The Multinational Monitor

OCTOBER/NOVEMBER 1984 - VOLUME 5 - NUMBERS 10 & 11


T H E   M Y T H   O F   I N V E S T M E N T   I N C E N T I V E S

The Failure of Corporate Tax Incentives

by Robert S/ McIntyre

The argument that tax breaks will stimulate business investment is a cornerstone of the corporate economic philosophy. Third world countries and stateside unemployed are repeatedly told that the road to jobs and growth is paved with concessions for the world's wealthiest corporations.

In this issue of the Monitor, George Black and Emilio Pantojas Garcia examine the implications of this strategy for two Caribbean islands with contrasting experiences; one where an almost totally accomodating government has failed to call forth the expected parade of international investors, and another where the technique of official subordination to corporate desires has succeeded all too well.

The debate over the corporate concession strategy and its implications for domestic U.S. economic policy has recently been transformed by a landmark study by Robert S. McIntyre, Director of Federal Tax Policy at Citizens for Tax Justice, a Washington, D.C.-based research and advocacy group.

Drawing on an analysis of the annual reports and Securities and Exchange Commission filings of the nation's largest industries, utilities and financial corporations, McIntyre demonstrates that the fundamental premise behind the corporate concession philosophy is incorrect: tax breaks do not spur investment-the companies receiving the largest benefits from the Reagan tax program have actually decreased their investment and retained the windfall or used it for dividends. The heaviest new investments, by contrast, have tended to come from companies that pay more in taxes.

The following article is adapted from the McIntyre study, The Failure of Corporate Tax Incentives, available for $10 from Citizens for Tax Justice, 1313 L St., N. W., Washington, D. C. 20005.

Also see the accompanying table, Profits, Federal Income Taxes and Changes in Investments and Dividends, 1981-1983, for 238 Major, Non-Financial American Corporations.1


The federal corporate income tax is but a loophole-riddled shadow of its former self. Back in the 1950's and 1960's, it contributed a quarter of all federal revenues. By 1983, its share had dropped to 6.2%.

The largest corporate loophole was implemented as part of the 1981 Reagan tax bill - the Accelerated Cost Recovery System (ACRS), a system of superaccelerated write-offs for business investments in plant and equipment. Together, ACRS, the investment tax credit and other corporate loopholes now cost the federal government more than any other program in the budget except defense and Social Security, and far more than all federal programs for the poor combined.

Our study of the impact of ACRS and other loopholes on the actual taxes paid by 250 major U.S. corporations from 1981 through 1983 found that:

  • The companies paid an overall federal income tax rate of 14.1 % on domestic profits totalling $291.4 billion, making a mockery of the statutory 46% corporate tax rate, and adding $91 billion to the federal deficit;

  • 17 companies with $14.9 billion in profits paid no federal income taxes whatsoever during the three years and claimed benefits totalling $1.2 billion through rebates of taxes paid before Reagan took office or from the sale of excess tax breaks to other companies;

  • 65 companies with $49.5 billion in pretax profits paid an average of zero or less over the three years, receiving outright tax subsidies that brought their after--tax profits to $3.2 billion more than they made before taxes - a tax rate of "negative" 6.5%; and

  • 128 companies paid zero or less in taxes in at least one of the three years, claiming an additional $5.7 billion in tax benefits on top of the $57.1 billion in pretax profits they earned in their no-tax years.

When asked about the burden this legalized tax avoidance shifts onto middle and lower income wage earners, the corporate lobbyists have a ready answer. What most people call loopholes, they call "incentives." Without these incentives, they argue, businesses won't be able to expand their investment, undermining economic growth and America's competitiveness in the world economy.

This argument has served the loophole lobbyists well, as officially designated corporate "tax expenditures" have grown from $7 billion in 1970 to over $100 billion in fiscal 1985. What politician, after all, wants to go on record against investment, growth, and competitiveness in the world economy?

Surprisingly, however, after the "incentives" enter the tax code, few seem interested in finding out if they actually result in the promised capital spending. Each year, in the name of encouraging investment, the federal government forgoes tens of billions of dollars in corporate tax revenues without holding either the lobbyists or their employers accountable if it fails to materialize.

Corporate Tax Breaks Spur Dividends, Not Investments

Our study found that corporate claims about tax "incentives" are dead wrong. The companies with the lowest taxes actually reduced investment and did so at above-average rates, while the investment of the highest-taxed companies increased.

The 50 lowest-taxed non-financial corporations in the study had an average tax rate of minus 8.4 percent. Yet, despite all the "incentives" they took advantage of, they reduced their investment by 21.6%. By contrast, the 50 corporations with the highest tax rates increased their investment over the same period by 4.3%, while paying 33.1% of their profits in federal income taxes.

Interestingly, while cutting back on new investment, the low-tax companies also increased their dividends at a pace more than 30% greater than the high-tax companies.

Consider the following findings:

  • the 15 non-financial companies that each year paid zero or less in taxes reduced investment by 29.6%, while increasing dividends by 9.5%.

  • the 58 non-financial companies that over the three years averaged zero or less in taxes reduced investment by 19.3% while increasing dividends by 17.6%.

  • the 118 companies that paid zero or less in at least one of the three years reduced investment by 15.7% while increasing dividends by 21.2%.

Each of the five companies claiming the largest tax rebates over the last three years increased its dividends while reducing investment. General Electric earned $6.5 billion in profits, paid nothing in taxes, and claimed rebates totalling $283 million. Despite taking full advantage of all the investment incentives in the federal tax code, GE actually reduced its level of new investment by 15% while increasing dividends by 19%.

The four other high-rebate companies followed the same pattern: Boeing ($267 million rebate) reduced investment by 59%, Dow Chemical ($233 million rebate) by 46%, Tenneco ($189 million rebate) by 31.8%, and Santa Fe Southern Pacific ($141.7 million rebate) by 21%.

These five companies slashed their rate of new investment by 29.8% while increasing dividends to their shareholders by 11.8%. Together, they earned $13.1 billion in profits, paid nothing in taxes and gained $1.1 billion in tax rebates, for an overall tax rate of negative 8.4%.

Our study revealed many other examples of corporations taking full advantage of tax incentives while reducing investment and increasing dividends:

  • Union Carbide earned $613 million in profits, paid no taxes and claimed net tax benefits of $70 million (a -11.4% tax rate), yet reduced investment by 35.8% and increased dividends by 7.1%.

  • Pacific Power and Light, with a -3.7% tax rate on $598 million in profits, reduced investment by 20.7% and upped its dividends by 26%.

  • AT&T paid only 1.1 % of its $31.4 billion profit in federal income tax, yet reduced its new investment by 21.9% while raising dividends 28.6%.

  • Sperry Corporation paid taxes of only 0.5% on its $607.9 million profit, reduced new investment by 26.8% and increased dividend payments by 20.1%.

  • Panhandle Eastern Corp. slashed investment by 64.9%, while adding 19.7% to dividends, despite a tax rate of -3.1% on its $938 million in profits.

In sharp contrast, Whirlpool Corporation - the highest-taxed company in the study, paying 45.6% on profits of $650.2 million - increased its new investment by 7%.

The study revealed many other examples of relatively high tax companies which have increased their investment:

  • IBM paid a 28.5% tax rate on its $14.1 billion profit while increasing investment by 15.3%

  • Exxon paid 27.5% on profits of $9.4 billion while increasing investment by 26.4% and cutting dividends by 3%.

  • ABC paid 38.7% on profits of $818.7 million while increasing investment by 133.1 % and dividends by 3.1 %.

  • R.J. Reynolds Industries paid 40.3% on its $3.4 billion in profits, yet managed to raise investment by 34.1%.

Overall, the 238 non-financial companies included in our study had an effective tax rate from 1981 through 1983 of only 14.3%, far below the 46% corporate tax rate on income over $100,000. In exchange for the reduced effective tax rates made possible by ACRS, the investment tax credit and other tax "incentives," these companies reduced new investment by 15.5% and raised dividends by 17.0%

Adjusted for inflation in plant and equipment prices, investment by the 238 firms fell by 17.6% between 1981 and 1983. Thus, these major corporations had an even worse investment performance than did the overall economy, in which plant and equipment spending fell by 8.8% in constant dollars over the same period.

But the overall national experience is bad enough. Contrary to the claims and promises of the corporate lobbyists, as the cost of loopholes skyrocketed, real business outlays for plant and equipment fell. In fact, they fell in each of the first three years the investment "incentives" in the 1981 Reagan tax bill were in effect - the first such three-year decline in the postwar era.

Even with the rebound in 1984, the four years under the much-touted "Accelerated Cost Recovery System" have been pathetic ones for capital spending, and the record stands in sharp contrast to investment performance in the four years before ACRS was enacted.

Why Tax Incentives Don't Work

The evidence is overwhelming. The billions of dollars we spend each year on corporate tax "incentives" are wasted. While the generosity of the tax code certainly has enlarged the after-tax profits of many corporations, it has not produced the investment gains promised by corporate lobbyists.

There are, of course, low tax firms that have added to their investment. And there are high tax companies that have cut investment. But, overall, it was the 50 highest taxed firms that in the aggregate increased their investment, while the lowest taxed firms made substantial reductions in capital spending.

What is the explanation? One answer, of course, is that in the real world companies invest only when they need new plant and equipment to produce products they can sell to consumers. When consumers don't spend money, plants are idled and new investment drops.

As the ink was drying on the Reagan tax bill in August 1981, the business managers responsible for investment decisions (as opposed to the lobbyists, whose mission is to lower corporate taxes) began explaining why the massive new tax incentives really wouldn't increase their planned investment after all.

The chairman of one major U.S. corporation told the New York Times that "with or without the tax bill we would have done what we did in 1981 and what we plan to do in 1982. One can spend money on men and materials only at a given rate. Beyond that it becomes foolish."

Corporate annual reports provide many confirmations that investment decisions are driven by "demand-side" market forces rather than by "supply-side" theories. W.R. Grace & Co., for example, despite $684.1 million in profits between 1981 and 1983, actually made $12.5 million off the tax system by selling its excess tax breaks. At the same time it reduced new investment by 15.8% in 1982 and by another 37% in 1983. In its 1983 annual report, the company offered a simple and cogent explanation for its actions: the cut in investment was make in "response to the reduced demand" for its products.

"Demand-side" economics were also endorsed by many other firms. Tenneco, for example, cited "the weakness in natural gas demand" to explain its 31.8% investment cut between 1981 and 1983, despite its use of tax "incentives" to pay no taxes on $2.7 billion in profits and claim an extra $189 million in tax rebates.

Colt Industries, which was extremely active in lobbying for the "investment incentives" in the 1981 Reagan tax bill, saw its capital spending peak in 1980. By 1983, Colt had reduced its investment spending by 39% from 1980, explaining to shareholders that "the slow recovery in capital spending by American industry continued to affect our capital goods businesses."

Companies like Colt Industries, Tenneco and other capital intensive firms benefit from tax breaks like ACRS whether or not they actually increase the level of their new investment. In effect, ACRS, the investment tax credit, and other corporate loopholes reward companies for doing what they would do anyway.

While these tax breaks may not increase corporate investment, they do increase after-tax profits. The added corporate cash flow they generate may be used for additional investment, but it also may be used to increase dividends, expand cash reserves, fund mergers or acquisitions, raise executive pay, or increase advertising budgets.

Our study has documented the increase in dividends while investment was declining between 1981 and 1983. Our 238 companies raised dividends by 17% over the three years while slashing investment by 15.5% and paying only 14.3% of their profits in taxes. Of the 238 firms studied, 126 (52.9%) cut investment - and of these, 109 increased dividends.

Many companies noted in their annual reports that they had added substantially to their cash reserves. General Electric, the champion refund recipient, which cut its investment by 15% from 1981 to 1983, reports that by the end of 1983 it had amassed "almost $3 billion in liquid funds" (cash and marketable securities).

Phillips Petroleum, whose investment fell 57.2% between 1981 and 1983, says that at the end of 1983 it had $906 million in cash on hand. Colt Industries brags about its "determined effort to improve liquidity... Through these efforts,...capital expenditures were held to $36.3 million," while "cash and marketable securities were $164.9 million on December 31, 1983, an increase of $19.6 million (13.5%) over 1982."

Fluor Corp., after relating (in a section of its annual report humorously captioned "CAPITAL INVESTMENT CONTINUES STRONG") how its 1983 investment fell by 42.6% from 1982 and by 32.6% since 1981, reports that it increased cash and short-term investments by $64.8 million in 1983, an 80.1 % jump from 1982.

Union Pacific Corp., which cut its investment by 20.1 % from 1981 to 1983 and increased dividends by 48.4%, while paying an effective tax rate of only 3.5%, reports that "cash and temporary cash investments" rose to $751 million in 1983, an increase of $296 million (65%) over 1982 and an increase of $676 (901 %) since 1981.

Many companies also report substantial use of funds to acquire other firms - not surprising, given the recordbreaking $209 billion wave of mergers over the 1981-1983 period (with another $100 billion-plus in 1984).

Phillips Petroleum for example, notes that it spent $1.2 billion in 1983 to acquire General American Oil Company of Texas. Fluor spent $1.6 billion in 1981 to acquire St. Joe Minerals Corp. CSX Corp., which cut investment by 38.4% between 1981 and 1983 despite its "negative" tax rate, spent $1.1 billion in 1983 to acquire Texas Gas Resources Corporation. Union Pacific acquired Missouri Pacific Corporation in December of 1982 for $998 million. And Air Products and Chemicals, which cut its 1983 investment by almost one-third from its 1980 level despite a negative tax rate of 4.6%, used $210 million in cash in 1982 to purchase the Steam-Roger group of companies.

Time to Stop the Waste

In order to protect taxpayers against "waste, fraud and abuse" when government provides aid to our poorest citizens, Congress has created an extensive set of rules and regulations requiring the poor to disclose even the most intimate details of their personal lives in exchange for government assistance.

But when government assists the richest corporations with billions of dollars in "investment tax incentives," the commitment of Congress to protect taxpayers from "waste, fraud and abuse" - so piously expressed when directed at the poor - suddenly vanishes.

If the President and Congress held the largest corporations to the same standard of accountability they apply to the poorest welfare recipient, no corporate lobbyist--no matter how persuasive, no matter how many campaign contributions he or she might control - could prevent the repeal of ACRS, the investment tax credit, and the host of other "incentives" which, on the evidence, have failed to achieve their stated objective.

This double standard is especially intolerable when the federal government is facing annual budget deficits in excess of $200 billion. Between 1981 and 1983, the 238 companies in our study used the many "incentives" to avoid almost $90 billion in federal taxes, yet reduced their investment. Looking at the economy as a whole, business investment declined by 9% between 1980 and 1983 while the cost of federal tax loopholes rose 41 %. In view of this dismal record, how can members of Congress consider new limitations on Social Security payments or cuts in health benefits for veterans, while billions of dollars are literally being wasted on corporate tax subsidies intended to encourage investment that has never materialized?

In its tax reform plan released in November 1984, the U.S. Treasury proposed repeal of the Accelerated Cost Recovery System, the investment tax credit, and most other corporate tax loopholes - together with a reduction in corporate rates. Repeal of ACRS and the investment credit alone would raise over $100 billion a year by 1990.

Another way to state the issue is that failure to repeal ACRS and the investment credit would mean that by the end of the decade the federal government will be wasting over $100 billion a year on. tax incentives that don't work.

Corporate tax reform can work. Restoring corporate America to the tax rolls can obviate the need to cut Social Security or veterans' benefits. It can help reduce the deficit. And it can help strengthen the economy by forcing corporations to stop relying on lobbyists and loopholes to bolster profits, and instead, go back to making money the old fashioned way - by earning it.


1 How the Companies Were Chosen: Citizens for Tax Justice wrote to 600 major American corporations asking for copies of their 1983 annual reports and 10 K forms filed with the Securities and Exchange Commission. The companies chosen were the top 300 from the Fortune 500 along with those listed in Fortune's compilations of the top 50 firms among utilities, service industries, commercial banks, life insurance and transportation companies. The list was also supplemented by writing to several other companies covered in the studies of corporate taxes done by the congressional Joint Committee on Taxation in 1983 and 1984. The study eliminated companies that either did not respond or fell into one of two categories: those that actually lost money over the three years - or lost so much in one year that the results would be distorted; or those whose reports did not provide sufficient information to calculate domestic profits, current federal income taxes, or both.


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