For this week's podcast, Jeff Gerth and fellow senior reporter Jesse Eisinger take a moment to examine the nuances that help GE save millions when it comes to its taxes.
From overseas profits to utilizing the finance arm of its empire, GE has made the most of its assets to keep its tax rate low. And in the process, the company has attracted a lot of attention. In particular, Gerth notes that GE is motivated to keep its taxes low since its executive compensation is based on after-tax earnings.
"You really see the importance of a tax benefit and a tax department as a profit center, not only for shareholders in the share price but it can go down to the benefit of the management of the company as well," said Gerth.
Mike Webb: Hi, I'm Mike Webb, and welcome to the ProPublica Podcast. Last week, ProPublica's Jeff Gerth and Fortune's Allan Sloan published two pieces about General Electric and how they pay, or avoid paying, taxes. For this week's podcast, we asked ProPublica's senior reporter and New York Times' DealBook columnist Jesse Eisinger to talk to Jeff Gerth about his GE tax reports.
Gerth has twice been honored with a Pulitzer Prize, and he was an investigative reporter for the New York Times for nearly 30 years. What follows is an edited version of their podcast conversation.
Jesse Eisinger: Jeff, so my first question is GE has a very low tax rate, correct?
Jeff Gerth: Correct.
Jesse: And it had a very low tax rate for last year. What exactly are we talking about here? What is its tax rate?
Jeff: Well, the question sounds simple, but the answer is not so simple. They're a global corporation that they operate all over the world. Most of their profits are abroad. They obviously pay taxes in many, many jurisdictions, and they pay many forms of taxes. The question that's in the air for the last two weeks, in part because of the New York Times story, is how much taxes did they pay in the United States? And unfortunately, that question is essentially unanswerable unless you see GE's tax returns because there's no disclosure of what they actually pay in taxes to the IRS. The closest you can come to figuring this out is perhaps looking at what they pay in taxes in the aggregate around the world, but that includes sales taxes, payroll taxes in the United States, VAT taxes in Europe, etc.
Jesse: What do we know now about federal income tax, corporate income tax, in the United States for 2010?
Jeff: Well, we know this for sure that GE hasn't yet filed their tax return, and they have I believe up until September to do so. So the simplest answer is no one knows yet. The most approximate answer is that they expect, so they say, to have what's called a "small positive tax liability," which means when they check the line on the corporate tax form that's filed with the IRS, the number that they owe for taxes. Just like the number when you file your personal income tax returns, there's a number somewhere on the form on the 1040 that says what you owe.
Then of course you have to then figure out whether you've already paid enough payments to meet that. And if you paid more than that, you get some back or you store it up as a credit for future years. Of course, when they use the word "small" and don't define it, it's hard to understand what it can mean.
Theoretically, it could mean $10 or it could mean $100 million because for GE, a $150 billion corporation, $100 million is a small sum of money. But we don't know, and they of course haven't yet filed their tax returns.
Jesse: But I assume that what we do know is that, while the corporate tax rate in the United States is 35 percent, GE is not paying anywhere close to that.
Jeff: No, I mean if you take the 35 percent tax rate and applied it to whatever their earnings are that they report to the IRS, they're not going to be paying at that rate. And the explanation they give, and it's I think somewhat consistent with their publicly reported earnings, is that they had losses in GE Capital, which is the large finance arm that's part of GE and that was impacted like many other financial institutions. It's part of the financial crisis over the last couple years.
Jesse: Right, so GE Capital, which has produced in past years as much as half of their company's profits, popularly it's thought of as a company that does appliances and light bulbs, but in reality it's a giant finance company with some manufacturing operations on the side. Now I had a question about GE Capital, because if I understood it correctly, in recent years despite the financial crisis GE Capital has lost money in the United States but made profits overseas. Is that correct?
Jeff: First of all, I would correct you a little bit about GE and GE Capital. I think first and foremost GE is still a classic sort of industrial company, but there are no other industrial companies that have such a large finance arm attached to it. In the heyday of GE Capital, say three, four years ago, it was almost 50 percent of the profits. But these days it's significantly less, and GE has been cutting back the size and activity of GE Capital trying to put more emphasis on the industrial side. They're moving in that direction rather successfully, if you will.
So the reason why GE has more profits overseas is that they have a structure that allows them to, in essence, shift their profits overseas into lower tax jurisdictions. That comes through GE Capital because unlike other kinds of products finance products can be moved around easily. They're really just bookkeeping entries on paper.
On the other hand if you make a turbine or a jet engine, it's hard to make that in lots of different places and shift it around very easily. You need a huge plant and a lot of workers, etc. What you can say is that the depth and breadth of GE Capital and its ability to interact with so many pieces of the GE empire offers the company flexibility that's virtually unmatched in any other company like that in the world.
Jesse: Gotcha, but in general it's fairly common that big corporations have a much lower effective tax rate than the 35 percent, right?
Jeff: Yeah, I think that the studies I've seen show that in the United States the effective tax rate for corporations is about 10 percent less.
Jesse: So 25 percent instead of 35 percent.
Jeff: The actual tax rate of 35 percent is different than what people wind up paying in taxes, and that's because of all the different exemptions and special provisions that exist for different kinds of businesses and different kinds of transactions. And GE, of course, takes not only maximum advantage of them. But I think to go back to the overriding salient point here, it's because of the diversity of the company. It can not only get all the benefits that a manufacturing company gets that includes like accelerated depreciation and other things, R&D credits that IBM and companies like that get. But it then has the finance arm that allows it to get another set of exemptions and special provisions that might only be available to banks or insurance companies, and so it gets the best of both worlds.
Jesse: And its tax department has expanded dramatically in the last 20 years and really become a profit center, correct?
Jeff: Yes, it's not only expanded. It was about 250 around 1988 when John Samuels, who's the current head of the tax department, came to GE. But it also has become more centralized. When Samuels joined the company, there were tax...
Jesse: He joined from the treasury, correct?
Jeff: No, he joined from a law firm, Dewey Ballantine. He had been at the treasury in the 1970s in the Carter Administration. He had been a treasury tax official. Since he's been there, the tax function has become centralized so there is a tax department per se‑‑not tax people in different parts of the GE corporate structure. He reports to the CFO, the Chief Financial Officer, of the company. So I think in some ways, this is the most salient aspect of the reporting. The overseas deferral of income gives companies like GE the opportunity to make different decisions depending upon the circumstance. As a result they can book a tax benefit or book a tax liability for profit purposes.
And we point out in the piece that in 2008 and 2009 when GE was obviously under duress and looking anywhere for profits, they reversed and changed positions on some money they had abroad and how they were going to treat it for tax purposes. It resulted in a billion‑dollar‑plus increase in their profits those two years, which was a nice time to have that happen.
Again, none of this really impacts what they wind up paying the IRS because they never paid the IRS in the first place. But they had set aside a provision for taxes on their accounting books. Therefore by reversing that, they were able to create a tax benefit on their books and thereby have this billion‑dollar increase in profits ‑‑ all really in essence just a bookkeeping maneuver that had no impact whatsoever on what they actually paid the IRS.
Jesse: But it looked better for shareholders.
Jeff: It looked better for shareholders. Not coincidentally, or certainly it's worth pointing out, that GE, like a minority of companies, bases their executive compensation on after‑tax earnings. So their managers from Jeff Immelt on down, their bonuses and their compensation is based on how they do after tax.
Jeff: You really see the importance of a tax benefit and a tax department as a profit center, not only for shareholders in the share price but it can go down to the benefit of the management of the company as well.
Jesse: Huh! So a lot of companies base their compensation on the operating earnings, which is before things like taxes, and GE is the opposite.
Jeff: We found a Ph.D. study that was done recently that estimated that about 25 percent of companies use after‑tax earnings as a basis, and the rest use before tax or just, as you said, operating earnings.
Jesse: So last question. Nobody's alleged so far that GE's done anything illegal with regard to its taxes. Is that correct?
Jeff: Well, they're in a series of tax disputes around the world, including one still kicking around in the United States.
Jesse: With the IRS?
Jeff: Yeah, the IRS has accused them of doing something in Bermuda that amounts to a tax shelter, and GE is contesting it. It's been through courts in Connecticut and then the courts of appeal. There have been findings on both sides. The district judge in Connecticut sided with GE, and the court of appeals sided with the IRS and said it was a shelter and it was abusive. The case is back again before the court of appeals. But that's a civil case, so obviously there's no allegations we're aware of that they engaged in any criminal tax evasion.
Jesse: All right. Thanks, Jeff.
Mike: That was Jeff Gerth and Jesse Eisinger. You can read the GE tax stories at ProPublica.org. Now for the Officials Say the Darndest Things Quote of the Week. Here it goes: "We may not in this room have tiger blood like he does. But we do have something else in common with him: There's going to be a lot of winning on the Republican side. If this was a Lady Gaga song, the relationship between the youth vote and Barack Obama would be 'Bad Romance.'" Who said it? Former Minnesota Governor and Republican presidential hopeful Tim Pawlenty, making pop culture references at a recent speech in Iowa.
OK, thanks to Minhee Cho for producing this podcast and to you for listening. For ProPublica, I'm Mike Webb. We'll see you next time.
Transcription by CastingWords