Tax reform grand bargaining

So everyone is prattling away with their grand bargain ideas on tax reform, etc. so I will re-up the basic idea at the heart of the tax reform I proposed in my book Balancing the Budget is a Progressive Priority:

  • A tax reform that resulted in fewer rate brackets: 12, 22 and 28 were the marginal rates proposed by the Fiscal Commission that could be obtained with a capping of deductions and exemptions (you could substitute the Romney notion of a general cap, or we could pick winners and losers; this post has examples).
  • Ending the corporate income tax and
  • Raising the top personal income tax rate above the 28 percent noted above while making dividends and capital gains normal income. I am unsure of how much higher the top individual rate should be raised, and there would obviously have to a full reform of the individual tax code to keep individuals from becoming corporations and being very creative about avoiding tax (the general idea would work with whatever the top individual rate would otherwise be)

Of all the topics my book covered, what to do about the corporate income tax is the one that I most changed my mind about as I researched and wrote. I began by thinking that we needed to reduce exemptions and drop the marginal corporate rate (now 35%) to increase such receipts (standard broaden base, raise rates, increase receipts while incentivizing business). However, the truth is that very few corporations pay 35%, and so dropping the rate but ending deductions and exemptions would likely be a tax increase on many corporations, and certainly the most powerful who have essentially negotiated effective rates that are very low (or 0 in some cases). The more I have read the less convinced I am that corporations can effectively be taxed in practice.

Most of the wealth (but not all) flowing from corporations is going to flow to persons in the top marginal personal income tax bracket, and making dividends and capital gain normal income is a more efficient way to tax these flows. Some libertarians and conservatives have said as much before, and I think they are correct.

The thing that really changed my thinking was how small a proportion of the total federal tax receipts (between 10-13%,or ~ 2% of GDP) that the corporate tax has produced the past 30 years.

Ending the corporate tax, raising the top individual rate above what it otherwise would be, while making dividends and capital gains normal income seems to be a more efficient way to collect revenue than the strange dance that is the corporate income tax code we now have.

cross posted at freeforall.

Author: Don Taylor

Don Taylor is an Associate Professor of Public Policy at Duke University, where his teaching and research focuses on health policy, with a focus on Medicare generally, and on hospice and palliative care, specifically. He increasingly works at the intersection of health policy and the federal budget. Past research topics have included health workforce and the economics of smoking. He began blogging in June 2009 and wrote columns on health reform for the Raleigh, (N.C.) News and Observer. He blogged at The Incidental Economist from March 2011 to March 2012. He is the author of a book, Balancing the Budget is a Progressive Priority that will be published by Springer in May 2012.

22 thoughts on “Tax reform grand bargaining”

  1. If the only recipients of corporate income were wealthy taxable individuals, I would also be unreservedly in favor of eliminating the corporate tax, and making it up at the top marginal rate. But many recipients are untaxable: especially endowments. Eliminating the corporate tax would transfer wealth to these non-taxable recipients–which already figure into the tax planning of wealthy individuals. Many endowments do very good work, although few of them are in the direct wealth redistribution business. And do business school endowments really need more juice? An alternative to eliminating corporate taxes would be to eliminate the multiple sets of books, at least for public corporations. What’s good enough for the investors is good enough for the tax man.

    And if you want to eliminate strange corporate tax dances, you probably also want to get rid of capital gains recognition treatment for investments in public entities. Public entities already have mark-to-market prices–treat ordinary changes in this pricing as ordinary income or loss, rather than allow investors to defer until death do them part from taxation. (Section 1014 of the IRC, which should also be repealed in any sane world.)

    1. I strongly agree that calculating taxes based on the GAAP income public companies report to the SEC would be an improvement. Among other things, it would get rid of complaints about the complexity of corporate taxes. They have to report to the SEC anyway, so figuring taxes is a trivial additional task.

      1. It’s not just a matter of simplicity, but also of public policy. Any time you get to keep multiple sets of books it becomes unlikely that any of them present an accurate picture.

        The other side, though, is that the corporate tax (potentially at least) offers a point of leverage on corporate behavior that mere regulation and suasion don’t. But perhaps that can be done without making the preferences about reported net income. Maybe even better.

  2. I agree with much of what Mr Taylor proposes but also agree with caution of the partner of Jacob Marley, the motivation to incorporate oneself or some other chicanery would intensify.

    Back in the 80’s and early 90’s, when inflation and Gordon Gecko corporate raiding were the great bugaboos, I proposed that capital gains be taxed as income but a with a deflator or depreciation for inflation, which would only apply in the following year to discourage rapid turn over of investments [little did I dream that the rapidity of trades would reach the point that it was limited by the value of c.] A Tobin tax would work better now for financial instruments but the mechanism does elegantly handle home-owners capital gains. My other proposal for the Geckos of this world was that corporations be taxed on retained income instead of income, with provisions favorable to long term reserves tied tightly to capital and R&D investment.

    At the time, the capitol gains as income minus deflator was a Democratic position that was not revived under Clinton.

    While we are at it, a just slightly revenue positive carbon tax with graduated refunds to the lower 60% of incomes would be nice.

    1. I agree about a carbon tax….and you are correct that a tax reform of the individual code would be needed to address “chicanery” related to making oneself a corporation, loaning yourself money, forgiving the loan, etc.

      1. Why should it be ‘slightly revenue positive’? Carbon tax discourages carbon use – what’s not to like? Make gasoline 3x current price, you have a lot of money which can allow you not to tax income more (the more you tax income, the more you discourage work) and you encourage car pooling. It’s all good!

        1. One reason might be that we need more revenue, so it’s not a bad idea to tax carbon, instead of something else, to get it.

    2. I didn’t realize somebody else had the inflation-adjusted normal-rate idea for capital gains and interest. It has another advantage, in that it’s anti-cyclical compared to our present system. To avoid unnecessary hassle, registration of investments for this inflation-adjustment should be optional. Registered investments should have a wealth tax- say 0.5%- less than the top marginal rate times the typical inflation rate. Most people would just see simplified taxes and could ignore the whole thing. Major investors would have incentives to register and would be taxed at higher rates than now, but in a fair and anti-cyclical fashion.

  3. Gnerally agreed, but why reduce the number of rates? As has been pointed out, the actual tax computation from income (the only part the rates apply to) is very simple,
    it’e getting to the income that’s hard.

    There may be arguments for different rates for long-term capital gains, but I can’t think of one for dividends (aka “unearned income”), except to comfort the comfortable.

    1. I am not stuck on the number of rates…my main point would be to raise the top one (whatever it was based on the system going forward) and then undertake the other changes.

    2. the principle of lower tax rates on dividends is to encourage people with extra money to put it into something that may be productive but that may also be risky, by providing that the income from the productive/risky investment gets a tax break compared to the income from just putting the money in the bank and drawing interest. Whether that principle is right or justifies the rules that flow from it is a different question, but it’s not just to ‘comfort the comfortable’.

      1. Actually, I think it’s based on the “double taxation” argument. Dividends are paid out of after-tax earnings. Hence, the argument goes, any tax on them imposes a second tax on money that has already been taxed once. Not only is this unfair, it leads to inefficiency because it cause firms to retain funds and invest them internally less than optimally, seeking capital gains, rather than paying them out and letting the recipients use them more wisely.

        Of course many things, like the employee portion of payroll taxes, come out of after-tax income, so the fairness argument is not very compelling. As for the efficiency argument, well, it sounds nice.

        I don’t think risk is much of a factor. Debt securities carry risk also, and the way risk is dealt with by financila markets is that they generally demand higher expected returns on systemically riskier investments.

        1. I think this “double taxation” issue is hogwash, generally trotted out by people who (suprise!) want to avoid paying taxes. If there were a perfect symmetry between a corporation’s profits and its dividends, the argument might be slightly more persuasive, but the connection between the two can be tenuous indeed. And besides, how is taxing income that has been taxed somewhere else in the economy unfair in itself? When I hire a plumber to fix my toilet, I then pay her out of my own income that has already been taxed. Should plumbers be exempt from the income tax? When I buy dinner at a restaurant in Washington, I use that same already-taxed income to pay for it, and then pay 10% sales tax on top of that. Is the sales tax inherently unfair?

        2. If people were taking the efficiency argument seriously, they wouldn’t object to increases in the capital gains rate for stock sales to a level that would discourage excess retained earnings.

          The double-taxation thing is of course baloney — all it does is set up additional special rights for corporate persons.

        3. Of course, as Don suggests, eliminating the corporate tax entirely destroys the arguments for preferential rates for dividends and capital gains. The problem is getting the numbers to add up. In 2008, the last year that seems to be available, the IRS collected about $200 billion in corporate income tax. Reported qualified (taxed at 15%) dividends were $159 billion, so even raising the rate from 15% to 40% only makes up $40 billion. The capital gains figures as reported are a little unclear, but don seem to offer the prospect of making up the difference.

          You can find the statistics, and many others, at the IRS site.

  4. If low taxes created jobs, we’d be awash in jobs. More jobs than people, but No! Look around at our economy; there are plenty of toasters of every kind in stores; what’s missing is not another foreign toaster factory, but someone with a job able to buy said toaster.

    To push corporations into being better citizens, and more involved, I propose a 100% corporate income tax. First, what is a corporation for? It’s an investment vehicle and a mechanism for delivering product/service ideally with a profit. The corporations operate unimpeded; deducting all costs including business taxes, expenses, and employee pay and ancillary costs. They can pay their CEO anything they want, and pay any dividend they want. Then allow a 5 year tax-free revolving unlimited cash ‘slush” fund that hopefully would be used for growth/infrastructure/investment. Whatever is left is taxed 100%.
    This pushes cash out into our economy. Money spread out by expense, pay, dividends, and taxes are the power that our economy needs. Give the businesses a 5 year strategic reservoir, then push the rest out into our economy. If they hate taxes, the companies could either pay out more in wages and/or dividends, or lower prices.

  5. Suppose I am the sole owner of a business which (under Taylor’s proposal) doesn’t pay income tax. And suppose I spend a bunch of money each year on political contributions. It seems to me that I could avoid paying tax on the money I spend on political contributions by the simple expedient of having my corporation make the political contributions. I don’t see any way to close this loophole that’s consistent with the Citizens United decision.

  6. How do you deal with the issue of small business or wealthy individuals gaming the system with trade-offs between personal and corporate taxes? Simple example: I operate a business that generates 500,000 in net income every year. As a proprietorship or S-corp that income is taxes at personal rates. As a C-corp the income is at corporate rates. Depending on the tax regime of the day, I switch between the two ways of doing my business. It would seem you either need a complex set of rules to prevent this or comparable tax rates on both business organizations.

  7. The Fiscal Commission proposed nothing. It failed to produce a report. Its co-chairs would like their own ideas to have the imprimateur of the Commission but they don’t have any more official standing than mine.

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