Document originally published in Tax Notes
on February 25, 2008.

Effective corporate tax rates, as reported to shareholders and to the Securities and Exchange Commission, play a critical role in a corporation's bottom line. The profit numbers universally cited in the financial press are after-tax figures, so corporate tax managers can contribute significantly to a corporation's reported profits by managing the effective tax rate.

In the late 1990s it became fashionable for corporations to aggressively reduce tax rates. Part of this trend involved a rise in the use of corporate tax shelters. Since the late 1990s — in the wake of Enron and other corporate scandals and a stepped-up campaign against corporate tax shelters by Congress and the IRS — there has been less discussion about the need to lower effective tax rates and more talk about avoiding tax shelter investigations that could damage a corporation's reputation. A few years ago, all of the Big Four accounting firms released discussion papers on the need to exercise caution and restraint in the pursuit of lower effective tax rates. (See "Reputation or Lower Taxes?" Tax Notes, Aug. 29, 2005, p. 981, Doc 2005-17826, or 2005 TNT 168-1.) If indeed tax managers have become less aggressive, one might expect an increase in corporate effective tax rates due to a decline in the amount of tax sheltering activity.

However, a detailed analysis of America's largest and most profitable corporations indicates just the opposite: a substantial decline in the effective tax rates reported to shareholders between the late 1990s and a few years ago.

For our sample of 80 corporations from 1997 to 1999 — the heyday of corporate tax shelters — the average effective corporate tax rate was 34.1 percent. For the 2004-2006 period — during the shelter crackdown — the average effective corporate tax rate was 30 percent.

Of the 80 corporations, 65 reported a decline in effective tax rates. Thirty-four corporations saw their effective tax rates decline by more than 5 percentage points. Only four saw their effective tax rates increase by more than 5 percentage points.

The 80 corporations account for total after-tax profits of $506 billion in 2006, out of a total of $1.1 trillion in after-tax profits for 2006 as reported by the U.S. Commerce Department (http://www.bea.gov/newsreleases/national/gdp/2007/xls/gdp307f.xls).

Reported tax expense — the numerator in a reported effective tax rate — does not always correlate with actual cash payments of income tax. Tax expense is reported on an accrual basis. The main differences between tax expense and actual tax payments are timing differences. So, for example, bonus depreciation available from 2001 through 2004 reduced tax payments but did not directly reduce the effective corporate tax rate as reported to shareholders.

Foreign income taxes as well as state and local income taxes are included in the reported effective corporate tax rate.

Of course, a lot of other factors besides tax shelters could explain the decline in reported effective tax rates. Our next article will discuss the other potential causes. Our sources of information for this discussion are each corporation's reconciliation tables, which list the major items contributing to the difference between the U.S. top statutory corporate tax rate and the corporation's effective tax rate.

Anytime you use the income tax footnotes of corporations' annual reports as your source, there will be a lot of data issues — missing data, inconsistent presentation, huge one-time charges, low or negative taxable income — that make interpretation of effective tax rates tricky. For those more technically inclined, a lengthy data appendix follows.

Data Appendix

Our starting point is Fortune magazine's largest 500 firms (ranked according to gross receipts) for 2007 as reported at http://money.cnn.com/magazines/fortune/fortune500/2007/full_list/ind ex.html. Those 500 firms were ranked according to reported after-tax profits, and the top 100 of those, the most profitable for that year, were selected for more detailed analysis. Of those 100, 66 are members of the Fortune 100.

The largest Fortune 100 companies excluded from our sample of the most profitable companies were General Motors, Ford Motor, McKesson, Cardinal Health, and Kroger. Firms included in our sample that are not in the Fortune 100 are Owens Corning, US Bancorp, Texas Instruments, Occidental Petroleum, and Oracle.

Company annual reports were downloaded from the SEC's EDGAR database (http://www.sec.gov/edgar/searchedgar/companysearch.html).

From our 100 most profitable firms, 4 are excluded because they have data in neither the earlier (1997-1999) nor the later (2004- 2006) period. They are either mutual firms or tax-exempt organizations: Nationwide, State Farm Insurance, TIAA-CREF, and USAA.

Eight of the 100 are excluded because they did not exist, or did not exist as stand-alone, publicly traded U.S. corporations during the 1997-1999 period: Comcast, Agilent Technologies, Prudential Financial, Medtronic, Time Warner, Google, Goldman Sachs Group, and News Corp.

               Table 1. Effective Tax Rates of Excluded Companies

                                   '97-'99                      '04-'06
                 1997   1998   1999   Avg.    2004  2005   2006    Avg.  Change
 Chesapeake
 Energy           0.0    0.0    4.9    1.6    36.0  36.5   38.5    37.0    35.4
 Devon Energy   -37.0  -20.0   41.0   -5.3    33.4  35.6   29.6    32.9    38.2
 DuPont          47.9     36   83.4   55.8   -22.8  41.3    5.9     8.1   -47.6
 Halliburton    -37.4  -87.5  -53.6  -59.5    37.1   2.6   33.2    24.3    83.8
 Hess            94.1  -10.7   37.6   40.3    37.8  44.2   52.6    44.9     4.5
 Mirant          -224   19.0   17.0  -62.7    -2.0   1.3  -48.4   -16.4    46.3
 Owens
 Corning         12.0  -32.0   35.0    5.0    52.0   9.0   11.0    24.0    19.0
 PepsiCo         35.4   11.9   43.9   30.4    24.7  36.1   19.3    26.7    -3.7

Eight of the 100 (see Table 1) were excluded because their data are extremely "noisy" — that is, they contain a number of losses, one-time charges, and other discrepancies:

• Chesapeake Energy was excluded because of losses in 1997 and 1998 and huge adjustments to valuation allowances in 1997, 1998, and 1999.
• Devon Energy was excluded because of losses in both 1997 and 1998.
• DuPont was excluded because of huge one-time adverse tax effects due to a transaction in 1999 and a similar but smaller transaction in 1997. Also, there were large, one-time charges in 2004 and 2006.
• Halliburton was excluded because of losses in 1997, 1998, and 1999, as well as large special charges in 1998.
• Hess was excluded because of losses in 1998 and a huge foreign tax expense in 1997.
• Mirant was excluded because of losses in 1998, a large charge from discontinued operations in 2004, losses in 2005, and a huge valuation adjustment in 2006.
• Owens Corning was excluded because it underwent a major reorganization when it settled asbestos litigation claims in 2006, a huge change to valuation allowances in 2005, and losses in 1998.
• Pepsi Co. was excluded because of significant one-time charges in 1998, 2004, and 2006. (Pepsi Co. could have been included in this study, but with an effective tax rate change of -3.7 percentage points, its effect on our overall results is infinitesimal.)

The unadjusted reported effective tax rates of the eight firms excluded from our sample are shown in Table 1.

For 11 of the 80 firms included in the sample, data were deleted for a single year in which there was a loss: Anadarko Petroleum (1998), Apache (1998), Apple (1997), Boeing (1997), Motorola (1998), Phelps Dodge (1999), Texas Instruments (1997), TXU (2004), UnitedHealth Group (1998), Valero Energy (1998), and Wyeth (2004). Data for two years with losses (1998 and 2004) were excluded in the case of Travelers. These 12 companies, when loss years are excluded, had an average rate reduction of 3.63 percentage points. If they are excluded from our sample, leaving only 68 companies with no losses in any year, the average effective tax rate reduction is 4.16 percentage points compared with 4.08 percentage points for the 80-firm sample.

In the majority of cases, corporations reported their effective tax rates directly. However, in other cases the rate had to be calculated by multiplying 0.35 by a ratio with the numerator equal to reported income tax expense and the denominator equal to income tax expense due on pretax income taxed at the U.S. statutory rate.

For 20 firms out of the sample total of 80, these calculations were required for both the earlier and later periods. The firms were: Anadarko Petroleum, Apache, Apple, AT&T, Berkshire Hathaway, Dow Chemical, ExxonMobil, Hartford Financial Services, Home Depot, Lehman Brothers Holdings, Marathon Oil, Merrill Lynch, Motorola, Oracle, Qualcomm, Texas Instruments, Travelers, TXU, US Bancorp, and UnitedHealth Group.

                     Table 2. Reported Effective Tax Rates

                                   '97-'99                      '04-'06
                 1997   1998   1999   Avg.    2004  2005   2006    Avg.  Change

 Freddie Mac     29.0   27.8   29.8   28.9    21.2  14.4   -5.1    10.2   -18.7
 Occidental
  Petroleum      59.0   53.0   53.0   55.0    41.0  28.0   44.0    37.7   -17.3
 Phelps Dodge    31.0   40.0     --   35.5     9.7  24.6   20.9    18.4   -17.1
 Cisco Systems   44.4   41.4   36.8   40.9    28.6  26.9   22.5    26.0   -14.9
 General
  Electric       26.6   31.0   31.2   29.6    18.2  17.8   16.1    17.4   -12.2
 Morgan Stanley  39.5   37.0   38.0   38.2    24.5  30.1   24.5    26.4   -11.8
 United Parcel
  Service        41.5   40.0   57.7   46.4    32.3  36.3   35.5    34.7   -11.7
 AT&T            37.5   36.2   39.4   37.7    30.5  16.3   32.4    26.4   -11.3
 Altria Group    40.5   40.9   39.5   40.3    32.4  29.9   26.3    29.5   -10.8
 Dow Chemical    35.3   34.1   35.4   34.9    23.1  27.8   23.2    24.7   -10.2
 Anadarko
  Petroleum      34.7     --   59.4   47.0    38.0  39.1   34.0    37.1   -10.0
 MetLife         34.2   34.7   43.0   37.3    27.9  28.5   26.4    27.6    -9.7
 Verizon
  Communications 38.4   40.2   37.8   38.8    26.1  28.7   32.8    29.2    -9.6
 Boeing            --   19.8   30.5   25.2     7.1   9.1   30.9    15.7    -9.5
 Coca-Cola Co.   31.8   32.0   36.3   33.4    22.1  27.2   22.8    24.0    -9.3
 Lockheed Martin 32.9   39.7   38.6   37.1    23.9  30.2   29.6    27.9    -9.1
 Texas
  Instruments      --   34.2   30.3   32.3    22.2  21.1   27.2    23.5    -8.8
 Disney          42.0   41.4   43.8   42.4    30.8  34.5   37.2    34.2    -8.2
 Alcoa           33.0   32.0   29.9   31.6    25.0  23.0   24.3    24.1    -7.5
 Oracle          36.0   38.7   34.9   36.5    28.8  29.7   28.6    29.0    -7.5
 Qualcomm        15.2   27.0   34.5   25.6    23.7  21.7    8.9    18.1    -7.5
 Merrill Lynch   36.3   34.0   31.0   33.8    24.0  29.2   28.1    27.1    -6.7
 Citigroup       35.7   34.9   35.8   35.5    28.4  30.8   27.3    28.8    -6.6
 Microsoft       35.0   36.9   35.0   35.6    26.3  31.0   30.0    29.1    -6.5
 J.P. Morgan
  Chase & Co.    37.3   36.2   35.0   36.2    27.3  30.3   31.4    29.7    -6.5
 TXU             31.7   35.4   41.0   36.0      --  26.3   33.9    30.1    -6.0
 U.S. Bancorp    39.7   36.6   36.2   37.5    32.5  31.7   30.8    31.7    -5.8
 Pfizer          27.0   24.8   28.0   26.6    18.4  29.4   15.3    21.0    -5.6
 Allstate        29.9   30.0   29.4   29.8    26.8  15.5   30.4    24.2    -5.5
 Wells Fargo     40.4   40.8   37.0   39.4    34.9  33.6   33.4    34.0    -5.4
 Wyeth           27.4   31.0   27.1   28.5      --  23.5   22.7    23.1    -5.4
 Hewlett-
  Packard        29.5   27.5   26.0   27.7    32.3  13.8   20.8    22.3    -5.4
 Chevron         30.0   62.8   50.0   47.6    36.6  44.1   46.4    42.4    -5.2
 Intel           34.8   33.6   34.9   34.4    27.8  31.3   28.6    29.2    -5.2
 Honeywell
  Int'l          32.2   31.3   31.5   31.7    23.2  31.9   25.7    26.9    -4.7
 Dell            29.0   31.0   30.0   30.0    31.5  21.8   22.8    25.4    -4.6
 Procter &
  Gamble         34.9   33.8   35.5   34.7    30.6  30.0   29.7    30.1    -4.6
 SunTrust Banks  34.9   35.2   33.7   34.6    30.3  30.7   29.1    30.0    -4.6
 Bank of
  New York Co.   36.4   35.2   37.3   36.3    31.9  32.1   32.0    32.0    -4.3
 Bear Stearns    39.5   37.9   36.8   38.1    33.5  33.8   34.7    34.0    -4.1
 Apache          40.1     --   41.7   40.9    37.3  37.6   36.3    37.1    -3.8
 ConocoPhillips  49.5   43.7   48.6   47.3    43.6  42.1   45.1    43.6    -3.7
 Caterpillar     33.0   30.6   32.0   31.9    27.0  28.7   28.9    28.2    -3.7
 Wal-Mart
  Stores         36.8   37.0   37.4   37.1    34.3  33.1   33.6    33.6    -3.4
 3M              36.1   35.1   35.8   35.7    32.5  33.7   30.6    32.3    -3.4
 United
  Technologies   32.7   31.4   25.9   30.0    26.2  26.8   27.2    26.7    -3.3
 Bank of
  America Corp.  38.0   35.8   35.5   36.4    33.3  32.7   33.9    33.3    -3.1
 Capital One
  Financial      38.0   38.0   37.1   37.7    34.6  36.1   33.9    34.9    -2.8
 PNC Financial
  Services       35.0   34.8   33.2   34.3    30.3  30.2   34.0    31.5    -2.8
 Baker Hughes    37.8   35.4   34.7   36.0    32.3  31.6   35.8    33.3    -2.7
 Loews           31.0   33.0   32.0   32.0    29.0  27.0   32.0    29.3    -2.7
 McDonald's      31.8   32.8   32.5   32.4    28.8  29.6   31.0    29.8    -2.6
 Washington
  Mutual         42.5   37.3   37.0   38.9    37.8  36.9   34.7    36.5    -2.4
 Hartford
  Financial
  Services       19.6   26.3   23.3   23.1    15.3  23.8   23.8    21.0    -2.1
 Motorola        35.0     --   30.0   32.5    32.6  29.5   29.3    30.5    -2.1
 Home Depot      38.9   38.9   39.2   39.0    36.8  37.1   38.1    37.3    -1.7
 UnitedHealth
  Group          38.1     --   36.5   37.3    35.3  36.3   36.3    36.0    -1.3
 National
  City Corp.     31.6   35.0   34.6   33.7    31.8  33.1   32.8    32.6    -1.2
 Amgen           25.2   29.5   30.0   28.2    30.4  24.5   26.6    27.2    -1.1
 Target          39.5   38.2   38.8   38.8    37.8  37.6   38.0    37.8    -1.0
 Int'l Business
  Machines       33.0   30.0   34.0   32.3    30.0  35.0   29.0    31.3    -1.0
 Merck           28.6   35.5   31.7   31.9    27.1  37.1   28.7    31.0    -1.0
 Johnson &
  Johnson        27.8   28.2   27.6   27.9    33.7  23.3   24.2    27.1    -0.8
 Berkshire
  Hathaway       31.8   33.8   34.8   33.4    32.6  32.5   32.8    32.7    -0.8
 Countrywide
  Financial      39.0   39.0   39.0   39.0    38.9  39.0   38.3    38.7    -0.3
 Travelers Cos.  25.9     --   23.4   24.6      --  22.8   26.5    24.7     0.0
 Burlington No.
  Santa Fe       37.0   37.6   37.5   37.4    37.9  37.5   36.9    37.4     0.1
 Valero Energy   36.3     --   29.2   32.8    33.4  32.1   33.3    32.9     0.1
 American Int'l
  Group          28.7   28.4   29.5   28.9    29.7  28.0   30.1    29.3     0.4
 American
  Express        27.6   26.8   28.0   27.5    29.8  24.2   30.0    28.0     0.5
 Anheuser-Busch  38.4   38.0   38.0   38.1    39.0  39.4   39.5    39.3     1.2
 Lowe's          36.0   36.5   36.7   36.4    38.5  38.5   37.9    38.3     1.9
 Wachovia Corp.  28.5   27.1   33.3   29.6    31.7  32.0   32.5    32.1     2.4
 Lehman
  Brothers
  Holdings       30.9   30.1   28.0   29.7    32.0  32.5   32.9    32.5     2.8
 Wellpoint       40.6   18.5   39.0   32.7    33.5  36.7   37.0    35.7     3.0
 Eli Lilly       30.5   21.3   21.5   24.4    38.5  26.3   22.1    29.0     4.5
 Marathon Oil    32.2   31.5   33.2   32.3    36.2  36.3   44.8    39.1     6.9
 Chubb           21.0   16.8   12.5   16.8    25.1  25.4   28.3    26.3     9.5
 ExxonMobil      38.7   31.8   28.1   32.9    41.4  43.0   44.2    42.9    10.0
 Apple             --    6.1   11.1    8.6    26.5  29.4   30.2    28.7    20.1

 Sources and notes: See data appendix for details.

For eight firms, effective tax rates had to be calculated for the 1997-1999 period only: Freddie Mac, Boeing, JPMorgan Chase & Co., Intel, SunTrust Banks, Bank of America, Valero Energy, and American Express.

For six firms, effective tax rates had to be calculated for the 2004-2006 period only: Baker Hughes, Lockheed Martin, MetLife, Wal- Mart Stores, Washington Mutual, and Wyeth.

Of the 80 firms sampled, 68 had fiscal years that coincided with calendar years. The 12 firms that did not report on a calendar-year basis were Apple, Bear Stearns, Dell, Home Depot, Lehman Brothers Holdings, Lowe's, Microsoft, Morgan Stanley, Oracle, Procter & Gamble, Qualcomm, and Walt Disney. For the earlier 1997-1999 period, we used data for the three fiscal years ending in calendar year 1999. For the later 2004-2006 period, we used the three fiscal years ending in calendar year 2007 (providing us with the most recent data available at the time of this article).