The Strenuously Hushed-Up Fundamental Flaw In The Tax Code

Wolf Richter's picture

Wolf Richter

Corporate Tax Dodging In The Fifty States,” a report that the CTJ released today, found that the largest corporations paid little or no state income taxes in any state for the years 2008-2010. In a prior report, the CTJ found that some of the most profitable US corporations paid no federal income taxes over the same period. Both reports point at one of the major problems dogging the US economy: the tax code—and its most fundamental flaw that not even tax reformers dare to mention.

The Internal Revenue Code serves two functions: raise money for the government; and dole out benefits and subsidies to industries, companies, pet projects, individuals, shrimp fisheries, etc. in return for campaign contributions, votes, and fringe benefits such as free plane rides, bundles of cash, sweetheart mortgages, or well-paid jobs for staffers when they move on. It’s the congressional bread and butter. And the economy pays the price.

Tax reform has been in the air in greater concentrations recently. The proposals address some of the symptoms of what’s wrong with the tax code (tax rates, inequality, constraints on business growth, complexity, etc.). But none address the most fundamental flaw that impacts every aspect of the tax code applicable to businesses: the separation of tax accounting from financial accounting.

For example, for the three years from 2008 through 2010, Well Fargo reported $49 billion in earnings, based on Generally Accepted Accounting Principles (GAAP), but it paid zero federal income taxes—it received a refund of $681 million (CTJ). GE reported $14 billion in income in 2010, of which $5.1 billion came from operations in the US. Income taxes? None. Instead, it claimed a refund of $3.2 billion (New York Times).

That these companies were legally able to tell investors that they made a ton of money while telling the IRS that they lost money shows just how absurd the system has become (not to speak of the absurdity that they received hundreds of billions in bailout money from the Fed and from TARP, plus a host of other taxpayer-funded benefits and guarantees).

This whole debacle could be avoided if the portions of the tax code as applicable to businesses were replaced by a single paragraph that states that income taxes are to be paid at x, y, and z rates on income as reported to investors under GAAP.

GAAP allows companies to seduce investors in a myriad ways with inflated profits and asset values. In fact, it incentivizes companies to engage in economically unproductive activities simply to make their numbers look better.

The tax code does the opposite. It encourages the very same companies that reported inflated income and asset values under GAAP to report little or no income to the IRS. The tax code incentivizes companies to invest heavily in economically unproductive strategies, such as massive lobbying or shifting income-producing activities offshore.

Making GAAP the accounting system for tax purposes would have a number of beneficial consequences. Among them:

  • Tax rates could be much lower than current rates because the income they’re applied to is the same inflated income that investors get dished up on a quarterly basis. Rates could be low enough to incentivize companies to re-shore profitable activities.
  • Companies would face a choice: inflate profits and asset values to look good but pay higher taxes as a consequence; or report realistic numbers and pay less in taxes. As an unintended consequence, financial reporting might become more reliable for investors.
  • Companies would have some certainty about income taxes and could commit to long-term investments with less risk.
  • The corporate tax profession could be shifted to productive activities. At GE, for example, the third-grade daughter of one of the employees could spend a few minutes every quarter doing GE’s income taxes (rate tables applied to reported income). Um, I’m being facetious. There will still be issues for professionals to tear their hair out over, such as international activities. But most of the tax professionals now on staff could be retrained to do productive work. IRS personnel would also be retrained, and auditors would follow GAAP in their audits.

Though the list of economic benefits is long, the noise from tax professionals and lobbyists would blow out the national eardrums. Profitable companies that pay no income taxes might dig in their heels. And unemployment might briefly edge up as tax professionals merge into other activities. Yet, the business and economic advantages of using one accounting system for tax and financial reporting, along with much lower tax rates, would be enormous. Alas, as ugly, complex, and dysfunctional as the current tax code is, it remains the congressional bread and butter—and that might never change.

Another ode to our lawmakers: a Cheneyesque banana-republic law would allow the military to imprison Americans for life.

Wolf Richter

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oleander garch's picture


Because of GAAP, in 2010 GE claimed $14 billion dollars in income and paid 0 in income tax...and even got a $3.2 billion dollar refund.


Drunken Monkey's picture

A "modest proposal" a.k.a. the one paragraph long tax code:

- Abolish all corporate taxes

- Attribute all corporate "profit" calculated according to GAAP, as income to the shareholders.

- Abolish all consumption taxes

- Abolish all deductions from personal income and tax credits i.e. "a dollar is a dollar"

- Impose a "flat tax" i.e. a fixed percentage regardless of income on all personal income.

Setarcos's picture


In another thread I tried to post a comment and got "ACCESS DENIED'.

I am not kidding you, this really has happened.

What the hell is goung on?  I have no reason to think that ZH would deny access.

PulauHantu29's picture

Corporate Taxes?...What a bold idea!

Setarcos's picture

Simple answers to corporations not paying taxes.

Quit paying a military that protects and projects their international enterprizes.

Quit building and maintaining road, rail, air and ALL the conduits for conducting business that corporations now get for free, on the back of tax payers.

Quit providing tax-funded schools which provide the human "feed-stock" for corporations ... oh and quit the public health-care system that keeps the fodder alive and/or repairs damaged people who can no longer work.

Get rid of everything and anything that can ONLY be funded by taxes ... but continue to allow banksters to levy compound interest (a privatatized form of taxation) which provides nothing that actually enables corporations to function.

I am not saying that taxes cannot be misappropriated into gravy trains AND paying bankster interest on private loans taken out by governments, BUT I am saying that NOTHING could function (in the modern world) without taxes that actually enable the grossest tax avoiders to get their ill-gotten gains.

Here is a curly one for all you Ron Paul fans:

If he got his way (of near-zero taxation and government), he would be out of the 'job' he has had, as a politician, for around forty years AND the entire economy would collapse.

Never forget that he is a disciple of Ayn Rand ... that's why he named his son Rand Paul.

Greenspan was/is a disciple of Ayn Rand, so is the Bernank.

"Oh what a tangled web we weave, when first we practice to deceive ..."  Rabbie Burns.

Ron Paul is essentially in the same camp as all other tax avoiders at the high end.

On the one hand he affects to be "on the side" of the little people, whilst being totally in favour of the neo(economic) ideology of removing ALL state protection from the deregulation of financial instruments of mass destruction, e.g. CDS.

Whatever ...

We are on the cusp of VERY major changes.

Will the likes of Ron Paul totally destroy any kind of "social contract" between government and the general OWS/99% population?

Will "civil society" collapse into yet another instance of fascism ... the joining of corporate and state interests?

Will economic/financial tensions yield WW3?

That does seem likely ... given the defeat of Libya, threats against Syria and Iran ... and the Russian Federation drawing a line in the sand on those global issues.

"May you be cursed to live during interesting times."


Judge Arrow's picture

Fresh from a meeting in his convoluted mind, a meeting packed with shouted quotations, factoids and incontinence, Setarcos exemplifies how we are doomed to inchoate babbling whilst beating each other with sticks.

g speed's picture

Wow a mind reader--telling us exactly what is tn RP's mind and thoughts ---amazing to say the least--

I say you're a fucking troll-- not to mention very stupid if you believe what you write.


Setarcos's picture

Thanks. Though I do not pretend to know whst is IN RPs mind ... I only go on what he says.

GMadScientist's picture

Stupidest fucking idea I've heard in a month.

c'mon man's picture

Just spit out my coffee reading your comment GMad....Funniest fu#king comment I've read in a month...

TK69's picture

What needs to happen is to get rid of the tax system and make taxes voluntary.  Why people think there entitled to others people money is beyoned me.  It is as if they think America was built on theft and econonic servitude.  End all taxes, filings, permits, fees, etc and replace them with an equal, per person tax based on needed revenue, and make the payment voluntary.  Then you can end all of this corruption business, etc and you can hold government accountable.


Besides, if the government can create money, then why do people have to pay taxes?

LawsofPhysics's picture

Government, like most of the sheeple is LAZY and decided to PAY a private banking cartel to create money instead of doing it themselves.  THAT IS THE FUCKING PROBLEM!!!!

Wake the fuck up dude.  Looking forward to joining the local militia are you?  That is where you will be once all the armed services are gone (paid for by taxes) and police (also paid for by taxes).

Hey, fine with me, fucking bring it!!!

TK69's picture

Really?  And how do they pay the private banking cartel to produce money?  A commsion?  Is it taken out of the bond interest collected form the treasury, which also pass right back to the treasury?  Collateral?  ANd Why would the government need to do this in the first place if it can print its own money?

What the Ellen brown freaks don't understand is that Money in its self does not create production, it only can enhance it.  

And Governemtn doesn't produce anything, it must take it from people that do which in its self diminishes that market.  Through legal tender laws, taxes, and regulations, people are forced to accept worthless money.  It it were not for these things, you would see the effects on production, high cost, decreasing quality, and diminished wealth on the masses.  Loans crated out of thin air hide can hid this effect until it corrects.

Why? Because without innovation and creativity there is no way of overcoming diminshing returns and this mains higher cost and diminished quality over time.

And the governemtn could change legal tender laws overnight thus rendering the banking cartel obsolete over night and their is nothing the banking cartel can do about it.  

All all of this is done in order to pay for social welfare or the military, neither of which is self sustainable.  It all depends on expanding the money supply because too many people do not produce anything for what ever the reason.

ATM's picture

They didn't create the Fed because they were lazy, they did it because they are sinister.

TK69's picture

NO, the fed was created to protect the large banks from the US government.

my puppy for prez's picture

I listened to a great audio CD by G Edward Griffin titled "The Perfect Tax".

He explains the evil and real purpose of the Tax Amendment, and then reveals what he advocates as the most constitutional, freedom-based tax of all:


He makes his case succinctly and convincingly.  But of course, that would make way too much since for the likes of Amerika!

rufusbird's picture

"Corporations just pass their taxes through to the end user of their service or product anyway, so it really doesn't matter how they are taxed."

If that is true then US Tax payers are subsidizing the not tax paying corporation's customers.

El Gordo's picture

If we as taxpayers are subsidizing the non-tax paying corporations' customers, are you saying that we are subsidizing ourselves?

rufusbird's picture

At least the cost is being carried by the users of that product or service. Why should I who lives on the west coast pay the costs of an East Coast Bank which I don't use?

El Gordo's picture

Corporations just pass their taxes through to the end user of their service or product anyway, so it really doesn't matter how they are taxed.

Buckaroo Banzai's picture

You are right. Given that fact here is the case that corporations should bear 100% of the brunt of income taxes in a free society: because corporations are creatures of statute, and thus entirely beholden to the State; and men are creatures of God, with inalienable rights bestowed upon us by our Creator, and born to be subject to no other man. It's no accident the last part sounds like its from the Constitution.

Just Observing's picture

Yep....THAT is the real dirty little secret of corporate income tax....businesses DON'T pay taxes....people do.

So it either gets passed on as a cost of business, and included in the price of the product/service,


The income is distributed to shareholders ( less the corporate income tax ), who then pay income tax on that reduced effect, being double taxed.


The whole freaking thing is simply a shell game, and gives politicians a "bad boy" to "fight"......pure bullshit.

The net effect is corporations run to all the areas of the world where they DON'T have that business expense, or double taxation of distributions, and the stupid fucking politicians and voters moan about "lost jobs"...........

Einstein was right about the most abundant thing in the universe: human stupidity.

mophead's picture

You are 100% correct.

connda's picture

This is basically corruption.  Not the in-your-face, money-under-the-table type of corruption that you see in a third-world or developing country.  This is the perfectly legal type of corruption -- why legal?  Because these people never evolved a moral compass.  What they do is not by a strict definition illegal.  Immoral?  Unconscionable?  You and I and the rest of the "little people" know that these people who insist on being addressed as "Honorable"  in reality have no honor and maintain the scruples of a two-bit conman.  Do you think that any of these people would actually "sack-up", develop a backbone, and do what's right? Not likely.

So I guess that we should blame these moral indigents for not being able to discern the difference between right and wrong.  But to be honest, I place the blame directly on the constituents of these morally bankrupt individuals who time and time and time again, vote their own slimeballs right back into office.  Pump enough money into the campaign, buff the candidate nice and bright, and the voters (who have all of the simple intelligence of ravens) will simply pick the shiniest nominee on the ballot. 

philipat's picture

Corporations pay Politicians to get elected. Politicians reward Corpoerations in Congress by passing friendly legislation and then the same Corporations give them high paying jobs after they leave. If they don't move into Lobbying positions.. Welcome to the United Corporatocracy of America and wake up.

Perhaps I am missing something here but isn't that the same "In your face" corruption as anywhere else in the world? Which is why the rest of the world is sick and tired of being lectured by the US?

billsykes's picture

"GAAP allows companies to seduce investors in a myriad ways with inflated profits and asset values"

ok, I know about the asset value fakery, but how do they inflate profits, and if they do inflate profits why do pub co's show gaap losses?


LawsofPhysics's picture

One way companies inflate profits, especially paper pushing financial fucknut companies, is to pay bills in one currancy, but then collect and or book profits in another OR do a number of accounting tricks, for example, they can declare losses on asset depreciation and get a tax break which is then counted as income.  

ebworthen's picture



Tax refunds to corporations on top of Supine Court authorization for them to fund campaigns and take away my property?


Where is the best place to expatriate again?

non_anon's picture

the late Aaron Russo interviews IRS Commissioner Sheldon Cohen

geekgrrl's picture

Maybe it's time to get out the pitchforks?

topcallingtroll's picture

Yes indeed cutie.
Maybe we could discuss it over dinner and drinks?

Boxed Merlot's picture

Don't forget the fines, penalties and court awards judges (gone to seed attorneys), dole out to their partners in crime. Everything from class action lawsuits and Teneo induced extortion settlements are tax free transfers of wealth that move from party to party with less paper trail than any Swiss account could ever have hoped for.

I'd still like to see the menu of items available for purchase that Teneo has offered for Corzine to purchase and the asking prices. No doubt the cover charge of frn 50k per month was nothing more than access to the trough.

Michael's picture

I hear the effective tax rate for corporations is like 6% after deductions. We should just have a flat tax rate of 6% for everyone with no deductions whatsoever.

Ghordius's picture

hahaha 6%!

say it again? hahahaha

a realistic flat tax for the US? 25%, dude

but of course if you make it as many countries do, i.e. with the "kickback", then for the lower incomes it comes down to 5% easy

LawsofPhysics's picture

Did you say 25%?  I'll fucking take it!!!  Right now we are around 40%.  Something like this happens or the U.S. become like every other third world country including India and China.  Kickbacks, bribes, and extortion will become the norm.

Buckaroo Banzai's picture

Can we reduce the size of federal govt by 95% first? Then we can ELIMINATE the income tax, and return to living in a society of free men, and not slaves.

Enzo's picture

The devil is in the details... That would be 6% of what? What is the definition of income? For those with W-2 income, the answer is not as difficult. For businesses - is it net income based on GAAP? Remember, "deductions" such as meals and entertainment, are 100% expensed under GAAP. We currently have approximately 25,000 pages of tax code trying to define income.

A national sales tax (NOT a VAT) would be efficient since it could be collected by states who would then remit it to the Fed. The income tax would have to be constitutionally abolished or we would end up with both. The IRS would be eliminated. Savings would also be encouraged and individuals would have more freedom in deciding if the next best widget was worth the associated tax. Also, it is more difficult to avoid a sales tax than an income tax. There would still be the issue of defining what sales are included, such as real estate sales or services rendered, but there really are very few simple solutions to anything...

Sandmann's picture

Get rid of Double-Taxation of Dividends and move to the Imputation System to reduce the attractions of Debt and to stop the tax shield being used to boost investor returns at the expense of economic stability. The Tax Code favours corporations with captive finance subsidiaries like GE and the way banks keep container leasing arms and shipping businesses as tax write-offs is bemusing. The whole system is corrupt

Zero Govt's picture

Er, how about we get rid of tax ...forever

it bleeds the good and rewards the big corporate tax dodgers... enriching a useless bunch of crones, accountants, along the way

the tax code has 2 objectives; to suck from the productive; State monitoring of all its minions

Neither is valuable to society

Commander Cody's picture

So, you would hand over all common infrastructure (roads, bridges, tunnels, dams, irrigation systems, defense facilities, etc.) to "capitalists".  Methinks your simplistic view of no tax merits some further thought.

Buckaroo Banzai's picture

Whoops! You fell into the liberal intellectual trap.

No income taxes is not the same as no taxes.

The federal govt ran itself for over 120 years on only excise taxes.

Income taxes are the functional equivalent of slavery-- involuntary servitude to your beltway masters. The fruits of your labors go to the IRS first, then they decide how much they keep for themselves, and how much the pass along to you.

Commander Cody's picture

Er, how about we get rid of tax ...forever

Er, I see no specific reference to income tax.

lasvegaspersona's picture

A great point. It is obvious and yet I did not know that was the case.

As a small business I do use GAAP so heck yes!!!

AndrewCostello's picture

This is the point that we have all been pointing out for many, many years - but the system is so damn corrupt that too many people are benefiting from it for the politicians to do anything.


The only honest system is one flat tax, with absolutely NO write offs or credits of any kind.


That is the only way toward an honest and robust economy.  But will it ever happen?  Who knows.



baldski's picture

But most of their profits are overseas. So, those people should pay the tax. But they want a tax holiday to repatriate profits. Welcome to the fascist state!

Fidel Sarcastro's picture

I have been arguing this exact point for years.  Thanks for the great article.

Wolf Richter's picture

Thanks. Good to know that I'm not the only one out there who thinks that.

Buckaroo Banzai's picture

Good stuff! But this paragraph needed fixing:

"The Internal Revenue Code serves two functions: to dominate and enslave the 14th Amendment citizens by turning them into de facto employees of the State, and to dole out benefits and subsidies to industries, companies, pet projects, individuals, shrimp fisheries, etc. in return for campaign contributions, votes, and fringe benefits such as free plane rides, bundles of cash, Prostitutes, sweetheart mortgages, or well-paid jobs for staffers when they move on. It’s the congressional bread and butter. And the economy pays the price.