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Why Reported Effective Corporate Tax Rates Are Falling

Posted on March 3, 2008 by Martin A. Sullivan
Document originally published in Tax Notes
on March 3, 2008.


Last week we showed that America's most profitable corporations were reporting significantly lower effective tax rates on their financial statements in recent years than they did in the late 1990s. For 80 corporations accounting for approximately half of total U.S. profits, the average effective tax rate for 1997-1999 was 34.1 percent. For 2004-2006, the average effective tax rate was 30 percent. (See Figure 1; see also "Reported Corporate Effective Tax Rates Down Since Late 1990s," Tax Notes, Feb. 25, 2008, p. 882, Doc 2008-3456 , or 2008 TNT 38-6 ).)

This week we look at the causes of this 4.1 percentage point decline. In the footnotes to their financial statements, publicly traded corporations are required to quantify any factors that cause significant deviations between the firm's reported effective tax rate and the U.S. top statutory rate of 35 percent. Companies have a lot of leeway regarding whether and how they report rate differences, so, as we shall detail below, we had to use some judgment in how to categorize the reported changes. But no matter how you slice it, some clear patterns emerge: The three most important factors explaining the decline in effective tax rates are (1) the growing role of lower foreign taxes in the overall tax burden, (2) the declining impact of state and local income taxes, and (3) increasingly favorable audit outcomes.

Of the 15 possible explanations for lower effective tax rates that we examined, those 3 had the largest aggregate effect. But our sample is a diverse bunch. For some companies, none of the leading three causes played a major role. The detailed discussion at the end of this article, in addition to providing necessary technical details about the data, also tries to highlight situations in which other factors were important to a particular group of firms even though in the aggregate they were not significant.

Table 1 shows how frequently the most important factors determining effective tax rates are reported by the 80 corporations in our sample. Table 2 and Figure 2 summarize our key findings.


Figure 1. Average Corporate Effective Tax Rate
For 80 Large U.S. Corporations - Comparison of
1997-1999 and 2004-2006 Periods



Reported Effect of Foreign Taxes

By a wide margin, lower foreign taxes on foreign earnings, accounting for an average decline of 2.9 percentage points, are the most significant factor behind the average total 4.1 percentage point decline in effective tax rates. What are the explanations for this change? We can think of three possibilities:

Explanation 1. An increasing share of U.S. multinational real business activity is occurring outside the United States in low-tax jurisdictions. For example, if a U.S. corporation were able to shift 10 percent of its operations out of the United States (or another country with a similar tax rate) to a country with a 10 percent corporate tax rate, its reported effective tax rate would decline by 2.5 percentage points.

Explanation 2. U.S. multinational corporations are increasingly able to shift profits (and not necessarily real business activity) into low-tax jurisdictions. For example, if a U.S. corporation could shift 10 percent of its worldwide profit from the United States to a low-tax jurisdiction, its reported effective tax rate would decline by 2.5 percentage points.

Explanation 3. Foreign jurisdictions where U.S. multinationals operate have lowered their corporate tax rates. If a U.S. corporation had one-third of its operations outside the United States, a reduction of 7.5 percentage points in the average foreign tax rate would reduce the effective tax rate by 2.5 percentage points.

        Table 1. Data Availability for 80 Corporations



 Factors Affecting
 Reported Effective        1997-       2004-       Both
 Tax Rate                  1999        2006       periods

 Foreign taxes               1           9          46
 State and local taxes       2           6          55
 Audit                       4          25           1
 Nondeductible
 expenses                   22           8           7
 AJCA repatriations          0          21           0
 Equity method               2           5           3
 Valuation allowance         8          11           3
 Tax credits                 3          15          19
 Manufacturing
 deduction                   0           7           0
 Adjustments to prior
 years' taxes                3           3           1
 Tax-exempt income           5           3          22
 Restructuring              14           7           1
 FSC/ETI                     1           4           4
 Other                       0           6          74
 Miscellaneous               8          19           9

Of course, the lower reported effective tax rates could be the result of a combination of all three factors, and given what we have been reading about international taxation lately, that does not seem too far-fetched. It is impossible to tell from the data presented here which explanation carries the most weight. In the near future, we hope to be able to examine data on multinational corporations like those available from the U.S. Commerce Department's Bureau of Economic Analysis. With the bureau's data, we will be able to see by how much the composition of U.S. real activity (as measured by capital expenditures, sales, value added, and employment) and of worldwide profits is shifting outside the United States and to which countries. Then maybe we will be able to say which of the three explanations above is most important.

In the meantime, we can still say something useful. Let's first suppose Explanation 1 — that U.S. corporations are doing a larger share of business abroad in lower-tax countries — is the cause of the foreign pressure contributing to the decline in reported effective tax rates. Within that general explanation there are two subpossibilities. First, (A) the process is the inevitable result of globalization and has little to do with taxes. In that case, U.S. tax policy does not play a major role in U.S. employment, productivity, and growth. Second, (B) corporations are doing a larger share of their business abroad as a result of favorable tax policies. We must then ask ourselves if it is in the United States' interests to provide U.S. multinationals with tax breaks for operating overseas. That question is at the center of the current U.S. debate between proponents of territorial taxation and proponents of worldwide taxation.

Alternatively, let's assume Explanation 2 — that multinationals are shifting profits to low-tax jurisdictions — is the main factor behind declining reported tax rates. In that case, the United States should tighten its transfer pricing rules to preserve revenue.

Finally, let's assume Explanation 3 — legislated lower foreign tax rates — is behind the lower reported U.S. effective tax rates. That possibility highlights how much the United States is falling out of step with the rest of the world. Unless the U.S. lowers its rates, it is leaving itself susceptible to both job losses and revenue losses.

Most of the above possibilities do not present a particularly flattering picture of current U.S. tax policy. There is one exception, however, under Explanation 1, part (B): The decline in reported effective foreign tax rates is a welcome development if you believe that taxes matter in cross-border investment decisions and that a lower rate of tax on foreign investment by U.S. corporations is good for the domestic U.S. economy. That is, in fact, precisely the view expressed by John Samuels, vice president and tax adviser of GE, in a recent speech to the Tax Council Policy Institute. (For coverage of similar comments by Samuels in October 2007, see Tax Notes, Oct. 29, 2007, p. 431, Doc 2007-23748, or 2007 TNT 210-3 ).)

Notes and Comments on Individual Factors



The 15 categories of factors affecting effective corporate tax rates are outlined and discussed below. Most are accompanied by tables listing the individual corporations affected by each factor, along with the percentage point change in effective tax rate those corporations experienced between 1997-1999 and 2004-2006. For others, the data sample was so small that, instead of providing a table, we will discuss the results in the text.

Foreign taxes. As shown in Table 2, the changing effect of foreign taxes had the most impact on effective corporate tax rates, accounting for 2.92 percentage points of the total 4.1 percentage point decline. As shown in Table 1, 46 corporations had data available on foreign taxes for both periods, while 9 had data available for only the later period and 1 had data for only the earlier period. Companies described foreign tax effects as "foreign earnings including earnings invested indefinitely," "operations outside the United States," and "foreign earnings taxed." Those entries usually include operations in Puerto Rico. In some cases, firms also separately reported effects of U.S. taxes on foreign earnings (which were usually small compared with the effect of foreign taxes on foreign earnings). In cases in which those two effects were separately recorded, we added them together. Table 2 also shows that for all 46 corporations reporting for both periods, the effect of foreign earnings changed by more than 1 percentage point. Of those 46 firms, 43 had negative changes — that is, foreign taxes contributed significantly more toward reducing effective tax rates in 2004-2006 than in 1997-1999. Table 3 lists the changing effect of foreign taxes on individual firms' effective tax rates between 1997-1999 and 2004-2006 for rate changes of more than 1 percentage point in either direction.

 Table 2. Effects of Various Factors on Effective Corporate Tax Rates



                           Percentage
                             Point      More       More       Excess of
 Factors                   Contribu-   than 1     than 1     significant
 Affecting                  tion to   percentage percentage   positives
 Reported                  Effective    point      point         over
 Effective                 Tax Rate    positive   negative   significant
 Tax Rates                  Change      effect     effect     negatives

 Foreign taxes              -2.92          3        43           -40
 State and local taxes      -0.55          4        24           -20
 Audit                      -0.51          2        23           -21
 Nondeductible
 expenses                   -0.43          3        16           -13
 AJCA repatriations          0.38         12         1            11
 Equity method              -0.24          2         3            -1
 Valuation allowance         0.23          7         8            -1
 Tax credits                -0.07          8        14            -6
 Domestic production
 deduction                  -0.06          1         0             1
 Adjustments to prior
 years' taxes               -0.02          0         2            -2
 Tax-exempt income           0.06          9        10            -1
 Restructuring               0.02          3         4            -1
 FSC/ETI                     0.01          2         5            -3
 Other                       0.01         18        20            -2
 Miscellaneous              -0.10          8        11            -3
Figure 2. Major Factors Contributing to Decline in
Effective Tax Rate



State and local income taxes. As shown in Table 2, changes in the effect of state and local taxes were responsible for 0.55 percentage point of the total decline in effective tax rates. As shown in Table 1, 55 corporations had data for both periods, 6 had data for only the later period, and 2 had data for only the earlier period. Table 2 also shows that for 28 corporations — fewer than half of the total surveyed — the effect of state and local taxes changed by more than 1 percentage point. Of those 28 firms, 24 had negative changes — that is, the effect of state and local taxes was less in 2004-2006 than in 1997-1999. Table 4 lists the changing effect of state and local income taxes on individual firms' effective tax rates between 1997-1999 and 2004-2006 for positive or negative rate changes of at least 1 percentage point.

          Table 3. Significant Changes in Effective Tax Rate


                        Due to Foreign Earnings

                                Percentage point change
 Corporation                          in ETR

 Qualcomm                             -21.9
 ConocoPhillips                       -16.0
 Motorola                             -14.5
 GE                                   -12.0
 Merck                                -11.9
 Pfizer                               -11.5
 Occidental Petroleum                  -9.7
 Anadarko Petroleum                    -9.5
 Amgen                                 -9.5
 Oracle                                -9.3
 Cisco Systems                         -9.1
 Chevron                               -8.3
 Hewlett-Packard                       -7.2
 Dell                                  -6.8
 Coca-Cola                             -6.7
 Alcoa                                 -5.9
 Phelps Dodge                          -5.7
 Altria Group                          -4.7
 Dow Chemical                          -4.5
 Caterpillar                           -4.4
 Microsoft                             -4.3
 Honeywell Int'l                       -4.2
 Procter & Gamble                      -4.2
 Citigroup                             -4.0
 Eli Lilly                             -3.8
 Wyeth                                 -3.6
 Valero Energy                         -3.1
 Texas Instruments                     -2.4
 Apache                                -2.3
 3M                                    -2.2
 United Technologies                   -2.1
 American Express                      -2.1
 AT&T                                  -2.1
 Apple                                 -2.0
 Merrill Lynch                         -1.8
 MetLife                               -1.6
 Baker Hughes                          -1.6
 Morgan Stanley                        -1.4
 Lehman Brothers Holdings              -1.4
 Wal-Mart Stores                       -1.3
 Int'l Business Machines               -1.3
 McDonald's                            -1.2
 Johnson & Johnson                     -1.1
 Anheuser-Busch                         1.2
 Exxon Mobil                            4.5
 Marathon Oil                           6.1

                Table 4. Significant Changes in ETR
                     Due to State and Local Taxes

                              Percentage point change
 Corporation                          in ETR

 Wellpoint                             -4.7
 Boeing                                -4.2
 Disney                                -3.7
 Bear Stearns                          -3.6
 Bank of New York Co.                  -3.2
 Cisco Systems                         -3.0
 Morgan Stanley                        -2.9
 Loews                                 -2.7
 United Parcel Service                 -1.9
 Intel                                 -1.7
 J.P. Morgan Chase & Co.               -1.7
 Hewlett-Packard                       -1.7
 Occidental Petroleum                  -1.7
 Washington Mutual                     -1.6
 Phelps Dodge                          -1.5
 Verizon Communications                -1.4
 Apache                                -1.4
 U.S. Bancorp                          -1.2
 MetLife                               -1.2
 AT&T                                  -1.2
 Honeywell Int'l                       -1.2
 Wells Fargo                           -1.1
 3M                                    -1.1
 UnitedHealth Group                    -1.0
 Lowe's                                 1.0
 ConocoPhillips                         1.4
 Amgen                                  2.0
 Motorola                               6.4

Favorable audit outcomes. As shown in Table 2, the changing effect of audit adjustments was responsible for 0.51 percentage point of the total 4.1 percentage point decline in effective tax rates. As shown in Table 1, only 1 corporation had data for both periods, 25 had data for only the later period, and 4 had data for only the earlier period. (For an explanation of why and how we have analyzed rate changes for corporations that do not provide data for both periods, see "A Note About Potential Bias" at the end of this article.) Companies described those changes on their statements as "IRS settlements," "audit settlements," and "favorable proposed audit adjustments." Table 2 shows that for 25 corporations, the effect of audit adjustments changed their effective tax rate by more than 1 percentage point. Of those 25 firms, 23 had negative changes — that is, the effect of favorable audit adjustments was larger in 2004-2006 than in 1997-1999. Table 5 lists the changing effect of audit adjustments on individual firms' effective tax rates between 1997-1999 and 2004-2006 for rate changes of at least 1 percentage point in either direction.

                Table 5. Significant Changes in ETR


                       Due to Audit Adjustments

                              Percentage point change
 Corporation                           in ETR

 United Parcel Service                  -5.9
 AT&T                                   -5.6
 Boeing                                 -5.3
 Qualcomm                               -3.8
 Alcoa                                  -3.2
 Hartford Financial                     -2.9
 Lockheed Martin                        -2.9
 Pfizer                                 -2.9
 Hewlett-Packard                        -2.6
 Altria Group                           -2.0
 American Express                       -1.8
 Microsoft                              -1.8
 Texas Instruments                      -1.8
 Disney                                 -1.7
 McDonald's                             -1.6
 U.S. Bancorp                           -1.5
 Citigroup                              -1.4
 United Technologies                    -1.3
 Honeywell Int'l                        -1.2
 Oracle                                 -1.2
 GE                                     -1.1
 Cisco Systems                          -1.0
 Loews                                  -1.0
 Wellpoint                               7.3
 ConocoPhillips                          7.8

Nondeductible expenses. Before 2001, corporations had stricter rules than they do now for recognizing expenses attributable to amortization of goodwill and other intangible assets. In 2001 the Financial Accounting Standards Board issued FASB Statement No. 142, "Goodwill and Other Intangible Assets." A major effect of FAS 142 was a reduction in expenses (and a corresponding increase in income) for book purposes, with no change in tax expense. Thus, FAS 142 reduced the negative impact of nondeductible amortization on effective tax rates, thus lowering effective tax rates in both periods in this study. As shown in Table 2, the changing effect of nondeductible expenses was responsible for 0.43 percentage point of the total decline in effective tax rates. Seven corporations had data for both periods, 8 had data for only the later period, and 22 had data for only the earlier period. Nondeductible expenses were reported by corporations as, for example, "nondeductible compensation/penalties," "nondeductible in-process research and development," and "amortization intangibles." Table 2 also shows that for 19 corporations, the effect of nondeductible expenses changed by more than 1 percentage point. Of those 19 firms, 16 had negative changes — that is, the effect of nondeductible expenses was larger in 2004-2006 than in 1997-1999. Table 6 lists the effect of nondeductible expenses on individual firms' effective tax rates between 1997-1999 and 2004-2006 for firms whose effective tax rate changed by at least 1 percentage point.

                Table 6. Significant Changes in ETR


                     Due to Nondeductible Expenses

                              Percentage point change
 Corporation                          in ETR

 Lockheed Martin                       -6.0
 Cisco Systems                         -5.8
 Disney                                -4.9
 Wells Fargo                           -3.2
 Berkshire Hathaway                    -2.8
 Bank of America Corp.                 -2.4
 Wyeth                                 -2.4
 National City Corp.                   -1.9
 U.S. Bancorp                          -1.8
 Altria Group                          -1.7
 Wachovia Corp.                        -1.6
 Boeing                                -1.6
 TXU                                   -1.6
 Oracle                                -1.5
 GE                                    -1.1
 United Technologies                   -1.0
 Eli Lilly                              1.4
 Pfizer                                 3.5
 Amgen                                  5.5

Repatriation provision (section 865) enacted as part of the American Jobs Creation Act of 2004 (AJCA). The effect of this 2004 provision registers only in the later period of our analysis, when 21 corporations report AJCA repatriation effects. Even though section 865 was a taxpayer-favorable provision, it increased reported effective tax rates because it imposed a 5.25 percent tax on large amounts of dividends included in income in prior years. As shown in Table 2, the effect of repatriation was to increase the effective tax rate by 0.38 percentage point. Table 2 also shows that for 13 corporations, the effect of AJCA repatriations affected the average effective tax rate by more than 1 percentage point. Of those 13 firms, 12 had positive changes — that is, the effect of AJCA repatriations was to increase the effective tax rates reported in 2004-2006. Table 7 lists the changing effect of AJCA repatriations on individual firms' effective tax rates between 1997-1999 and 2004-2006 for firms whose effective tax rate changed by at least 1 percentage point.

                Table 7. Significant Changes in ETR


                       Due to AJCA Repatriations

                              Percentage point change
 Corporation                            in ETR

 Motorola                               -1.9
 McDonald's                              1.0
 Oracle                                  1.0
 Wyeth                                   1.2
 Int'l Business Machines                 1.3
 Dell                                    1.5
 Coca-Cola                               1.6
 Johnson & Johnson                       1.6
 Honeywell Int'l                         2.3
 Merck                                   3.5
 Pfizer                                  4.8
 Eli Lilly                               5.3
 Hewlett-Packard                         6.5

Equity method of accounting. In some circumstances, when a company uses the equity method of accounting (sometimes called "one-line consolidation") for its ownership of a minority interest over which it has considerable control, the income from that investment is taken into income without a corresponding income tax expense. So the equity method can reduce a corporation's effective tax rate. The changing effect of the equity method of accounting was responsible for 0.24 percentage point of the total decline in effective tax rates. Three corporations had data for both periods, five had data for only the later period, and two had data for only the earlier period. Companies described the changes due to the equity method as "effect of equity method of accounting," "equity income affiliates," and "equity in earnings from unconsolidated businesses," among other terms. Table 2 also shows that for five corporations, the equity method of accounting changed effective tax rates by more than 1 percentage point; three had negative changes, and two had positive changes. Because of the relatively small number of affected corporations, no table is provided for this factor; individual firms with significant changes in their effective tax rates from the equity method are Dow Chemical (-5.2 percentage points), Verizon Communications (-5.1 percentage points), Coca-Cola (-2.3 percentage points), Merck (1.3 percentage points), and Chevron (10 percentage points).

                Table 8. Significant Changes in ETR


                Due to Valuation Allowance Adjustments

                              Percentage point change
 Corporation                          in ETR

 Phelps Dodge                          -8.3
 Occidental Petroleum                  -4.7
 Chevron                               -4.2
 Freddie Mac                           -2.2
 Motorola                              -2.1
 Altria Group                          -1.6
 Merrill Lynch                         -1.6
 Procter & Gamble                      -1.4
 Travelers Cos.                         1.0
 Dow Chemical                           1.4
 Eli Lilly                              1.8
 Lockheed Martin                        4.7
 Washington Mutual                      4.7
 Qualcomm                               5.1
 Apple                                 26.1

Adjustments to valuation allowances. The changing effect of adjustments to valuation allowances increased the average effective tax rate over the two periods by 0.23 percentage point. Three corporations had data for both periods, 11 had data for only the later period, and 8 had data for only the earlier period. Companies reported the changes as "reversal of other tax accruals no longer required," "adjustment of valuation allowances," and "reversal of tax reserves," among other terms. Table 2 shows that for 15 corporations, the effect of valuation allowance adjustments changed effective tax rates by more than 1 percentage point. Of those 15 firms, 7 had positive changes — that is, unfavorable valuation allowance adjustments had a larger impact in 2004-2006 than in 1997-1999. Table 8 lists the changing effect of valuation allowance adjustments on individual firms' effective tax rates between 1997-1999 and 2004-2006 for positive or negative rate changes of at least 1 percentage point.

Tax credits. In the aggregate, tax credits had little effect on changing effective tax rates between the two periods. Nineteen corporations had data for both periods, 15 had data for only the later period, and 3 had data for only the earlier period. Although they usually described credits simply as "domestic tax credits" or "general business credits," firms often listed specific credits, including the research credit, the orphan drug tax credit, the nonconventional fuels credit, low-income housing tax credits, oil and gas credits, and work opportunity tax credits. For 22 corporations, tax credits changed their effective tax rate by more than 1 percentage point; of those 22, 14 had negative changes — that is, the favorable effect of tax credits was larger in 2004-2006 than in 1997-1999. Table 9 lists the changing effect of tax credits on individual firms' effective tax rates between 1997-1999 and 2004- 2006 for rate changes of at least 1 percentage point in either direction.

Section 199 domestic production deduction. Described by corporations in their annual reports as the "production activities deduction" and "domestic manufacturer's deduction," among other terms, the section 199 deduction enacted under the AJCA in 2004 had little impact on effective tax rates in the aggregate. The provision registers only in the later period of our analysis for seven corporations, and it reduced average effective tax rates by more than 1 percentage point for only one corporation: Texas Instruments (-3.2 percentage points).

                Table 9. Significant Changes in ETR


                          Due to Tax Credits

                              Percentage point change
 Corporation                          in ETR

 Freddie Mac                          -11.9
 Morgan Stanley                        -4.9
 Bank of New York Co.                  -3.7
 J.P. Morgan Chase & Co.               -3.5
 SunTrust Banks                        -2.1
 PNC Financial Services                -1.7
 Bank of America Corp.                 -1.7
 National City Corp.                   -1.5
 GE                                    -1.3
 U.S. Bancorp                          -1.2
 Motorola                              -1.1
 American Int'l Group                  -1.0
 Dow Chemical                          -1.0
 Apple                                 -1.0
 Marathon Oil                           1.3
 Bear Stearns                           1.5
 Boeing                                 1.6
 TXU                                    1.6
 Amgen                                  1.7
 Valero Energy                          2.3
 ConocoPhillips                         3.7
 Qualcomm                              16.8

Adjustments to prior years' taxes. In the aggregate, this factor had minuscule effects on the change in effective corporate tax rates between the two periods. One corporation had data for both periods, three had data for only the later period, and three had data for only the earlier period. Only two corporations saw their effective rates change by more than 1 percentage point as a result of adjustments to prior years' taxes: MetLife (-1.5 percentage points) and Allstate (-1.1 percentage points).

                Table 10. Significant Changes in ETR


                       Due to Tax-Exempt Income

                                Percentage point change
 Corporation                             in ETR

 Freddie Mac                              -5.0
 MetLife                                  -4.9
 J.P. Morgan Chase & Co.                  -3.2
 Allstate                                 -1.9
 Travelers Cos.                           -1.7
 Morgan Stanley                           -1.7
 Hartford Financial Services              -1.6
 Bank of America Corp.                    -1.5
 Wells Fargo                              -1.3
 Lockheed Martin                          -1.0
 National City Corp.                       1.1
 Cisco Systems                             1.5
 UnitedHealth Group                        1.5
 GE                                        1.8
 American Express                          2.8
 Loews                                     3.3
 Lehman Brothers Holdings                  3.7
 Berkshire Hathaway                        4.2
 Chubb                                     9.3

Tax-exempt income. In the aggregate, tax-exempt income made practically no difference in the calculation of effective tax rates in 1997-1999 and 2004-2006. Twenty-two corporations had data for both periods, three had data for only the later period, and five had data for only the earlier period. Of the 19 corporations whose rates changed by more than 1 percentage point as a result of exempt income, 10 had negative changes — that is, the favorable effect of tax-exempt income was larger in 2004-2006 than in 1997-1999. Table 10 lists the changing effect of exempt income on individual firms' effective tax rates between 1997-1999 and 2004-2006 for positive or negative changes of at least 1 percentage point.

                Table 11. Significant Changes in ETR


                        Due to "Other" Factors

                              Percentage point change
 Corporation                          in ETR

 United Parcel Service                 -3.9
 Boeing                                -3.5
 Merrill Lynch                         -2.7
 Cisco Systems                         -2.7
 Allstate                              -2.5
 Occidental Petroleum                  -2.3
 Capital One Financial                 -2.1
 Wal-Mart Stores                       -2.0
 Bear Stearns                          -2.0
 Loews                                 -2.0
 Washington Mutual                     -1.9
 Citigroup                             -1.5
 Eli Lilly                             -1.4
 Johnson & Johnson                     -1.4
 Int'l Business Machines               -1.3
 Target                                -1.3
 Hewlett-Packard                       -1.2
 Lockheed Martin                       -1.1
 Qualcomm                              -1.1
 AT&T                                  -1.0
 Disney                                 1.2
 Verizon Communications                 1.2
 United Technologies                    1.3
 Honeywell Int'l                        1.5
 3M                                     1.5
 Exxon Mobil                            1.6
 Lehman Brothers Holdings               1.7
 Travelers Cos.                         1.7
 Pfizer                                 1.8
 American Express                       1.9
 J.P. Morgan Chase & Co.                2.0
 Bank of America Corp.                  2.2
 PNC Financial Services
 Group                                  2.2
 Phelps Dodge                           2.2
 MetLife                                2.3
 Motorola                               2.8
 Oracle                                 4.4
 Merck                                  5.6

Restructurings and transactions. Overall, restructurings and transactions made practically no difference in the calculation of effective tax rates in 1997-1999 and 2004-2006. One corporation had data for both periods, 7 had data for only the later period, and 14 had data for only the earlier period. A wide variety of labels was applied to this category in corporate filings, including "purchase accounting and asset acquisitions," "effect of sale of investment in an affiliate," "divestitures," "nondeductible merger expense," "write-down of foreign investments," and "tax benefit on disposition of subsidiaries." The effect of transactions and restructurings changed effective tax rates by more than 1 percentage point for only seven corporations, and four of those seven had negative changes — that is, the favorable effect of transactions and restructurings was larger in 2004-2006 than in 1997-1999. The individual firms with significant changes in their effective tax rates from restructurings and transactions are Chevron (-2.2 percentage points), Apple (-1.7 percentage points), Travelers (-1.5 percentage points), Verizon (-1.3 percentage points), GE (1.6 percentage points), Valero Energy (3.1 percentage points), and Wachovia (4.6 percentage points).

Repeal of the foreign sales corporation and extraterritorial income exclusion regime. In the aggregate, the repeal of the FSC/ETI tax subsidy for exports in the AJCA had little impact on reported effective tax rates. The AJCA provided generous transition relief, allowing corporations 80 percent of prerepeal FSC/ETI benefits in 2005 and 60 percent of benefits in 2006. Four corporations had data for both periods, four had data for only the later period, and one had data for only the earlier period. For seven corporations, the effect of FSC/ETI changed effective tax rates by more than 1 percentage point, and of those seven, five had negative changes — that is, the favorable effect of FSC/ETI was larger in 2004-2006 than in 1997-1999. The individual firms that experienced significant changes in their effective tax rates from FSC/ETI are Motorola (8 percentage points), Cisco Systems (2.4 percentage points), 3M (-1 percentage point), Boeing (-1.3 percentage points), Disney (-1.7 percentage points), Lockheed Martin (-2.2 percentage points), and Intel (-3.2 percentage points).

                Table 12. Significant Changes in ETR


                     Due to Miscellaneous Factors

                              Percentage point change
 Corporation                           in ETR

 TXU                                   -5.3
 Phelps Dodge                          -3.8
 Washington Mutual                     -3.6
 Verizon Communications                -3.0
 UnitedHealth Group                    -2.8
 MetLife                               -2.6
 Qualcomm                              -2.2
 Coca-Cola                             -1.7
 Wachovia Corp.                        -1.7
 PNC Financial Services                -1.7
 AT&T                                  -1.3
 Dell                                   1.1
 Occidental Petroleum                   1.7
 Boeing                                 2.2
 Hartford Financial                     2.5
 Bank of New York Co.                   2.7
 Exxon Mobil                            3.2
 Motorola                               3.2
 Texas Instruments                      3.8

Other. Factors affecting the effective tax rate that are not separately listed by corporations are usually identified as "other" in the annual reports. Presumably they are the combined net effect of factors that are each less significant than the factors explicitly listed. "Other" factors on average did not account for a large difference between 1997-1999 and 2004-2006 average effective tax rates. Seventy-four corporations had data on "other" factors available for both periods, and six had data for only the later period. For 38 corporations, the effect of "other" factors changed effective tax rates by more than 1 percentage point. Of those 38, 20 had negative changes — that is, the favorable effect of "other" factors was larger in 2004- 2006 than in 1997-1999. Table 11 lists the changing effect of "other" factors on individual firms' effective tax rates between 1997-1999 and 2004-2006 for changes of at least 1 percentage point in either direction.

Miscellaneous. This category is for all the items separately listed by individual corporations that do not fit comfortably into any of the categories already listed and do not appear with any frequency among the corporations' entries. In the aggregate, miscellaneous factors accounted for a 0.10 percentage point decline in the average effective tax rate between the two periods. We recorded approximately 70 instances of miscellaneous factors. Most of them were mentioned only once; only percentage depletion was mentioned by two firms, once each in 1997-1999 and in 2004-2006. Nine corporations had miscellaneous entries for both periods, 19 had entries for only the later period, and 8 had entries for only the earlier. For 19 corporations, the effect of miscellaneous factors changed the effective tax rates by more than 1 percentage point. Of those 19 firms, 11 had negative changes — that is, the favorable effect of miscellaneous factors was larger in 2004- 2006 than in 1997-1999. Table 12 lists the changing effect of miscellaneous factors on individual firms' effective tax rates between 1997-1999 and 2004-2006 for changes of at least 1 percentage point in either direction.

A Note About Potential Bias in the Data



When reporting the major factors determining their effective tax rates, corporations are frequently inconsistent from year to year or with each other. For example, Microsoft reported the effect of low foreign taxes on its effective tax rate in the 2004-2006 period but not during the 1997-1999 period. In this study we assume that if an item does not explicitly appear, it is not significant and is thus equal to zero. If the effect of foreign taxes on Microsoft earnings in the 1997-1999 period was not zero (and assuming, unlike with many oil companies, that the effect of foreign taxes is to reduce the effective tax rate), this introduces a bias into our estimate that the reduction in effective corporate tax rates due to foreign taxes is larger than it actually is.

If we excluded corporations with only one period of data, we would have introduced a bias in the other direction. Then, in the case of Microsoft, we would be implicitly assuming that the effect of foreign taxes on Microsoft's effective tax rate did not change between the two periods.

Fortunately, the effect of the bias, although potentially troublesome, is in fact not large. To see an example of why this is the case, let's take a closer look at the effect of foreign taxes. Nine firms separately identify and quantify the negative impact of the taxation of foreign earnings on the effective tax rate in 2004- 2006, but they make no explicit mention of the effect of taxation of foreign earnings for 1997-1999. Presumably the foreign effect in the earlier period was small, but it was not zero either. Therefore, when we include those nine firms in our analysis, the estimated 2.9 percentage point decline in effective tax rates is undoubtedly too large. To get a feel for how large this bias might be, we redid our calculations for 46 firms that reported foreign effects in both periods and presumably would not suffer from the bias. Among those 46 firms, the average decline is 2.56 percentage points. This finding, and similar findings for our other factors behind the effective tax rate, demonstrates that there is a bias, but it also shows that the bias is small and does not change the central conclusions.