Tuesday, April 12, 2011

A Word About Corporate Taxes

There are people in the world who know a lot more about corporate taxes than I do. This isn't really saying much, because here's what I know about corporate taxes: companies pay taxes on their net earnings. That's about it. (And to be honest, I'm not really sure how accurate that statement is.) But there has been a lot of talk lately about corporate taxes, namely that some companies that make a lot of money haven't paid any income taxes. It's got me thinking: Why do corporations need to pay any income taxes at all? (Bet you didn't see that coming.)

Before you answer, let me share my thinking so that you know that I'm not completely insane. It seems to me that when a company makes money, it can only do one of four things with that money (there may be more, but I can only come up with four):

  1. Spend it to maintain or grow the business
  2. Keep it
  3. Give it to employees through wages or bonuses
  4. Give it to owners/shareholders through distributions or dividends
It is my understanding that option one makes the money non-taxable. Companies only pay taxes on net profits, so any earnings re-invested in the company are non-taxable.  (Please, somebody, correct me if I'm wrong.)

Option two allows the company to to build up a reserve, making it a stronger and more stable in the future.

Options three and four have the money passing from the company to actual people, all of whom presumably pay income taxes on that money.

So to recap, if a company doesn't pay income taxes, the only things it can do with the money is reinvest it, save it (both of which strengthen the company and presumably benefit the economy), pay it out in higher salaries, or pay it out in dividends (both of which give money to real people who pay income taxes on that money). Plus, if there is no corporate income tax in America, wouldn't that provide a huge incentive for companies to be based here (and bring  job with them).

I do see that it's possible that companies could be based here, even though all their employees or shareholders are actually not in America, but that seems pretty easy to fix. American companies can only avoid income taxes if at least 75% of their workforce and 75% of their shareholders are American, otherwise, you pay. Done.

So that's one take on the subject. Now you, many, many people who are much smarter than me, tell me where the holes are. (I am assuming there must be many, or there would be a lot more countries with no corporate taxes.)


Bernadette said...

Companies don't pay income taxes because they pass it on to the consumer. Just think of all the companies that would come to the US if we had no corporate tax. More companies, more jobs.

Big enough companies like GE pay millions to avoid taxes. It's estimated US companies have 13 trillion in overseas banks to protect it from the high corporate tax. Just think if corporate taxes were eliminated and 13 trillion was brought into our economy.

Fair Tax not only eliminates income tax, FICA, payroll tax but corporate tax too. Eliminating most of the IRS would save this country billions.

Tim said...

I agree with you on no corporate tax, but with some considerations...

If corps were not taxed then a person could set up a corporation and keep their money in it to avoid personal taxes. I would propose something more along the lines of allowing a corp to only retain untaxed as much money as their average costs of the previous X years (varying by sector).

A corollary is why are capital gains and dividends treated differently than regular income on personal taxes? A middle class family is more likely to receive bank interest (taxed at their wage income rate) than dividends or capital gains which are taxed much lower. Part of the justification for this is the double taxation of dividends, so in exchange for no corp tax the individual tax code should be changed to tax this income the same as wage income.

There may be some downside depending on the remaining corp filing requirements in that the government would have a harder time keeping track of businesses for the purpose of law enforcement. (money laundering, etc).

I'm not in favor of the fair tax/sales tax replacing income tax plan. I don't believe it would eliminate most of the IRS as there would still need to be tax enforcement and audits even of individuals. I can see how the poor can be subsidized to make it work for them. I believe the rich would pay less in tax, but I know that can be debated. The biggest problem I see is the transition. Imagine someone who is now retiring finding everything costs 30% more than they planned. The only way to make that fair would be to allow people to prove their money was already taxed so they could get their sales tax money back. That would be as if not more complicated than filing taxes today. It might start off being simpler but it would really just be a trade off the complexity of tax deductibles for the complexity of credits and rebates. I don't see why we can't just clean up holes in the progressive income tax system we have now.

rubyspikes said...

I originally bought into the idea of the Fair Tax. But I do think that when you get to the ultra rich level, there's just no way that Bill Gates is going to spend enough money. Unless he turns into Richard Prior from that 80's movie that I can't remember the name of.

But, Bernadette, you did remind me of a 5th option of where the money could go: lower prices for consumers! Very important.

Could a person set up a corporation and keep their money there to avoid personal taxes? Hmm. I guess, but if they ever wanted to spend it, they'd have to take it out and pay taxes then. So I guess it would become a 401k of sorts with no age requirement on when you take the money out.

I completely agree with you, Tim, that if corp taxes were eliminated, then dividends should be taxed at standard income rate.

Tax reform is tricky. Fair Tax is interesting, but possibly a little too regressive, if just for those folks at the VERY top not paying as much. Flat Tax has quite an appeal in the realm of simplification, but a Progressive tax seems more fair. It is just SO MUDDLED UP by the fact that it is used to both collect revenue to fund government as well as a tool to encourage or discourage actions in Americans, presumably to benefit the nation as a whole. But since those are very different goals, it's hard to keep it from becoming a complete mess.

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