Important methodological decisions to make when computing effective  tax rates on corporate income are the scope of the corporate taxpayer to  study and what measures of taxes and income to use. Corporations Vary Considerably Both in the United States and across Foreign Locations

The weighted average U.S. effective tax rate on the domestic income of  large corporations with positive domestic income in 2004 was 25.2  percent, while the median effective tax rate for this population of  corporations was 31.8 percent. However, as figure 1 shows, under these  two summary measures there was considerable variation in effective tax  rates across taxpayers. The Residual U.S. Average Effective Tax Rate on the Foreign Income of Large U.S. First, in  cases where a U.S. MNC has paid foreign income taxes at a rate that is  close or equal to the U.S. tax rate, the U.S. foreign tax credit eliminates  most or all of the U.S. tax liability on that corporation’s foreign-source  income. Another approach for estimating the effective tax rate on the foreign- source income of U.S. businesses is to use BEA’s data on the operations of  U.S. MNCs, which includes the amount of net income earned and foreign  taxes paid by foreign affiliates of these MNCs. Effective Tax Rates by Principal Place of Business

Although the CFC data may be preferable to the BEA data for estimating  an overall average effective tax rate for the foreign operations of U.S.  MNCs, the former data provide an imperfect basis for estimating average  effective tax rates for specific countries. Most of the Activity of U.S. MNCs Remains Located in the United States, but the Share of Activity Located Abroad Has Increased

Figure 5 shows the trends across the last four BEA benchmark studies of  U.S. MNC operations (1989–2004) for six key measures of business  activity: value added, sales, physical assets, compensation of employees,  number of employees, and pretax income excluding income from equity  investments. Business activity by all measures increased in absolute  terms both domestically and abroad during this period, but the relative  share of activity that was based in foreign affiliates increased. Nevertheless, as of 2004, over 60 percent of the activity (by all six  measures) of U.S. MNCs remained located in the United States. With the  exception of China, all of the countries with relatively low effective rates  of tax have income shares that are significantly larger than their share of  the three measures least likely to be affected by income-shifting practices:  physical assets, compensation, and employment. This relationship holds  for all three income measures. Luxembourg, the United Kingdom  Caribbean Islands (and, to a lesser extent, Bermuda and Switzerland) also  have significant shares of income from equity investments. Appendix II: BEA Data Used in This Report

Bureau of Economic Analysis (BEA) data provide a wide array of data  items on multinational corporations (MNC) cross-classified by country  and industry.
Why GAO Did This Study

U.S. and foreign tax regimes influence decisions of U.S. multinational corporations (MNC) regarding how much to invest and how many workers to employ in particular activities and in particular locations. Tax rules also influence where corporations report earning income for tax purposes. The average effective tax rate, which equals the amount of income taxes a business pays divided by its pretax net income (measured according to accounting rules, not tax rules), is a useful measure of actual tax burdens. In response to a request from U.S. Senate Committee on Finance, this report provides information on the average effective tax rates that U.S.-based businesses pay on their domestic and foreign-source income and trends in the location of worldwide activity of U.S.-based businesses. GAO analyzed Internal Revenue Service (IRS) data on corporate taxpayers, including new data for 2004 and Bureau of Economic Analysis data on the domestic and foreign operations of U.S. MNCs. Data limitations are noted where relevant. GAO is not making any recommendations in this report.

What GAO Found

The average U.S. effective tax rate on the domestic income of large corporations with positive domestic income in 2004 was an estimated 25.2 percent. There was considerable variation in tax rates across these taxpayers. The average U.S. effective tax rate on the foreign-source income of these large corporations was around 4 percent, reflecting the effects of both the foreign tax credit and tax deferral on this type of income. Effective tax rates on the foreign operations of U.S. MNCs vary considerably by country. According to estimates for 2004, Bermuda, Ireland, Singapore, Switzerland, the United Kingdom (UK) Caribbean Islands, and China had relatively low rates among countries that hosted significant shares of U.S. business activity, while Italy, Japan, Germany, Brazil, and Mexico had relatively high rates. U.S. business activity (measured by sales, value added, employment, compensation, physical assets, and net income) increased in absolute terms both domestically and abroad from 1989 through 2004, but the relative share of activity that was based in foreign affiliates increased. Nevertheless, as of 2004, over 60 percent of the activity (by all six measures) of U.S. MNCs remained located in the United States. The U.K., Canada, and Germany are the leading foreign locations of U.S. businesses by all measures except income. Reporting of the geographic sources of income is susceptible to manipulation for tax planning purposes and appears to be influenced by differences in tax rates across countries. Most of the countries studied with relatively low effective tax rates have income shares significantly larger than their shares of the business measures least likely to be affected by income shifting practices: physical assets, compensation, and employment. The opposite relationship holds for most of the high tax countries studied.