Corporate Tax Dodges: Ugly and Antisocial

A fuse was lighted under the old tax reform bonfire last week when the Government Accounting Office reported that 60% of U.S. corporations didn’t pay a penny in taxes on their income from 1996 to 2000.

That wasn’t exactly a bolt out of the blue for most Americans. Maybe it was a surprise to some that the corporations didn’t commit any crimes, but just engaged in some complicated and counterproductive -- to the Treasury, at least -- sheltering transactions.

Bombshell or no, the GAO report renewed interest in the tax escapes that, particularly as April 15 approaches, have rankled all the working people who share big chunks of what they earn every year with Uncle Sam.

We’ve been here before, and we’ve seen Congress revamp the system before. It could happen again. Both parties on Capitol Hill and tax experts from conservative and liberal think tanks in Washington are complaining that corporate tax abuses have been growing and that it’s again time to plug some of the leaks.

Dozens of shameful sheltering plots abound, but Sen. Charles E. Grassley of Iowa, the Republican head of the Senate Finance Committee, singles out one for special condemnation: the one in which companies buy and then lease back municipal transit and utility systems so that they can take advantage of the depreciation of the subway cars and buses, maintenance yards and sewer lines to shield income from taxes.

That, Grassley says, is “just good old-fashioned fraud.” It will cost the federal Treasury $33 billion and state governments $6 billion in lost revenue this decade. So the senator, with backing from the Treasury Department, has placed a prohibition on such deals in legislation being considered by the Senate.

The lease-back tax dodge is nationwide, and even global, with U.S. companies buying up municipal systems in London and Vienna as well as Chicago, New York, Los Angeles and Long Beach. And the practice isn’t new: The Los Angeles County Metropolitan Transportation Authority has been leasing its buses and subway cars for more than six years from, among others, Bank of America Corp., Wells Fargo & Co., Agilent Technologies Inc. and Philip Morris Capital Corp., the financing and investment arm of the tobacco giant now named Altria Group Inc.

Here’s how the scheme works for Philip Morris Capital: It bought buses worth $400 million from the MTA and immediately leased them back to the county agency. Most of the $400 million goes to finance payments on the leases while the county continues to operate and maintain the buses. The MTA did net $14 million upfront, and that supplements its operating budget. Meanwhile, Altria gets to use the depreciation on $400-million worth of buses -- an estimated $80 million a year in deductions from income subject to tax.

The MTA and cities around the country have kind words for the practice. Over the years, “these transactions have provided over $65 million” to help fund bus and rail operations, says Terry Matsumoto, the MTA’s executive finance officer. He points out that the alternative, particularly in a time of state and federal budget deficits, could be higher fares.

OK, maybe we should consider paying them. These lease-back tax shelter deals are ugly distortions of good economic practice. Corporate purchases of taxpayer-financed public facilities don’t return money to taxpayers; the money goes to pay for the leases.

The purchases don’t represent productive investments in the economy, either. In fact, they deny state and federal governments the tax revenue broadly needed for the whole society, not just people who use the MTA. Assuredly, the schemes add to corporate cash flows, but in ways that only emphasize the growing antisocial behavior of major companies.

Of course, our elected officials set up the corporate tax system to work this way. Corporate income tax collections have been declining as a percentage of all federal taxes taken in ever since World War II, because Congress has given companies credits and deductions to encourage investments in machinery or to promote exports or even overseas expansion of business. And however much they fail to fork over in income taxes, “corporations pay their share of Social Security and Medicare taxes,” says Lawrence Stone of Los Angeles law firm Irell & Manella, a tax expert who served in the Treasury Department in the Johnson administration. Beyond that, he says, “society relies on corporations to innovate and provide jobs and to pay benefits -- not so much to pay taxes on income.”

Many Americans would like them to pay some. The deferral of taxes on overseas income, for example, is being challenged by Sen. John F. Kerry of Massachusetts, the presumed Democratic presidential candidate, on grounds that bringing the money home would boost investment and jobs in the U.S.

There are many other ideas being floated, including that tax rates should be lowered to encourage companies to pay. Daniel Mitchell, a tax expert with the Heritage Foundation in Washington, says that high U.S. tax rates on corporations -- 35% at the federal level plus state levies -- “encourage tax avoidance behavior” and could send U.S. companies offshore.

Regardless of whether Kerry or Mitchell is right, corporate taxes are becoming a hot political issue in this election year. As Stone puts it, “Taxation is politics.”

What is undeniable amid the political arguments about how to proceed is that Congress should. Economist C. Eugene Steuerle of the Urban Institute led the reform effort in the Reagan administration in the early 1980s, when credits for everything from cattle farms to apartment buildings got out of hand. That effort produced the Tax Reform Act of 1986, which solved the problem by lowering tax rates but also cutting out many deductions and credits. The result was that more individuals and companies paid their taxes promptly, and the Treasury Department collected more money even though the rates had been reduced to those that prevail today.

Today, Steuerle worries that individuals will have false hopes that corporations will start paying much more to meet society’s needs -- and that “they will be disappointed.”

He shouldn’t worry. U.S. taxpayers would only be surprised if corporations these days lived up to their obligations.

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James Flanigan can be reached at jim.flanigan@latimes.com.