In the first two parts of this series, I explored ways to create substantial increases in tax revenues to be paid by America’s wealthiest families.
An examination of much-needed tax reform would not, however , be complete without an overhaul of the U.S. corporate tax system. There are at least two major changes that are needed.
The first pertains to corporate tax rates, while the second is based on eliminating the huge difference between accounting income and taxable income.
I believe that former President Trump’s decision to decrease corporate tax rates across the board to all corporations is much too generous, in that it provides the greatest benefit to the wealthiest Americans. The current corporate federal tax rate on business income is 21%- even for large profitable companies, This is lower than the 22% federal tax rate that applies to individuals on taxable income over $40,000.
I recommend keeping the small business corporate tax rate at 21% on the first $250,000 of annual active business earnings of private corporations but not public companies, as long as the after-tax profits are reinvested for business growth. I would tax excess profits of small businesses and all public corporations at a 33% rate.
I must stress that, to qualify for the private company tax rate on up to $250,000, the after-tax income would have to be used to expand the business and not to make passive investments (stocks or rental properties etc.) on behalf of the owners. There is already a set of rules in the Internal Revenue Code that allows the I.R.S. to impose an “Accumulated Earnings Tax” that applies to excessive retained earnings that are not used for business expansion, so no changes would be needed to enforce the penalties on passive investments.
As is the case today, if a business earns income from providing services, my suggested tax benefits would only apply if the private corporation were truly carrying on an active business and is not being used to mask or tax-shelter employment income.
Now, let’s tackle the issue of huge discrepancies between the accounting profits and taxable income of many of our largest public corporations.
Recently, I read an article published be the institute on Taxation and Economic Policy (www.itep.org) entitled “55 Corporations Paid $0 in Federal Taxes on 2020 Profits”. The article highlights the major loopholes that were employed to attain this result.
Collectively, these corporations generated $40.5 Billion in U.S. pre-tax income. At 21%, they would have paid $8.5 Billion in taxes. Instead, they received $3.5 Billion in tax rebates. If the tax rate had been 33% ( as I suggested above) their collective tax bite would have been over $13 Billion.
Some of these companies are household names: Consolidated Edison, FedEx, HP and Nike, just to name a few.
The ITEP article details some of the tax avoidance mechanisms they used. These include:
1.The write-off of expenses related to stock options
- Claiming Federal research and experimentation credits
- Claiming renewable energy credits
- Taking advantage of accelerated depreciation
Implementing wholesale tax changes would be, in my opinion, an unrealistic expectation- especially given the political differences in our times. There is, however one really easy fix.
All that is needed is a simple set of rules whereby all public companies (even those that trade over-the-counter) would be required to pay taxes on the greater of their accounting income and their taxable income.
If over a period of time a corporation’s cumulative accounting income exceeds cumulative taxable income, and their taxable income eventually begins to exceed their accounting income, credits would become available to reduce their future taxes.
Frankly, I am cynical enough to believe that few profitable companies would ever be in the position to receive credits. This is because big businesses usually try their hardest to maximize reported accounting profits in order to increase the trading value of their shares.
There are many other revenue-producing tax changes that could be introduced to reduce complexity and/or enhance fairness.
For example, financial organizations (both public and private) use complex mathematical algorithms and high speed computer power to trade stocks and commodities, taking advantage of even small market fluctuations during a single day. I believe that the U.S. tax system should impose a special tax of around 10% on each year’s profits from day-trading activities.
I believe that, while President Biden’s initiatives carry a hefty price tag, there are ways that the costs can be shouldered by those with the ability to do so. Let’s start by thinking outside the box.
Latest Developments
Yesterday, the Biden government unveiled a series of proposals designed to pay for a substantial portion of his new expenditure program. As I feared (but expected), essentially, all they did was tinker with tax rates for the wealthy. Was it a case of incompetence or was it because of the risk inherent in offending large donors, or both?
The tax proposals totally ignored the points I raised in Part 1 of this series explaining how the very wealthy are often able to manipulate their taxable incomes and can easily reduce them to zero by simply living off large loans secured by their much larger investments. As I said, whether the tax rate is 40% or 90%, when one multiplies by zero, the result is zero.
The administration backed off from imposing a wealth tax because of the difficulty in determining ongoing values before a sale takes place. However, they also made no attempt to eliminate and replace estate and gift tax rules that are ineffective and unwieldly. My suggestion in Part 2 of this series that the capital gains rules be expanded to include the concept of “deemed dispositions” in lieu of estate and gift taxes is a concept the administration obviously knows nothing about, although the deemed disposition rules have worked well in Canada for the past 49 years.
The proposals to impose higher tax rates on corporations continue to ignore the differences that I stressed here in Part 3 of this series between public companies and private (family-owned) businesses. More significantly, it seems that the administration does not seem to be aware that many large (public) corporations showcase huge profits on their financial statements but report zero taxable incomes. It’s hard for me to imagine that nobody else has ever said “Why don’t we consider accounting profits and not just reported taxable income?”
So, while the super-rich are no doubt guzzling champagne this morning, I’ll stick to my black coffee!
