Corporations are increasingly recognizing the importance of being responsive not just to their shareholders but also to the interests of stakeholders, such as customers, employees and their communities. The corporate leaders of the Business Roundtable issued an announcement to that effect last year.
Supreme Court jurisprudence over the past two centuries, including with Citizens United in 2010, has affirmed the doctrine of “corporate personhood” — the notion that corporations enjoy many of the protections afforded to individual Americans by the Constitution.
If corporations are, in effect, U.S. citizens, surely their country is a stakeholder to whom they owe an obligation.
Yet it is striking how little U.S. corporations pay in taxes: Based on public reporting, we calculate that in 2019, nearly 20 percent of large corporations that reported profits to shareholders of $100 million (or more) paid zero (or even negative) federal income taxes. Some nonpayment of taxes reflects corporations that make extensive use of tax benefits directed at spurring investment or research and development. But there are valid concerns about companies’ tactics to avoid bearing their fair tax burden, including domestic tax-sheltering, international profit-shifting and deceptive accounting around activities such as leasing and debt forgiveness.
Transparency is the route to accountability; that is why charities’ tax returns are public and why corporations disclose their financial conditions to investors. Yet there is no requirement for corporations to make public their taxable profits, or the ways in which they are avoided. All that companies report is the total taxes they pay. This despite the fact that the IRS, in its own efforts to increase corporate accountability, has since 2004 required the annual filing of Schedule M-3, which reconciles the differences between income reported to shareholders and income taxed by the IRS. The M-3 has been celebrated as a “Rosetta Stone,” providing clarity about exactly how large profits avoid the IRS’s reach and helping to focus limited enforcement resources on the most egregious avoiders. But this road map is available to the IRS alone, not to the public, who can hold companies accountable, nor to policymakers with the power to foreclose the gaming opportunities they exploit.
For individual taxpayers, there are many reasons their returns should be private. There may well be reasons the entirety of the corporate tax return should be private, to preserve competitive secrets and limit confusion, since large corporations’ returns are tens of thousands of pages long. But corporations should be required to publicly account for the gap between the income they report to the IRS and the income that they report to their shareholders.
Yes, there are reasons the gap exists, given that “book” income and taxable income follow different accounting standards, with different objectives. But firms should be required to publicly reconcile this discrepancy. Today, companies are incentivized to exaggerate their income reported to shareholders and to understate their income for tax purposes. Being forced into a transparent reconciliation would push more honesty in both directions. And since the M-3 is a concise, three-page report, it would deliver clarity, not confusion.
Two solutions present themselves. One, long advocated by tax experts, including Ed Kleinbard, former chief of staff of the congressional Joint Committee on Taxation, is for the IRS to release the M-3 directly. But that would require new legislation, since the 1976 Tax Reform Act creates a default of privacy for taxpayer information (the Tax and Trade Relief Extension Act of 1998 reversed this default for nonprofits only). The idea has substantial merit — it ought to be included in the next significant piece of tax legislation.
An alternative way of reaching the same objective, absent congressional action, would be for the Securities and Exchange Commission to compel disclosure. The agency has, in recent years, particularly under Democratic administrations, used reporting requirements as a tool to promote corporate accountability in areas such as diversity in leadership selection and cybersecurity threats. Clearly, if reporting requirements hold firms accountable for their exposure to climate risk, they should also be held to account about the extent to which they engage in potentially dubious tax avoidance.
It would be inappropriate for the SEC to mandate disclosure of tax-return documents, but it would be entirely reasonable for the SEC to require that a reconciliation of book and taxable income be included in regular financial reporting. This would be a low-cost rule for firms, since the information is already produced for tax purposes. And it would be beneficial to investors.
What would be the ultimate effect of publicizing this information? We cannot know precisely, since there is no way to know what drives the wedge between book and taxable income today. Instead, the public hears competing claims that a firm’s low tax payments are either a consequence of following the rules and nurturing growth through investment, or of simply exploiting badly drafted tax laws to shelter income. What we do know: In this area, as in so many, tax transparency will lead to accountability and ultimately wiser policy.