CORPORATE TAX 

EXPENDITURES

Evaluations of Tax 

Deferrals and 

Graduated Tax Rates

Report to Congressional Requesters

September 2013

GAO-13-789

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-13-789, a report to 

congressional requesters

September 2013

CORPORATE TAX EXPENDITURES

Evaluations of Tax Deferrals and Graduated Tax 

Rates 

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 Recommends

GAO made no recommendations. 

Treasury, IRS, the Joint Committee on 

Taxation, and external experts 

provided technical comments that were 

incorporated, as appropriate.

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.

View GAO-13-789. For more information, 

contact James R.White at (202) 512-9110 or 

whitej@gao.gov.
Page i GAO-13-789 Corporate Tax Expenditures

Letter 1 

Background 4

Evaluation of Tax Deferrals 9

Evaluation of Graduated Corporate Income Tax Rate Schedule 25

Agency and Third Party Comments and Our Evaluation 35

Appendix I Objectives, Scope, and Methodology 37

Appendix II Comparison of Territorial and Worldwide Corporate Income 

Tax Systems 43

Appendix III IRS Statistics of Income Data on the Number of C 

Corporations by Taxable Income and Size of Business 

Receipts, 2010 48

Appendix IV GAO Contact and Staff Acknowledgments 50

Tables

Table 1: Corporate Income Tax Rate Schedule 7

Table 2: Percentage of Corporations with Positive Taxable Income 

by Taxable Income and Size of Business Receipts, 2010 28

Table 3: Number of Corporate Taxpayers by Taxable Income and 

Size of Business Receipts, 2010 48

Table 4: Coefficient of Variation Calculations for Totals in Table 3 49

Figures

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

Income Tax System 5

Figure 2: Ratio of U.S. Corporate Profits Earned Abroad to Total 

U.S. Corporate Profits, 1987-2012 23

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

2008 27

Contents 
Page ii GAO-13-789 Corporate Tax Expenditures

Figure 4: Estimated Federal Tax Revenue Losses Due to Graduated 

Corporate Income Tax Rate Schedule, Reported by 

Treasury, 1998-2012 34

Figure 5: Example of Worldwide and Territorial Corporate Income 

Tax Systems 44

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

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Page 1 GAO-13-789 Corporate Tax Expenditures

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.

1

 

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, 

According to 

Treasury’s estimates, the amount of corporate tax revenue forgone from 

these three tax expenditures totaled almost $49 billion in fiscal year 

GAO-13-339 (Washington, D.C.: Mar. 18, 2013).

 
 

Page 2 GAO-13-789 Corporate Tax Expenditures

2012.2

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.

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.

3

Because the two deferral provisions are so similar, we combine them for 

evaluation purposes, and then evaluate the graduated rates separately.

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.

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?

 

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, 

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. 
 

Page 3 GAO-13-789 Corporate Tax Expenditures

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, 
 

Page 4 GAO-13-789 Corporate Tax Expenditures

JCT, and IRS data and estimates were sufficiently reliable for our 

purposes.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.

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.5

 

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.

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.

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).

Background 
 

Page 5 GAO-13-789 Corporate Tax Expenditures

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

System

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.

6

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 

Income ineligible 

for deferral is defined under Subpart F of the Internal Revenue Code 

(IRC).

 

6

Lowell D. Yoder, “Subpart F in Turmoil: Low-Taxed Active Income Under Siege” Taxes, 

vol. 77 (March 1999).
 

Page 6 GAO-13-789 Corporate Tax Expenditures

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.

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.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 financialservices 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 

 

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, GAO-09-934 

(Washington, D.C.: Sept. 15, 2009). 
 

Page 7 GAO-13-789 Corporate Tax Expenditures

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.9

Table 1: Corporate Income Tax Rate Schedule

Finally, for corporations with 

taxable income higher than $18,333,333, a flat rate of 35 percent applies 

to all taxable income.

Taxable Income over But not over... Tax rate Of the amount over...

$0 $50,000 15% $0

$50,000 $75,000 $7,500 + 25% $50,000

$75,000 $100,000 13,750 + 34% $75,000

$100,000 $355,000 22,250 + 39% $100,000

$335,000 $10,000,000 113,900 + 34% $335,000

$10,000,000 $15,000,000 3,400,000 + 35% $10,000,000

$15,000,000 $18,333,333 5,150,000 + 38% $15,000,000

$18,333,333 - 35% 0 

Source: Internal Revenue Service.

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.10

 

9

Once reached, the two highest brackets give corporations an average tax rate of 34 and 

35 percent, respectively. 

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 

10The 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.
 

Page 8 GAO-13-789 Corporate Tax Expenditures

reduce revenue received by the federal government below what it would 

be under the normal structure established by Treasury and JCT.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.

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.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.

 

11Both 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).

12Office 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).

13While, 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, 

GAO-05-690 (Washington, D.C.: Sept. 23, 2005).
 

Page 9 GAO-13-789 Corporate Tax Expenditures

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.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.

15

 

14As 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. 

In foreign markets, U.S. corporations face competitors 

that, operating under a territorial tax system in their own countries, pay 

15Competitiveness 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). 

Evaluation of Tax 

Deferrals

Deferral Is Viewed by 

Many as Promoting 

Competitiveness 
 

Page 10 GAO-13-789 Corporate Tax Expenditures

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.16

However, whether this definition of competitiveness that focuses on 

multinationals is appropriate has been a subject of debate among 

experts.

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.

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.18

 

16Other 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). 

Our prior work has shown that deferral and other aspects 

17See 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.

18A 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). 
 

Page 11 GAO-13-789 Corporate Tax Expenditures

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.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.20

Other tax experts argue that the appropriate definition of competitiveness 

should focus on broader industry or national purposes rather than 

corporations.21 For example, a U.S. industry is said to be more 

competitive by attracting more investment and resources than foreign 

industries.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.23

 

19GAO, U.S. Multinational Corporations: Effective Tax Rates Are Correlated with Where 

Income Is Reported, 

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 

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).

21See Eric Toder, “International Competitiveness: Who Competes Against Whom and for 

What?,” Tax Law Review, vol. 65 (Spring 2012).

22See Michael S. Knoll, “The Connection Between Competitiveness and International 

Taxation,” Tax Law Review, vol. 65 (Spring 2012).

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

Page 12 GAO-13-789 Corporate Tax Expenditures

concept. They argue that simply using the wrong concept in this way 

leads to bad policy outcomes.24

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.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 

 

24See Jane G. Gravelle, “Does the Concept of Competitiveness Have Meaning in 

Formulating Corporate Tax Policy?,” Tax Law Review, vol. 65 (Spring 2012).

25See 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.

Numerous Business 

Decisions Are Affected by 

Deferral and Each Has 

Consequences for 

Efficiency 
 

Page 13 GAO-13-789 Corporate Tax Expenditures

income from U.S. taxation, or, in effect, making deferral permanent.26

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.

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.

27

 

26CRS, 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). 

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. 

27Organisation for Economic Co-operation and Development, Tax Effects on Foreign 

Direct Investment: Recent Evidence and Policy Analysis: Tax Policy Study No. 17 (2007).
 

Page 14 GAO-13-789 Corporate Tax Expenditures

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.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 foreignsource income.

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.

30 In 2004, legislation was passed to limit the 

ability of U.S. corporations to change their country of incorporation to a 

foreign country.31

 

28Change 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).

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.

29Jim A. Seida and William F. Wempe, “Effective Tax Rate Changes and Earning 

Stripping Following Corporate Inversion,” National Tax Journal, vol. 57 (December 2004). 

30Eric 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).

31The 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).
 

Page 15 GAO-13-789 Corporate Tax Expenditures

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.

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.33

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.

In this case, 

deferral or a move to a territorial system would not produce significant 

efficiency gains.

34

 

32Mihir A. Desai and James Hines, “Evaluating International Tax Reform,” National Tax 

Journal, vol. 46 (September 2003).

However, the 

large repatriations under the 2004 tax holiday have suggested to some 

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

2012).

34Mihir 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). 
 

Page 16 GAO-13-789 Corporate Tax Expenditures

researchers that these earlier estimates may be too small.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.

36

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.

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.

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.

 

35The American Jobs Creation Act of 2004, section 422, allowed companies to pay a onetime 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).

36Harry Grubert and Rosanne Altshuler, Fixing the System: An Analysis of Alternative 

Proposals for the Reform of International Tax, Working Papers Series (Apr. 1, 2013).

Informed Judgments about 

Deferral’s Equity Require 

Information about 

Ultimate Beneficiaries
 

Page 17 GAO-13-789 Corporate Tax Expenditures

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.37

 

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

Page 18 GAO-13-789 Corporate Tax Expenditures

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.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.

39

Deferral also affects complexity by interacting with the foreign tax credit 

and transfer pricing. Our prior work has highlighted these areas as major 

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.

 

38Most 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 lookthrough 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). 

39The complexity of Subpart F has increased with the inclusion of the check-the-box 

regulations and the look-through rules discussed above. 

Deferral Adds Complexity 

to the Tax Code
 

Page 19 GAO-13-789 Corporate Tax Expenditures

sources of compliance risk and burden.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.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. 

Our prior work on corporate tax expenditures identified no related federal 

activities sharing the same reported purpose as the two deferral tax 

expenditures.42

 

40GAO, International Taxation: Study Countries That Exempt Foreign-Source Income 

Face Compliance Risks and Burdens Similar to Those in the United States, 

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 

GAO-09-934 

(Washington, D.C.: Sept. 15, 2009). 

41The 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.

42See GAO-13-339. 

Deferral Does Not Overlap 

Directly with Other 

Federal Programs
 

Page 20 GAO-13-789 Corporate Tax Expenditures

corporations.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.

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.

44

 

43GAO, 2013 Annual Report: Actions Needed to Reduce Fragmentation, Overlap, and 

Duplication and Achieve Other Financial Benefits, 

These estimates are based on specific proposals to change the tax code, 

GAO-13-279SP (Washington, D.C.: 

Apr. 9, 2013).

44Over 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.

Deferral May Have 

Relatively Modest 

Consequences for the 

Federal Budget but 

Estimates Vary
 

Page 21 GAO-13-789 Corporate Tax Expenditures

and include behavioral responses by taxpayers to the tax change.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.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.

 

47

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 

However, territorial systems in 

practice include design features, such as a minimum tax on foreign 

source income, that are intended to limit these losses.

 

45JCT 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).

46Overhead 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. 

47GAO, International Taxation: Study Countries That Exempt Foreign-Source Income 

Face Compliance Risks and Burdens Similar to Those in the United States, GAO-09-934 

(Washington, D.C.: Sept. 15, 2009).
 

Page 22 GAO-13-789 Corporate Tax Expenditures

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.48

 

48Treasury 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 

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.

GAO-13-339. 
 

Page 23 GAO-13-789 Corporate Tax Expenditures

Figure 2: Ratio of U.S. Corporate Profits Earned Abroad to Total U.S. Corporate 

Profits, 1987-2012

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.49

 

49The Tax Increase Prevention and Reconciliation Act (“TIPRA”) of 2005 (H.R. 4297), 

enacted on May 17, 2006 (Pub. L. No. 109-222). 

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 
 

Page 24 GAO-13-789 Corporate Tax Expenditures

corporations may have accumulated foreign earnings abroad in 

anticipation of another repatriation holiday.50

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.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.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.53

 

50Lee Sheppard and Martin Sullivan, “News Analysis: Multinationals Accumulate to 

Repatriate,” Tax Notes Today (January 15, 2009).

51GAO, Tax Policy: Tax Expenditures Deserve More Scrutiny, 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, 

GAO-05-690 (Washington, D.C.: Sept. 23, 2005).

52GAO, Managing For Results: Executive Branch Should More Fully Implement the GPRA 

Modernization Act to Address Pressing Governance Challenges, GAO-13-518 

(Washington, D.C.: June 26, 2013).

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

No Consensus Exists on 

Which Agency Should 

Evaluate Deferral
 

Page 25 GAO-13-789 Corporate Tax Expenditures

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.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 

 

54The 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.

Evaluation of 

Graduated Corporate 

Income Tax Rate 

Schedule 

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
 

Page 26 GAO-13-789 Corporate Tax Expenditures

the graduated corporate income tax rate schedule has developed and 

changed legislatively over time.55

Evidence is mixed on whether the lower corporate tax rates provided by 

the graduated rate schedule increases business formation.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.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.58

 

55U.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).

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.

56See 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). 

57Asli Demirguc-Kunt, Inessa Love, and Vojislav Maksimovic, “Business Environment and 

the Incorporation Decision,” Journal of Banking and Finance, vol. 30 (2006).

58Matthew J. Knittel and Susan C. Nelson, “How Would Small Business Owners Fare 

Under a Business Entity Tax,” National Tax Journal, vol. 64 (December 2011).
 

Page 27 GAO-13-789 Corporate Tax Expenditures

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

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.59

 

59These 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. 

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.
 

Page 28 GAO-13-789 Corporate Tax Expenditures

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

Corporate income tax rate bracket

Size of business receipts

First $50,000 

(15 percent)

$50,000 - $75,000 

(25 percent)

$75,000 - $100,000 

(34 percent)

Over $100,000

(34 percent or more)

Under $25,000 90.5% 3.3% 1.3% 4.9%

$25,000 under $100,000 95.3% 3.3% 0.6% 0.9%

$100,000 under $250,000 89.4% 5.6% 2.6% 2.4%

$250,000 under $500,000 83.6% 6.5% 5.0% 4.9%

$500,000 under $1,000,000 79.5% 10.0% 3.2% 7.2%

$1,000,000 under $2,500,000 68.8% 12.2% 5.9% 13.1%

$2,500,000 under $5,000,000 52.4% 13.0% 6.7% 28.0%

$5,000,000 under $10,000,000 31.0% 13.1% 7.6% 48.2%

$10,000,000 under $50,000,000 16.3% 6.2% 5.2% 72.4%

$50,000,000 under $100,000,000 4.4% 1.7% 2.2% 91.8%

$100,000,000 under $250,000,000 0.9% 0.9% 0.7% 97.5%

$250,000,000 and over 0.2% 0.2% 0.0% 99.7%

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

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.60

 

60We 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 GAO-13-518. 
 

Page 29 GAO-13-789 Corporate Tax Expenditures

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.

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.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 

 

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

1997).

62The 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.

Efficiency Effects of the 

Graduated Rates Are 

Disputed 
 

Page 30 GAO-13-789 Corporate Tax Expenditures

be more effective than graduated rates that apply to all corporations with 

less than a certain amount taxable income.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.

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.64

 

63For 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). 

64The question of who receives the benefit of the tax expenditure—referred to as the 

incidence of the benefit —is explored in more detail in GAO-13-167SP. 

Informed Judgments about 

the Graduated Rates’ 

Equity Require 

Information about 

Ultimate Beneficiaries
 

Page 31 GAO-13-789 Corporate Tax Expenditures

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.65

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 

This clustering of 

filers around certain tax rates may be the result of tax planning that 

increases compliance costs.

 

65Tax 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 pretax 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).

The Graduated Rates 

Likely Add Little 

Complexity to Determing 

Tax Liability But Some 

Evidence of Tax Planning 

Has Been Found
 

Page 32 GAO-13-789 Corporate Tax Expenditures

costs, which increase at a decreasing rate as the business grows.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.

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.

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.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 

 

66See 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).

67See GAO-13-339. 

68GAO, Entrepreneurial Assistance: Opportunities Exist to Improve Programs 

Collaboration, Data Track, and Performance Management, GAO-12-819 (Washington, 

D.C.: Aug. 23, 2012). 

Graduated Rates Are 

Related to a Number of 

Spending Programs but the 

Relative Effectiveness of 

the Tax Expenditure Has 

Not Been Assessed
 

Page 33 GAO-13-789 Corporate Tax Expenditures

support small businesses may be preferable but has not been part of the 

discussion.

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 2012.69

 

69From 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).

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.

Moving to a Flat Corporate 

Income Tax Rate of 35 

Percent Would Have 

Relatively Modest 

Consequences for the 

Federal Budget
 

Page 34 GAO-13-789 Corporate Tax Expenditures

Figure 4: Estimated Federal Tax Revenue Losses Due to Graduated Corporate 

Income Tax Rate Schedule, Reported by Treasury, 1998-2012

The decrease in figure 4 may be due, in part, to less companies 

incorporating as C corporations, which we highlighted above.
 

Page 35 GAO-13-789 Corporate Tax Expenditures

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.70 In July 2013, OMB 

released guidance that directs agencies to identify tax expenditures that 

contribute to their goals.71

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 

http://www.gao.gov. 

 

70GAO, Managing For Results: Executive Branch Should More Fully Implement the GPRA 

Modernization Act to Address Pressing Governance Challenges, GAO-13-518 

(Washington, D.C.: June 26, 2013). 

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

No Consensus Exists on 

Which Agency Should 

Evaluate the Graduated 

Corporate Tax Rate 

Schedule 

Agency and Third 

Party Comments and 

Our Evaluation
 

Page 36 GAO-13-789 Corporate Tax Expenditures

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.

James R. White

Director, Tax Issues

Strategic Issues
Appendix I: Objectives, Scope, and 

Methodology

Page 37 GAO-13-789 Corporate Tax Expenditures

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.

To evaluate the three tax expenditures above, we applied our tax 

expenditure evaluation guide, which was issued in November 2012.1

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

The 

guide outlines a series of questions and sub-questions that can be used 

to evaluate tax expenditures. The five primary questions and subquestions outlined in the guide are:

• 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?

 

1 GAO, Tax Expenditures: Background and Evaluation Criteria and Questions, GAO-13-

167SP (Washington, D.C.: Nov. 29, 2012)

Appendix I: Objectives, Scope, and 

Methodology 

GAO Tax Expenditure 

Evaluation Guide
Appendix I: Objectives, Scope, and 

Methodology

Page 38 GAO-13-789 Corporate Tax Expenditures

• 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.
Appendix I: Objectives, Scope, and 

Methodology

Page 39 GAO-13-789 Corporate Tax Expenditures

• 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 resultsoriented 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.2

 

2

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).

We reviewed articles published in the National Tax 
Appendix I: Objectives, Scope, and 

Methodology

Page 40 GAO-13-789 Corporate Tax Expenditures

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.3 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 2012.4 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.5

 

3

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). 

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 

4

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.

5

See CBO, Reducing the Deficit: Spending and Revenue Options (Washington, D.C.: Mar. 

10, 2011).
Appendix I: Objectives, Scope, and 

Methodology

Page 41 GAO-13-789 Corporate Tax Expenditures

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.6

• 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.7

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 

 

6

See JCT, Summary of Economic Models and Estimating Practices of the Staff of the 

Joint Committee on Taxation (Washington, D.C.: Sept. 19, 2011). 

7

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). 
Appendix I: Objectives, Scope, and 

Methodology

Page 42 GAO-13-789 Corporate Tax Expenditures

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. 
Appendix II: Comparison of Territorial and 

Worldwide Corporate Income Tax Systems

Page 43 GAO-13-789 Corporate Tax Expenditures

Many proposals for changing the way the current U.S. system taxes 

foreign source income are detailed and complex.1

• 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.

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:

• 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. 

 

1

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). 

Appendix II: Comparison of Territorial and 

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

Worldwide Corporate Income Tax Systems

Page 44 GAO-13-789 Corporate Tax Expenditures

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

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-
Appendix II: Comparison of Territorial and 

Worldwide Corporate Income Tax Systems

Page 45 GAO-13-789 Corporate Tax Expenditures

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).2

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 

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.

 

2

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).
Appendix II: Comparison of Territorial and 

Worldwide Corporate Income Tax Systems

Page 46 GAO-13-789 Corporate Tax Expenditures

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 foreignearned 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.3 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.4

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 transferpricing 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 

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.

 

3

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. 

4

The incentive to shift income disappears, except for companies that have excess credits.
Appendix II: Comparison of Territorial and 

Worldwide Corporate Income Tax Systems

Page 47 GAO-13-789 Corporate Tax Expenditures

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 percountry minimum tax, which means that corporations will lack incentives 

to locate income in a country with a tax rate below the minimum.5

 

5

GAO, International Taxation: Study Countries That Exempt Foreign-Source Income Face 

Compliance Risks and Burdens Similar to Those in the United States, 

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.

GAO-09-934 

(Washington, D.C.: Sept. 15, 2009). 
Appendix III: IRS Statistics of Income Data on 

the Number of C Corporations by Taxable 

Income and Size of Business Receipts, 2010

Page 48 GAO-13-789 Corporate Tax Expenditures

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

Size of 

business 

receipts 

No 

taxable 

income

First 

$50,000 

(15 percent)

$50,000 - 

$75,000 

(25 percent)

$75,000 - 

$100,000

(34 percent)

$100,000 - 

$335,000 

(39 percent)

$335,000 - 

$10,000,000 

(34 percent)

$10,000,000-

$15,000,000 

(35 percent)

$15,000,000-

$18,333,333 

(38 percent)

Over 

$18,333,333 

(35 percent)

Under 

$25,000 353,943 67,381 2,427 996 2,471 1,107 14 11 43

$25,000 

under 

$100,000 181,917 65,036 2,251 383 440 166 ** ** 3 

$100,000 

under 

$250,000 183,569 68,107 4,304 1,945 1,753 83   ** 

$250,000 

under 

$500,000 137,421 51,575 3,980 3,071 2,702 340 **  

$500,000 

under 

$1,000,000 116,640 48,000 6,043 1,948 3,804 560 3 **  0 

$1,000,000 

under 

$2,500,000 101,849 46,875 8,325 4,014 6,868 2,027 6 ** 3 

$2,500,000 

under 

$5,000,000 43,176 18,972 4,701 2,416 6,749 3,369 4 ** 6 

$5,000,000 

under 

$10,000,000 21,690 7,560 3,204 1,860 6,772 4,955 9 3 10

$10,000,000 

under 

$50,000,000 19,801 4,014 1,531 1,280 6,112 11,455 152 56 98

$50,000,000 

under 

$100,000,000 2,934 167 63 86 479 2,649 190 50 150

$100,000,000 

under 

$250,000,000 2,081 24 23 19 127 1,564 292 135 457

$250,000,000 

and over 2,140 5 5 0 26 662 235 111 2,112

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

Appendix III: IRS Statistics of Income Data 

on the Number of C Corporations by Taxable 

Income and Size of Business Receipts, 2010
Appendix III: IRS Statistics of Income Data on 

the Number of C Corporations by Taxable 

Income and Size of Business Receipts, 2010

Page 49 GAO-13-789 Corporate Tax Expenditures

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

Size of 

Business 

Receipts 

No 

taxable 

income

First 

$50,000 

(15 percent)

$50,000 - 

$75,000 

25 percent)

$75,000 - 

$100,000 

(34 percent)

$100,000 - 

$335,000 

(39 percent)

$335,000 - 

$10,000,000 

(34 percent)

$10,000,000-

$15,000,000 

(35 percent)

$15,000,000-

$18,333,333 

(38 percent)

Over 

$18,333,333 

(35 percent)

Row 

Total

Under 

$25,000

4.28 10.70 57.40 89.45 56.67 81.84 205.37 733.58 16.50 3.80

$25,000 under 

$100,000

6.31 10.90 59.55 139.22 132.98 211.65 — — 51.64 5.27

$100,000 

under 

$250,000

6.27 10.65 43.08 64.04 67.05 291.45 — — — 5.15

$250,000 

under 

$500,000

7.35 12.28 44.76 51.01 54.03 150.34 — — — 5.99

$500,000 

under 

$1,000,000

8.02 12.74 36.32 63.94 45.62 115.06 — — — 6.39

$1,000,000 

under 

$2,500,000

8.60 12.89 30.84 44.47 33.87 61.07 0.00 — 51.64 6.53

$2,500,000 

under 

$5,000,000

13.32 20.38 41.05 57.13 33.90 45.50 0.00 — 44.70 9.73

$5,000,000 

under 

$10,000,000

18.60 32.31 49.65 65.15 33.87 36.80 53.95 89.27 34.62 12.71

$10,000,000 

under 

$50,000,000

18.46 44.14 71.52 77.80 35.50 23.86 10.89 17.40 12.33 12.39

$50,000,000 

under 

$100,000,000

36.36 206.26 329.60 302.03 123.58 44.41 9.75 16.27 8.9 26.00

$100,000,000 

under 

$250,000,000

25.48 487.74 478.36 580.59 210.34 40.56 165.20 23.53 17.78 21.51

$250,000,000 

and over

4.81 798.88 798.50 — 460.64 30.59 6.64 8.03 0.88 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.
Appendix IV: GAO Contact and Staff 

Acknowledgments

Page 50 GAO-13-789 Corporate Tax Expenditures

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

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.

Appendix IV: GAO Contact and Staff 

Acknowledgments 

GAO Contact

Staff 

Acknowledgments

(451037)
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