rate. The domestic 
corporation and the subsidiary of the foreign corporation each pay $35 
in taxes to Country A. Additionally, Country A taxes the income of the 
foreign subsidiaries of its corporations at the same 35-percent rate. 
However, in this case, it provides a credit for taxes paid to the 
country in which the subsidiary operates. The subsidiary gets a $15 
credit for the tax it pays to Country B, and subtracts this amount 
from the $35 tax liability that it owes its home Country A. The total 
tax paid by the subsidiary is $15 to Country B plus the $20 net tax 
that it pays at home for an overall tax of $35. For the worldwide 
system, taxes paid are the same for corporations operating within 
Country A, and for its corporations operating abroad. 

In a territorial system, income is taxed only by the country in which 
it is earned. In figure 5, Country B has a territorial system that 
imposes a 15-percent tax on corporations that operate within its 
borders. The domestic corporation and the subsidiary of the foreign 
corporation remit the same tax payment of $15 to Country B on $100 of 
income earned there. Unlike the worldwide system, the territorial 
system imposes no tax on the income of the foreign subsidiaries of its 
own corporations. For the territorial system, taxes paid are equal for 
corporations operating within Country B, but differ for corporations 
operating across borders. 

As discussed above, the experts we interviewed agreed and economic 
theory suggests that any corporate tax system's overall effect on 
efficiency depends on its relative effect on different types of 
investment decisions. The full inclusion system is likely to increase 
investment location efficiency relative to the current and territorial 
systems. Under the current system, investment abroad has a lower tax 
cost when repatriation of the foreign source income is deferred. Full 
inclusion would eliminate this tax advantage, and would be more 
consistent with efficient location decisions. When the foreign tax 
rate is lower than the U.S. tax rate, domestic corporations under full 
inclusion pay taxes on income earned at home and abroad at the same 
rate--the U.S. tax rate. The system does not provide incentives either 
to invest abroad or at home (i.e. it is neutral with respect to the 
location of investment).[Footnote 80] The territorial system, on the 
other hand, may increase investment location inefficiencies by making 
the location incentives that arise when countries adopt different tax 
rates permanent. 

However, as previously noted in this report, these inefficiencies may 
be offset to some extent by improved ownership efficiencies and 
reduced incentives to move corporate residences abroad. Corporations 
operating under a territorial system pay the same tax rate on income 
from their operations in each country. This would eliminate any tax 
advantage that would allow a less efficient owner in that country to 
acquire the more productive corporation. While the full inclusion 
system may not distort location decisions, it may distort decisions 
about who owns the foreign subsidiaries. Some advocates of the 
territorial system argue that efficiency gains from eliminating this 
ownership distortion can offset any efficiency losses from distorted 
location decisions. 

The experts whom we interviewed and the research that we reviewed 
agreed that both the territorial and full inclusion systems eliminate 
efficiency cost from the lockout effect that exists under the current 
system. Full inclusion eliminates the lockout effect by making foreign-
earned income taxable without repatriation. The territorial system 
eliminates the lockout effect by making foreign-earned income tax 
free, whether or not they are repatriated. The effect of the lockout's 
elimination could be significant because of possibly large efficiency 
costs due to growing accumulations of income abroad. 

Some research has suggested that income-shifting incentives should be 
significantly reduced under full inclusion, but may be increased under 
the territorial system. Researchers have found evidence of extensive 
income shifting under the current system.[Footnote 81] Full inclusion 
nearly eliminates incentives for income shifting because corporations 
pay the same rate under full inclusion, regardless of where the income 
is located and the timing of its repatriation.[Footnote 82] The 
territorial system, on the other hand, would likely increase the 
incentive to shift income to lower-tax countries because income earned 
abroad would be exempt from being taxed, even when repatriated. 

The relative effects of the alternatives on compliance and 
administrative burden depend on the specifics of their design. As 
described above, the current system is complex, and imposes compliance 
and administrative burden by requiring extensive calculations and 
adjustments involving foreign tax credits, sourcing rules for income 
and expenses, and transfer-pricing rules to limit income shifting. 
Some research has shown that, while a full inclusion system would 
reduce the benefits and scope for income shifting, it would also 
retain some of the current system's burden, such as the foreign tax 
credit and sourcing rules for income and expenses. The territorial 
system, by increasing income-shifting incentives, may require 
provisions to protect the tax base that can add considerable 
complexity to the tax code. The degree of complexity relative to the 
current system will depend in part on how much of the current rules 
are maintained or expanded in the new system. However, because both 
the territorial and full inclusion systems remove any incentive to 
delay repatriation, they would eliminate compliance and administrative 
burden due to the repatriation tax planning that occurs under the 
current system. 

Based on the research and revenue estimates we reviewed, the revenue 
raised by each system depends on the specifics of its design. How much 
of the potential worldwide tax revenue a country gets depends on its 
tax system's incentives to relocate income to a lower tax rate 
country. Some research has noted that under full inclusion, the 
corporation has no incentive to relocate income to a lower tax country 
unless it has excess foreign tax credits. However, under a territorial 
tax system, the corporation has an incentive to move income to a lower 
tax rate foreign country. Based on these incentives, it would appear 
that revenue for the home country is likely to decrease when a country 
moves from a worldwide to a territorial system. However, the relative 
effects on revenue ultimately depend on the details of the design. For 
example, some features of a territorial system's design are 
implemented specifically to limit revenue losses. Under its 
territorial system, Japan imposes a per-country minimum tax, which 
means that corporations will lack incentives to locate income in a 
country with a tax rate below the minimum.[Footnote 83] Other features 
of a tax system that affect revenues include changes in income and 
expense allocation rules that would increase foreign source income 
attributed to the home country under a territorial system. 

[End of section] 

Appendix III: IRS Statistics of Income Data on the Number of C 
Corporations by Taxable Income and Size of Business Receipts, 2010: 

Table 3: Number of Corporate Taxpayers by Taxable Income and Size of 
Business Receipts, 2010: 

Size of business receipts: Under $25,000; 
No taxable income: 353,943; 
First $50,000 (15 percent): 67,381; 
$50,000-$75,000 (25 percent): 2,427; 
$75,000-$100,000 (34 percent): 996; 
$100,000-$335,000 (39 percent): 2,471; 
$335,000-$10,000,000 (34 percent): 1,107; 
$10,000,000-$15,000,000 (35 percent): 14; 
$15,000,000-$18,333,333 (38 percent): 11; 
Over $18,333,333 (35 percent): 43. 

Size of business receipts: $25,000 under $100,000; 
No taxable income: 181,917; 
First $50,000 (15 percent): 65,036; 
$50,000-$75,000 (25 percent): 2,251; 
$75,000-$100,000 (34 percent): 383; 
$100,000-$335,000 (39 percent): 440; 
$335,000-$10,000,000 (34 percent): 166; 
$10,000,000-$15,000,000 (35 percent): **; 
$15,000,000-$18,333,333 (38 percent): **; 
Over $18,333,333 (35 percent): 3. 

Size of business receipts: $100,000 under $250,000; 
No taxable income: 183,569; 
First $50,000 (15 percent): 68,107; 
$50,000-$75,000 (25 percent): 4,304; 
$75,000-$100,000 (34 percent): 1,945; 
$100,000-$335,000 (39 percent): 1,753; 
$335,000-$10,000,000 (34 percent): 83; 
$10,000,000-$15,000,000 (35 percent): **; 
$15,000,000-$18,333,333 (38 percent): **; 
Over $18,333,333 (35 percent): **. 

Size of business receipts: $250,000 under $500,000; 
No taxable income: 137,421; 
First $50,000 (15 percent): 51,575; 
$50,000-$75,000 (25 percent): 3,980; 
$75,000-$100,000 (34 percent): 3,071; 
$100,000-$335,000 (39 percent): 2,702; 
$335,000-$10,000,000 (34 percent): 340; 
$10,000,000-$15,000,000 (35 percent): **; 
$15,000,000-$18,333,333 (38 percent): **; 
Over $18,333,333 (35 percent): **. 

Size of business receipts: $500,000 under $1,000,000; 
No taxable income: 116,640; 
First $50,000 (15 percent): 48,000; 
$50,000-$75,000 (25 percent): 6,043; 
$75,000-$100,000 (34 percent): 1,948; 
$100,000-$335,000 (39 percent): 3,804; 
$335,000-$10,000,000 (34 percent): 560; 
$10,000,000-$15,000,000 (35 percent): 3; 
$15,000,000-$18,333,333 (38 percent): **; 
Over $18,333,333 (35 percent): 0. 

Size of business receipts: $1,000,000 under $2,500,000; 
No taxable income: 101,849; 
First $50,000 (15 percent): 46,875; 
$50,000-$75,000 (25 percent): 8,325; 
$75,000-$100,000 (34 percent): 4,014; 
$100,000-$335,000 (39 percent): 6,868; 
$335,000-$10,000,000 (34 percent): 2,027; 
$10,000,000-$15,000,000 (35 percent): 6; 
$15,000,000-$18,333,333 (38 percent): **; 
Over $18,333,333 (35 percent): 3. 

Size of business receipts: $2,500,000 under $5,000,000; 
No taxable income: 43,176; 
First $50,000 (15 percent): 18,972; 
$50,000-$75,000 (25 percent): 4,701; 
$75,000-$100,000 (34 percent): 2,416; 
$100,000-$335,000 (39 percent): 6,749; 
$335,000-$10,000,000 (34 percent): 3,369; 
$10,000,000-$15,000,000 (35 percent): 4; 
$15,000,000-$18,333,333 (38 percent): **; 
Over $18,333,333 (35 percent): 6. 

Size of business receipts: $5,000,000 under $10,000,000; 
No taxable income: 21,690; 
First $50,000 (15 percent): 7,560; 
$50,000-$75,000 (25 percent): 3,204; 
$75,000-$100,000 (34 percent): 1,860; 
$100,000-$335,000 (39 percent): 6,772; 
$335,000-$10,000,000 (34 percent): 4,955; 
$10,000,000-$15,000,000 (35 percent): 9; 
$15,000,000-$18,333,333 (38 percent): 3; 
Over $18,333,333 (35 percent): 10. 

Size of business receipts: $10,000,000 under $50,000,000; 
No taxable income: 19,801; 
First $50,000 (15 percent): 4,014; 
$50,000-$75,000 (25 percent): 1,531; 
$75,000-$100,000 (34 percent): 1,280; 
$100,000-$335,000 (39 percent): 6,112; 
$335,000-$10,000,000 (34 percent): 
11,455; $10,000,000-$15,000,000 (35 percent): 152; 
$15,000,000-$18,333,333 (38 percent): 56; 
Over $18,333,333 (35 percent): 98. 

Size of business receipts: $50,000,000 under $100,000,000; 
No taxable income: 2,934; 
First $50,000 (15 percent): 167; 
$50,000-$75,000 (25 percent): 63; 
$75,000-$100,000 (34 percent): 86; 
$100,000-$335,000 (39 percent): 479; 
$335,000-$10,000,000 (34 percent): 2,649; 
$10,000,000-$15,000,000 (35 percent): 190; 
$15,000,000-$18,333,333 (38 percent): 50; 
Over $18,333,333 (35 percent): 150. 

Size of business receipts: $100,000,000 under $250,000,000; 
No taxable income: 2,081; 
First $50,000 (15 percent): 24; 
$50,000-$75,000 (25 percent): 23; 
$75,000-$100,000 (34 percent): 19; 
$100,000-$335,000 (39 percent): 127; 
$335,000-$10,000,000 (34 percent): 1,564; 
$10,000,000-$15,000,000 (35 percent): 292; 
$15,000,000-$18,333,333 (38 percent): 135; 
Over $18,333,333 (35 percent): 457. 

Size of business receipts: $250,000,000 and over; 
No taxable income: 2,140; 
First $50,000 (15 percent): 5; 
$50,000-$75,000 (25 percent): 5; 
$75,000-$100,000 (34 percent): 0; 
$100,000-$335,000 (39 percent): 26; 
$335,000-$10,000,000 (34 percent): 662; 
$10,000,000-$15,000,000 (35 percent): 235; 
$15,000,000-$18,333,333 (38 percent): 111; 
Over $18,333,333 (35 percent): 2,112. 

Source: IRS Statistics of Income (SOI) Corporate Tax File data 
estimates, 2010. 

Note: Data on the number of corporations are from IRS SOI Corporate 
Tax File, and include active corporations that filed a return on forms 
1120, 1120-F, 1120-L, and 1120-PC, but not forms 1120S, 1120-REIT, and 
1120-RIC. 

** Data have been combined with data in a lower size class to avoid 
disclosure for specific corporations. 

[End of table] 

Table 4: Coefficient of Variation Calculations for Totals in Table 3: 

Size of Business Receipts: Under $25,000; 
No taxable income: 4.28; 
First $50,000 (15 percent): 10.70; 
$50,000-$75,000 25 percent): 57.40; 
$75,000-$100,000 (34 percent): 89.45; 
$100,000-$335,000 (39 percent): 56.67; 
$335,000-$10,000,000 (34 percent): 81.84; 
$10,000,000-$15,000,000 (35 percent): 205.37; 
$15,000,000-$18,333,333 (38 percent): 733.58; 
Over $18,333,333 (35 percent): 16.50; 
Row Total: 3.80. 

Size of Business Receipts: $25,000 under $100,000; 
No taxable income: 6.31; 
First $50,000 (15 percent): 10.90; 
$50,000-$75,000 25 percent): 59.55; 
$75,000-$100,000 (34 percent): 139.22; 
$100,000-$335,000 (39 percent): 132.98; 
$335,000-$10,000,000 (34 percent): 211.65; 
$10,000,000-$15,000,000 (35 percent): --; 
$15,000,000-$18,333,333 (38 percent): --; 
Over $18,333,333 (35 percent): 51.64; 
Row Total: 5.27. 

Size of Business Receipts: $100,000 under $250,000; 
No taxable income: 6.27; 
First $50,000 (15 percent): 10.65; 
$50,000-$75,000 25 percent): 43.08; 
$75,000-$100,000 (34 percent): 64.04; 
$100,000-$335,000 (39 percent): 67.05; 
$335,000-$10,000,000 (34 percent): 291.45; 
$10,000,000-$15,000,000 (35 percent): --; 
$15,000,000-$18,333,333 (38 percent): --; 
Over $18,333,333 (35 percent): --; 
Row Total: 5.15. 

Size of Business Receipts: $250,000 under $500,000; 
No taxable income: 7.35; 
First $50,000 (15 percent): 12.28; 
$50,000-$75,000 25 percent): 44.76; 
$75,000-$100,000 (34 percent): 51.01; 
$100,000-$335,000 (39 percent): 54.03; 
$335,000-$10,000,000 (34 percent): 150.34; 
$10,000,000-$15,000,000 (35 percent): --; 
$15,000,000-$18,333,333 (38 percent): --; 
Over $18,333,333 (35 percent): --; 
Row Total: 5.99. 

Size of Business Receipts: $500,000 under $1,000,000; 
No taxable income: 8.02; 
First $50,000 (15 percent): 12.74; 
$50,000-$75,000 25 percent): 36.32; 
$75,000-$100,000 (34 percent): 63.94; 
$100,000-$335,000 (39 percent): 45.62; 
$335,000-$10,000,000 (34 percent): 115.06; 
$10,000,000-$15,000,000 (35 percent): --; 
$15,000,000-$18,333,333 (38 percent): --; 
Over $18,333,333 (35 percent): --; 
Row Total: 6.39. 

Size of Business Receipts: $1,000,000 under $2,500,000; 
No taxable income: 8.60; 
First $50,000 (15 percent): 12.89; 
$50,000-$75,000 25 percent): 30.84; 
$75,000-$100,000 (34 percent): 44.47; 
$100,000-$335,000 (39 percent): 33.87; 
$335,000-$10,000,000 (34 percent): 61.07; 
$10,000,000-$15,000,000 (35 percent): 0.00; 
$15,000,000-$18,333,333 (38 percent): --; 
Over $18,333,333 (35 percent): 51.64; 
Row Total: 6.53. 

Size of Business Receipts: $2,500,000 under $5,000,000; 
No taxable income: 13.32; 
First $50,000 (15 percent): 20.38; 
$50,000-$75,000 25 percent): 41.05; 
$75,000-$100,000 (34 percent): 57.13; 
$100,000-$335,000 (39 percent): 33.90; 
$335,000-$10,000,000 (34 percent): 45.50; 
$10,000,000-$15,000,000 (35 percent): 0.00; 
$15,000,000-$18,333,333 (38 percent): --; 
Over $18,333,333 (35 percent): 44.70; 
Row Total: 9.73. 

Size of Business Receipts: $5,000,000 under $10,000,000; 
No taxable income: 18.60; 
First $50,000 (15 percent): 32.31; 
$50,000-$75,000 25 percent): 49.65; 
$75,000-$100,000 (34 percent): 65.15; 
$100,000-$335,000 (39 percent): 33.87; 
$335,000-$10,000,000 (34 percent): 36.80; 
$10,000,000-$15,000,000 (35 percent): 53.95; 
$15,000,000-$18,333,333 (38 percent): 89.27; 
Over $18,333,333 (35 percent): 34.62; 
Row Total: 12.71. 

Size of Business Receipts: $10,000,000 under $50,000,000; 
No taxable income: 18.46; 
First $50,000 (15 percent): 44.14; 
$50,000-$75,000 25 percent): 71.52; 
$75,000-$100,000 (34 percent): 77.80; 
$100,000-$335,000 (39 percent): 35.50; 
$335,000-$10,000,000 (34 percent): 23.86; 
$10,000,000-$15,000,000 (35 percent): 10.89; 
$15,000,000-$18,333,333 (38 percent): 17.40; 
Over $18,333,333 (35 percent): 12.33; 
Row Total: 12.39. 

Size of Business Receipts: $50,000,000 under $100,000,000; 
No taxable income: 36.36; 
First $50,000 (15 percent): 206.26; 
$50,000-$75,000 25 percent): 329.60; 
$75,000-$100,000 (34 percent): 302.03; 
$100,000-$335,000 (39 percent): 123.58; 
$335,000-$10,000,000 (34 percent): 44.41; 
$10,000,000-$15,000,000 (35 percent): 9.75; 
$15,000,000-$18,333,333 (38 percent): 16.27; 
Over $18,333,333 (35 percent): 8.9; 
Row Total: 26.00. 

Size of Business Receipts: $100,000,000 under $250,000,000; 
No taxable income: 25.48; 
First $50,000 (15 percent): 487.74; 
$50,000-$75,000 25 percent): 478.36; 
$75,000-$100,000 (34 percent): 580.59; 
$100,000-$335,000 (39 percent): 210.34; 
$335,000-$10,000,000 (34 percent): 40.56; 
$10,000,000-$15,000,000 (35 percent): 165.20; 
$15,000,000-$18,333,333 (38 percent): 23.53; 
Over $18,333,333 (35 percent): 17.78; 
Row Total: 21.51. 

Size of Business Receipts: $250,000,000 and over; 
No taxable income: 4.81; 
First $50,000 (15 percent): 798.88; 
$50,000-$75,000 25 percent): 798.50; 
$75,000-$100,000 (34 percent): --; 
$100,000-$335,000 (39 percent): 460.64; 
$335,000-$10,000,000 (34 percent): 30.59; 
$10,000,000-$15,000,000 (35 percent): 6.64; 
$15,000,000-$18,333,333 (38 percent): 8.03; 
Over $18,333,333 (35 percent): 0.88; 
Row Total: 5.00. 

Source: GAO analysis of IRS Statistics of Income (SOI) Corporate Tax 
File data estimates, tax year 2010. 

Note: This table contains the coefficient of variation. It is the 
estimate divided by the standard error. The estimate can be either a 
total or a percent. When the estimate is small (1 percent or 5 
corporations), the coefficient of variation may be more than 100. Data 
on the number of corporations are from IRS SOI Corporate Tax File, and 
include active corporations that filed a return on forms 1120, 1120-F, 
1120-L, and 1120-PC, but not forms 1120S, 1120-REIT, and 1120-RIC. 

--: The sample has no observations in this cell. The population may 
have corporations in this cell. However, we do not have sufficient 
information to calculate an appropriate margin of error. 

[End of table] 

[End of section] 

Appendix IV: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

James R. White, (202) 512-9110 or whitej@gao.gov. 

Staff Acknowledgments: 

In addition to the contact name above, Kevin Daly (Assistant 
Director), Jason Vassilicos (Analyst-in-Charge), Elwood D. White, 
JoAnna Berry, Robert Gebhart, Eric Gorman, Lois Hanshaw, Benjamin 
Licht, Ed Nannenhorn, Karen O'Conor, Kathleen Padulchick, Robert 
Robinson, Stewart W. Small, Anne Stevens, and Jim Wozny all made 
contributions to this report. 

[End of section] 

Footnotes: 

[1] Our prior work highlighted a number of tax expenditures used by 
both corporate and individual taxpayers that had tax expenditure 
estimates that were larger or similar in size to the three tax 
expenditures covered in this report. See GAO, Corporate Tax 
Expenditures: Information on Estimated Revenue Losses and Related 
Federal Spending Programs, [hyperlink, 
http://www.gao.gov/products/GAO-13-339] (Washington, D.C.: Mar. 18, 
2013). 

[2] Corporate tax expenditure estimates totaled $147 billion in 2012 
while corporate income tax revenue totaled $242 billion. Corporate tax 
expenditure estimates may be larger relative to corporate income tax 
revenues due to the continuing effects of a recovering economy as well 
as bonus depreciation, a temporary provision to stimulate investment, 
scheduled to expire at the end of 2013. While sufficiently reliable as 
a gauge of general magnitude, summing tax expenditure estimates does 
not take into account any interactions between tax expenditures. In 
addition, tax expenditure estimates do not incorporate any behavioral 
responses. Thus, they do not represent the revenue amount that would 
be gained if a specific tax expenditure was repealed. 

[3] GAO, Tax Expenditures: Background and Evaluation Criteria and 
Questions, [hyperlink, http://www.gao.gov/products/GAO-13-167SP] 
(Washington, D.C.: Nov. 29, 2012). The graduated corporation income 
tax rate is the terminology used in Treasury's tax expenditure 
estimates, but we refer to it as the graduated corporate income tax 
rate schedule or graduated rates for this report. 

[4] The SOI corporate sample is not designed to estimate the number of 
corporations in small subgroups with the exception of groups 
consisting of only large corporations. In addition, some cells with 
very small numbers are collapsed or suppressed to protect taxpayer 
information. 

[5] Dividends are only one form of foreign source income. Others can 
include royalties, license payments, and export income. See CRS, 
Moving to a Territorial Income Tax: Options and Challenges 
(Washington, D.C.: July 25, 2012). 

[6] Lowell D. Yoder, "Subpart F in Turmoil: Low-Taxed Active Income 
Under Siege" Taxes, vol. 77 (March 1999). 

[7] PWC identified six countries that have a worldwide tax system with 
a foreign tax credit. These include the United States, Mexico, the 
Republic of Korea, Israel, Ireland, and Chile. See PWC, Evolution of 
Territorial Tax Systems in the OECD, prepared for the Technology CEO 
Council (Apr. 2, 2013). 

[8] GAO, International Taxation: Study Countries That Exempt Foreign-
Source Income Face Compliance Risks and Burdens Similar to Those in 
the United States, [hyperlink, http://www.gao.gov/products/GAO-09-934] 
(Washington, D.C.: Sept. 15, 2009). 

[9] Once reached, the two highest brackets give corporations an 
average tax rate of 34 and 35 percent, respectively. 

[10] The concept of tax expenditures extends beyond the income tax. 
Tax expenditures also exist for other types of taxes, such as excise 
and payroll taxes. However, this report considers only tax 
expenditures for the federal income tax system. Different tax 
expenditures would apply in the case of a consumption tax. 

[11] Both Treasury and JCT use judgment when establishing their normal 
baseline tax structures. It is sometimes the case that a particular 
provision is considered an exception to the baseline structure and 
another, very similar provision is not. For example, graduated rates 
for C corporations are considered an exception, while S corporation 
provisions that can also provide lower tax rates for businesses are 
not. Treasury also discusses an alternative baseline tax structure--
the reference tax baseline--which defines as tax expenditures only 
those provisions that are special exceptions from a generally defined 
tax rule that serves programmatic functions similar to spending 
programs. The general deferral provision and the graduated rates are 
not considered to be tax expenditures relative to this baseline. In 
addition, in 2008, JCT did not consider either of the deferral 
provisions as tax expenditures under a new approach for considering 
tax expenditures used only in that year. See JCT, Estimates of Federal 
Tax Expenditures for Fiscal Years 2008-2027, JCS-2-08 (Washington, 
D.C.: Oct. 31, 2008). 

[12] Office of Management and Budget (OMB), Analytical Perspectives, 
Budget of the United States Government, Fiscal Year 2014 (Washington, 
D.C.: 2013); and JCT, Estimates of Federal Tax Expenditures for Fiscal 
Years 2012-2017, JCS-1-13 (Washington, D.C.: Feb. 1, 2013). 

[13] While, in general, the tax expenditure lists Treasury and JCT 
publish annually are similar, they differ somewhat in the number of 
tax expenditures reported, and the estimated revenue losses for 
particular expenditures. The organizations use different (1) income 
tax baselines; (2) de minimis amounts, which is the minimum revenue 
loss threshold for Treasury and JCT to report a tax expenditure; and 
(3) economic and technical assumptions. For more information on how 
Treasury and JCT estimate revenue loss, see appendix III of GAO, 
Government Performance and Accountability: Tax Expenditures Represent 
a Substantial Federal Commitment and Need to Be Reexamined, 
[hyperlink, http://www.gao.gov/products/GAO-05-690] (Washington, D.C.: 
Sept. 23, 2005). 

[14] As the Congressional Research Service (CRS) points out in its tax 
expenditures compendium, deferral has been part of the U.S. tax system 
since the creation of the corporate income tax in 1909. See U.S. 
Congress, Senate Committee on the Budget, Tax Expenditures: Compendium 
of Background Material on Individual Provisions, S. Prt. 111-58, 
prepared by CRS (Washington, D.C.: December 2012). Initially, the 
deferral of tax on the income of controlled foreign corporations may 
have been meant to delay taxation until a corporation realized income, 
according to the notion that income should not be taxed before it is 
available for taxpayer use. 

[15] Competitiveness has been identified as the purpose of deferral in 
parts of the legislative history. Subsequent legislative changes, 
primarily during the creation of Subpart F, provided a more explicit 
purpose for deferral. While considering how to restrict deferral 
through Subpart F in 1962, as well as creating the exception for 
deferred taxes for certain income earned overseas by financial-
services firms, both the House and Senate reports recognized deferral 
was needed to help maintain active American business operations abroad 
on an equal competitive footing with other businesses operating 
overseas. See H.R. Rep. No. 87-1447, 62 (1962); S. Rep. No. 87-1881, 
at 83 (1962). See also H.R. Conf. Rep. No. 105-220 644-45 (1997). 
Changes in Subpart F were also introduced to encourage investment in 
less developed countries. See Treasury, The Deferral of Income Earned 
Through U.S. Controlled Foreign Corporations: A Policy Study 
(Washington, D.C.: December 2000). 

[16] Other factors, such as differences in regulatory and trade 
frameworks, may provide incentives to invest abroad as well. See Mihir 
A. Desai, C. Fritz Foley, and James R. Hines Jr., "Domestic Effects of 
the Foreign Activities of U.S. Multinationals," American Economic 
Journal: Economic Policy (2009), Martin Sullivan, "Economic Analysis: 
Will Obama's International Proposals Kill U.S. Jobs?", Tax Notes Today 
(June 1, 2009), and Harry Grubert, "Foreign Taxes and The Growing 
Share of U.S. Multinational Company Income Abroad: Profits, Not Sales, 
Are Being Globalized," National Tax Journal, vol. 65 (June 2012). 

[17] See Nicola Satori and Reuven S. Avi-Yonah, "Symposium on 
International Taxation and Competitiveness: Foreword," Tax Law Review, 
vol. 65 (Spring 2012). This paper summarizes a variety of viewpoints 
on competitiveness. 

[18] A number of tax expenditures benefit U.S. corporations that 
produce domestically, such as the inventory property sales source 
rules exception and the deduction for U.S. production activities, 
although both have tax expenditure estimates smaller than the general 
deferral provision. See OMB, Analytical Perspectives, Budget of the 
United States Government, Fiscal Year 2014 (Washington, D.C.: 2013). 

[19] GAO, U.S. Multinational Corporations: Effective Tax Rates Are 
Correlated with Where Income Is Reported, [hyperlink, 
http://www.gao.gov/products/GAO-08-950] (Washington, D.C.: Aug. 12, 
2008). Deferral reduces U.S. multinational corporations' effective tax 
rate. The present value of a tax paid in the future is generally less 
than that of a tax paid today because the taxpayer can then use the 
funds (for example, for investment) until the tax is paid. These funds 
would have been unavailable to the taxpayer had the tax been paid 
earlier. 

[20] See Kevin S. Markle and Douglas Shackelford, "Do Multinationals 
or Domestic Firms Face Higher Effective Tax Rates?," National Bureau 
of Economic Research Working Paper Series (June 2009). 

[21] See Eric Toder, "International Competitiveness: Who Competes 
Against Whom and for What?," Tax Law Review, vol. 65 (Spring 2012). 

[22] See Michael S. Knoll, "The Connection Between Competitiveness and 
International Taxation," Tax Law Review, vol. 65 (Spring 2012). 

[23] The concept of economic efficiency is described in more detail 
later in this report. 

[24] See Jane G. Gravelle, "Does the Concept of Competitiveness Have 
Meaning in Formulating Corporate Tax Policy?," Tax Law Review, vol. 65 
(Spring 2012). 

[25] See [hyperlink, http://www.gao.gov/products/GAO-13-167SP] for a 
more detailed discussion of economic efficiency. Also see appendix II 
of this report for an example of how these inefficiencies can occur 
when taxes affect how taxpayers make investment decisions. 

[26] CRS, among others, outlined a number of other considerations that 
may have to be evaluated if a move to a territorial tax system was 
implemented. CRS, Moving to a Territorial Income Tax: Options and 
Challenges (Washington, D.C.: July 15, 2012). 

[27] Organisation for Economic Co-operation and Development, Tax 
Effects on Foreign Direct Investment: Recent Evidence and Policy 
Analysis: Tax Policy Study No. 17 (2007). 

[28] Change of incorporation may occur through a corporate inversion 
or cross-border merger and acquisition. See Johannes Voget, 
"Relocation of Headquarters and International Taxation," Journal of 
Public Economics, vol. 95 (October 2011). 

[29] Jim A. Seida and William F. Wempe, "Effective Tax Rate Changes 
and Earning Stripping Following Corporate Inversion," National Tax 
Journal, vol. 57 (December 2004). 

[30] Eric J. Allen and Susan C. Morse, "Tax-Haven Incorporation For 
U.S.-Headquartered Firms: No Exodus Yet," National Tax Journal, vol. 
66 (June 2013); Martin Sullivan, "Economic Analysis: Another 
Pharmaceutical Inversion to Ireland; More on the Horizon?", Tax Notes 
Today (Aug. 8, 2013); and Bret Wells, "Cant and the Inconvenient Truth 
About Corporate Inversions," Tax Notes Today (July 5, 2012). 

[31] The American Jobs Creation Act of 2004 (P.L. 108-357) was 
targeted at restricting corporate inversion. See CRS, Firms That 
Incorporate Abroad for Tax Purposes: Corporate "Inversions" and 
"Expatriation" (Washington, D.C.: Mar. 5, 2010). 

[32] Mihir A. Desai and James Hines, "Evaluating International Tax 
Reform," National Tax Journal, vol. 46 (September 2003). 

[33] CRS, Reform of U.S. International Taxation: Alternatives 
(Washington, D.C.: Dec. 27, 2012). 

[34] Mihir A. Desai, C. Fritz Foley, and James R. Hines, "Repatriation 
Taxes and Dividend Distortions," National Tax Journal, vol. 54 
(December 2001); and Harry Grubert and John Mutti, Taxing 
International Business Income: Dividend Exemption versus the Current 
System (Washington, D.C.: American Enterprise Institute) (2001). 

[35] The American Jobs Creation Act of 2004, section 422, allowed 
companies to pay a one-time 5.25-percent tax rate on repatriated 
foreign earnings. Companies brought back $312 billion into the United 
States due to this change. See IRS, The One-Time Received Dividend 
Deduction, SOI Bulletin (Spring 2008). 

[36] Harry Grubert and Rosanne Altshuler, Fixing the System: An 
Analysis of Alternative Proposals for the Reform of International Tax, 
Working Papers Series (Apr. 1, 2013). 

[37] See IRS, The One-Time Received Dividend Deduction, SOI Bulletin 
(Spring 2008). 

[38] Most experts agree that the scope for income shifting and the 
resulting compliance and administrative burden have increased by the 
check-the-box regulations and the look-through provision of the IRC. 
The check-the-box regulations, issued by Treasury in 1997, permit U.S. 
taxpayers to treat certain wholly owned foreign entities either as 
separate corporations or to "disregard" them as unincorporated 
branches simply by checking a box on a tax form. Taxpayers have used 
this flexibility to create "hybrid entities," which are business 
operations treated as corporations by one country's tax authority, and 
as unincorporated branch operations by another's. See 26 C.F.R. §§ 
301.7701-1 to 4. Congress passed the look-through rules in 2006. The 
rules allow dividends, interest, rents, and royalties received or 
accrued by one controlled foreign corporation from a related 
controlled foreign corporation not to be treated as Subpart F income 
and thus eligible for deferral. See 26 U.S.C. § 954(c)(6). 

[39] The complexity of Subpart F has increased with the inclusion of 
the check-the-box regulations and the look-through rules discussed 
above. 

[40] GAO, International Taxation: Study Countries That Exempt Foreign-
Source Income Face Compliance Risks and Burdens Similar to Those in 
the United States, [hyperlink, http://www.gao.gov/products/GAO-09-934] 
(Washington, D.C.: Sept. 15, 2009). 

[41] The foreign tax credit also adds complexity when U.S. 
corporations try to time their repatriations to claim as much of the 
credit as possible. Corporations can lower the amount of U.S. tax they 
would otherwise have to pay by repatriating income from low-tax 
countries when they have excess foreign tax credits. The corporation 
uses cross-crediting where it applies excess foreign tax credits 
generated in a high-tax country to the U.S. tax owed on income 
generated in a low-tax country. Corporations, however, are not allowed 
to use excess credits associated with passive income to offset taxes 
on active income, or vice versa. 

[42] See [hyperlink, http://www.gao.gov/products/GAO-13-339]. 

[43] GAO, 2013 Annual Report: Actions Needed to Reduce Fragmentation, 
Overlap, and Duplication and Achieve Other Financial Benefits, 
[hyperlink, http://www.gao.gov/products/GAO-13-279SP] (Washington, 
D.C.: Apr. 9, 2013). 

[44] Over the 5-period from 2012 to 2016, CBO reports that the total 
estimated revenue effects of moving to a full inclusion worldwide 
system would be $49.7 billion, while the effect of moving to a 
territorial system would be $31.7 billion. These estimates were 
prepared for the CBO report by staff of JCT. For more details on the 
estimates, see CBO, Reducing the Deficit: Spending and Revenue Options 
(Washington, D.C.: Mar. 10, 2011). If estimates of the revenue effects 
of moving to a worldwide tax system more current than CBO's 2011 
estimates were made, there is some evidence that they could be larger. 
JCT's tax expenditure estimates increased substantially after this 
revenue estimate was made, increasing from $15.6 billion to $36.6 
billion in constant 2012 dollars. Although, as pointed out earlier, 
tax expenditure estimates do not include behavioral responses, the 
increase in the tax expenditure estimate may indicate a larger revenue 
impact if the U.S. moved to a full inclusion worldwide system. 

[45] JCT notes that its corporate tax model for estimating revenue 
effects includes possible behavioral changes in: (1) corporate 
dividends and retained earnings; (2) the corporate capital structure; 
(3) corporate equity valuations; (4) repatriations of deferred foreign 
income; and (5) business entity choice. See JCT, Summary of Economic 
Models and Estimating Practices of the Staff of the Joint Committee on 
Taxation. (Washington, D.C.: Sept. 19, 2011). JCT's revenue estimates 
prepared for specific proposals differ from its and Treasury's tax 
expenditure estimates that do not incorporate such behavioral 
responses. For an explanation of how JCT and Treasury complete their 
tax expenditure estimates, see JCT, Estimates of Federal Tax 
Expenditures for Fiscal Years 2012-2017, JCS-1-13 (Washington, D.C.: 
Feb. 1, 2013), and OMB, Analytical Perspectives, Budget of the United 
States Government, Fiscal Year 2014 (Washington, D.C.: 2013). 

[46] Overhead costs, such as interest expenses, of a U.S. parent 
corporation would be allocated between the company's U.S. and foreign 
activities, as is the case under current law for purposes of computing 
the foreign tax credit. In a departure from current law, however, 
overhead expenses allocated to foreign income would no longer be 
deductible from U.S. income. As noted by CBO, the net increase in 
revenues when the dividend exemption system is adopted occurs because 
revenues lost by exempting active dividends from U.S. taxation would 
be more than offset by increases in taxes because overhead expenses 
allocated to exempt foreign income could no longer be deducted from 
U.S. income. If the tax treatment of overhead expenses was not 
altered, moving to a dividend exemption system may entail a reduction 
in the tax revenue the federal government collects from corporations. 

[47] GAO, International Taxation: Study Countries That Exempt Foreign-
Source Income Face Compliance Risks and Burdens Similar to Those in 
the United States, [hyperlink, http://www.gao.gov/products/GAO-09-934] 
(Washington, D.C.: Sept. 15, 2009). 

[48] Treasury estimated that revenue losses from the deferral of 
income for controlled foreign corporations rose from about $7.7 
billion in 1999 to $42 billion in 2012. The difference in the 
estimation methods is illustrated by the 2012 estimated revenue loss 
of $42 billion, and JCT's estimate of a $4.7 billion revenue gain for 
a specific proposal to adopt full inclusion. Estimates for deferred 
taxes for financial firms on certain income earned overseas during a 
similar period show revenue losses increasing at a slower pace, from 
$1.3 billion to $2.5 billion during the same period. As we pointed out 
in our prior work on corporate tax expenditures, the general deferral 
provision was the second largest in terms of tax expenditure 
estimates, behind only accelerated depreciation of machinery and 
equipment. See [hyperlink, http://www.gao.gov/products/GAO-13-339]. 

[49] The Tax Increase Prevention and Reconciliation Act ("TIPRA") of 
2005 (H.R. 4297), enacted on May 17, 2006 (Pub. L. No. 109-222). 

[50] Lee Sheppard and Martin Sullivan, "News Analysis: Multinationals 
Accumulate to Repatriate," Tax Notes Today (January 15, 2009). 

[51] GAO, Tax Policy: Tax Expenditures Deserve More Scrutiny, 
[hyperlink, http://www.gao.gov/products/GAO/GGD/AIMD-94-122] 
(Washington, D.C.: June 3, 1994), and Government Performance and 
Accountability: Tax Expenditures Represent a Substantial Federal 
Commitment and Need to Be Reexamined, [hyperlink, 
http://www.gao.gov/products/GAO-05-690] (Washington, D.C.: Sept. 23, 
2005). 

[52] GAO, Managing For Results: Executive Branch Should More Fully 
Implement the GPRA Modernization Act to Address Pressing Governance 
Challenges, [hyperlink, http://www.gao.gov/products/GAO-13-518] 
(Washington, D.C.: June 26, 2013). 

[53] See also OMB Circular No. A-11 (July 2013). 

[54] The benefit that the graduated corporate income tax rates provide 
is taken back in the form of higher rates when the corporation's 
income exceeds the graduated rate income range. 

[55] U.S. Congress, Senate Committee on the Budget, Tax Expenditures: 
Compendium of Background Material on Individual Provisions, S. Prt. 
112-45, prepared by CRS (Washington, D.C.: December 2012). 

[56] See Simeon Djankov, Tim Ganser, Caralee McLiesh, Rita Ramalho, 
and Andrei Shleifer, "The Effect of Corporate Taxes on Investment and 
Entrepreneurship," American Economic Journal: Macroeconomics, vol. 2 
(July 2010); and Julie Berry Cullen and Roger H. Gordon, "Taxes and 
entrepreneurial risk-taking: Theory and evidence for the U.S," Journal 
of Public Economics, vol. 91 (2007). 

[57] Asli Demirguc-Kunt, Inessa Love, and Vojislav Maksimovic, 
"Business Environment and the Incorporation Decision," Journal of 
Banking and Finance, vol. 30 (2006). 

[58] Matthew J. Knittel and Susan C. Nelson, "How Would Small Business 
Owners Fare Under a Business Entity Tax," National Tax Journal, vol. 
64 (December 2011). 

[59] These data represent a snapshot of IRS data, and may not be 
representative of trends before and after the economic recession that 
occurred from December 2007 to June 2009. 

[60] We made a number of recommendations to OMB, which included that 
it provide guidance to agencies to identify tax expenditures that 
contribute to each appropriate agency goal. OMB agreed with the 
recommendations we made. See [hyperlink, 
http://www.gao.gov/products/GAO-13-518]. 

[61] Treasury, Taxes and Corporate Choice of Organizational Form 
(Washington, D.C.: 1997). 

[62] The effect of graduated rates on organizational form is difficult 
to determine because, in part, businesses have a variety of 
organizational forms available that affect their tax liabilities. For 
example, besides C corporations, they can organize as "pass-through" 
entities such as partnerships and S corporations that pay the 
individual tax rate and avoid the double tax on corporate dividends. 

[63] For more details on these studies of the impact of small 
businesses, see CRS' recently issued comprehensive study. CRS, Small 
Business Tax Benefits: Current Law and Main Arguments For and Against 
Them (Washington, D.C.: Mar. 11, 2013). 

[64] The question of who receives the benefit of the tax expenditure--
referred to as the incidence of the benefit--is explored in more 
detail in [hyperlink, http://www.gao.gov/products/GAO-13-167SP]. 

[65] Tax net income represents a firm's taxable income before 
subtracting any net operating loss carryforward or special deductions 
and is most closely comparable to domestic pre-tax book income. The 
most dramatic changes occurred in corporations currently in the zero-, 
25-, 34-, and 38-percent tax brackets, all of which face a different 
marginal tax rate from a 5-percent increase in tax net income. See 
IRS, The Distribution of Corporate Income: Tabulations from the 
Schedule M-3, 2004-2008, SOI Bulletin (Washington, D.C.: Spring 2012). 

[66] See Donald DeLuca, John Guyton, Wu-Lang Lee, John O'Hare, and 
Scott Stilmar, Aggregate Estimates of Small Business Taxpayer 
Compliance Burden, IRS Research Bulletin (2007). 

[67] See [hyperlink, http://www.gao.gov/products/GAO-13-339]. 

[68] GAO, Entrepreneurial Assistance: Opportunities Exist to Improve 
Programs Collaboration, Data Track, and Performance Management, 
[hyperlink, http://www.gao.gov/products/GAO-12-819] (Washington, D.C.: 
Aug. 23, 2012). 

[69] From 2012 to 2016, the revenue effects of this option would be 
$12.1 billion. The staff of the JCT prepared most of the revenue 
estimates in CBO's report. See CBO, Reducing the Deficit: Spending and 
Revenue Options (Washington, D.C.: Mar. 10, 2011). 

[70] GAO, Managing For Results: Executive Branch Should More Fully 
Implement the GPRA Modernization Act to Address Pressing Governance 
Challenges, [hyperlink, http://www.gao.gov/products/GAO-13-518] 
(Washington, D.C.: June 26, 2013). 

[71] See also OMB Circular No. A-11 (July 2013). 

[72] GAO, Tax Expenditures: Background and Evaluation Criteria and 
Questions, [hyperlink, http://www.gao.gov/products/GAO-13-167SP] 
(Washington, D.C.: Nov. 29, 2012) 

[73] U.S. Congress, Senate Committee on the Budget, Tax Expenditures: 
Compendium of Background Material on Individual Provisions, S. Prt. 
111-58, prepared by CRS (Washington, D.C.: December 2010) and U.S. 
Congress, Senate Committee on Finance, Economic Efficiency and 
Structural Analyses of Alternative U.S. Tax Policies For Foreign 
Direct Investment. Prepared by JCT (Washington, D.C.: June 2008). 

[74] We chose 1998 as the first year as that was the first year 
Treasury estimated revenue losses for deferred taxes for financial 
firms on certain income earned overseas since the exception was 
eliminated in 1986. See 26 U.S.C. § 954(h), which was added by the 
Taxpayer Relief Act of 1997, Pub. L. No 105-34 § 1175 (Aug. 5, 1997). 

[75] Treasury estimates the portion of revenue losses associated with 
corporate or individual taxpayers for each tax expenditure in its 
list. However, all three tax expenditures in the scope of our report 
only have tax expenditure estimates for corporate taxpayers. 

[76] See CBO, Reducing the Deficit: Spending and Revenue Options 
(Washington, D.C.: Mar. 10, 2011). 

[77] See JCT, Summary of Economic Models and Estimating Practices of 
the Staff of the Joint Committee on Taxation (Washington, D.C.: Sept. 
19, 2011). 

[78] Mihir A. Desai and James R. Hines Jr., "Old Rules and New 
Realities: Corporate Tax Policy in a Global Setting," National Tax 
Journal, vol. 57 (December 2004). 

[79] Harry Grubert and Rosanne Altshuler, Fixing the System: An 
Analysis of Alternative Proposals for the Reform of International Tax, 
Working Papers Series (Apr. 1, 2013) and CRS, Reform of U.S. 
International Taxation: Alternatives (Washington, D.C.: Dec. 27, 2012). 

[80] If the U.S. tax rate is lower than the foreign tax rate, the U.S. 
system, which limits the foreign tax credit to the U.S. tax liability 
on the foreign income, discourages investment abroad. See Organisation 
for Economic Co-operation and Development, Tax Effects on Foreign 
Direct Investment: Recent Evidence and Policy Analysis. Tax Policy 
Study No. 17 (2007). 

[81] Harry Grubert. "Foreign Taxes and the Growing Share of U.S. 
Multinational Company Income Abroad: Profits, Not Sales, Are Being 
Globalized," National Tax Journal, vol. 65 (June 2012). The author 
argues that income shifting may be growing due to tax-planning 
opportunities that were increased by check-the-box-rules in 1997. 

[82] The incentive to shift income disappears, except for companies 
that have excess credits. 

[83] GAO, International Taxation: Study Countries That Exempt Foreign-
Source Income Face Compliance Risks and Burdens Similar to Those in 
the United States, [hyperlink, http://www.gao.gov/products/GAO-09-934] 
(Washington, D.C.: Sept. 15, 2009). 

[End of section] 

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