July 28, 2021

Economix Blog: Kissing Away the Corporate Tax

My column on Wednesday startled some readers. Was I proposing to do away with corporate taxes simply because globalization is making it easier for multinational companies to avoid them? Should we really just roll over and accept defeat?

Well, other advanced nations seem on their way to doing exactly that.

They have found a way of reducing corporate tax rates that improves economic efficiency, lowers the cost of capital for their companies and may even increase the progressivity of their tax system: offsetting those lower corporate rates with higher tax rates on the income that companies provide to their shareholders.

Since 2000, the top corporate tax rate in Britain has fallen to 23 percent, from 30 percent; in France it has receded to 34.4 percent, from 37.8 percent, and in Denmark it has declined to 25 percent, from 32 percent, according to data from the Organization for Economic Cooperation and Development.

Source: Organization for Economic Cooperation and Development

Many of these countries have compensated for lowering the corporate rates by taxing dividends more. Over the same period, the dividend tax rate rose to 30.6 percent in Britain, from 25 percent; in France, it went to 44 percent from 40.8 percent, and in Denmark it rose to 42 percent from 40 percent. Most industrial countries have also eliminated exemptions to prevent double taxation of dividends.

The United States has rowed in the opposite direction. Companies complain, rightly, that the corporate tax rate in the United States is too high compared to those of its peers: 39.1 percent, combining federal and state taxes – virtually the same as it was 13 years ago. But they rarely mention that the tax on profits flowing to shareholders has fallen drastically.

Even after the New Year’s budget deal raised taxes on the highest earners, the 20 percent top rate for dividends and long-term capital gains remains much lower than in the 1990s — when the top capital gains tax was 28 percent, and dividends were taxed as ordinary income.

A paper published a couple of years ago by Rosanne Altshuler of Rutgers, Benjamin H. Harris of the Brookings Institution and Eric Toder of the Tax Policy Center suggested that the American mix is particularly inefficient.

Because American corporate tax mostly falls on domestic profits (foreign profits retained abroad pay no tax), it raises the cost of domestic investment and encourages companies to invest abroad. It also encourages them to seek out low-tax havens around the world to park their profits. And it encourages companies to shed their corporate status to avoid the tax altogether.

The Altshuler-Harris-Toder paper suggests that reducing the corporate tax rate and increasing taxes on dividends and capital gains would be a much more efficient way to raise money.

Their calculation — which is only rough because it assumes no change in the behavior of companies or their shareholders — suggests that raising the top tax on long-term capital gains to 28 percent and taxing dividends as ordinary income (which faced a top rate of 35 percent at the time of the study) would raise enough money to pay for a cut in the federal corporate tax rate from 35 to 26 percent.

But the most interesting bit of the study is their finding that these changes would make the tax structure more progressive – increasing the tax burden on Americans with the highest incomes. That’s because the rich would bear the brunt of the increase in the dividend and capital gains tax.

Even assuming that shareholders bear the entire burden of corporate taxation — an assumption that is being questioned in the economic literature — the change suggested by the economists would lower the average federal tax rate of everybody except the top 1 percent of Americans, who would suffer a tax increase of 1 percent.

Under a different assumption — that corporate taxes are mostly paid by workers because of the impact of the tax on investment, jobs and wages — the progressivity would be steeper. In particular, those in the top percentile of income would see their taxes rise by 1.8 percent.

So getting rid of corporate taxes — or at least reducing them substantially — may not be such a bad idea. The tax burden would just have to be shifted from the companies to their owners.

Article source: http://economix.blogs.nytimes.com/2013/05/31/kissing-away-the-corporate-tax/?partner=rss&emc=rss

Wealth Matters: Coping With the New Tax Law, Even for the Richest of the Rich

Many millionaires are certainly paying at least 30 percent of their income in taxes, a goal President Obama set out in last year’s State of the Union address. But they’re more likely to be doctors, lawyers and people working in the financial services industry who get the bulk of their earnings in the form of paychecks.

Partners in private equity firms and hedge fund managers, on the other hand, earn much of their money as a share of their funds’ earnings. And that income gets preferential tax treatment as so-called carried interest.

A similar special tax treatment still holds true for Mr. Buffett as long as the bulk of his income comes from his investments and not a paycheck. The long-term capital gains rate for incomes over $400,000 is 23.8 percent, including the Medicare surcharge. That’s a far cry from the top marginal tax rate on income above that amount of 40.5 percent, which includes a 0.9 percent Medicare surcharge on earned income.

How are people going to react to all of this? Here is advice and observations from some experts in wealth management:

INCOME ISSUES This year, income taxes are going up for almost everyone, even if the taxes go by different names. Greg Rosica, a tax partner at Ernst Young and a contributing author to the firm’s tax guide, laid out five tiers where taxes are increasing.

The bottom one includes everyone who receives a paycheck and is affected by the 2 percentage point increase in the payroll tax. In the top one are couples making more than $450,000 a year who will pay higher rates on income and investments, be subject to the Medicare surcharges of 0.9 percent on income and 3.8 percent on investments and lose some portion of their itemized deductions and exemptions.

Using assumptions on wages and deductions from Internal Revenue Service statistics, Mr. Rosica calculated that a person making $500,000 a year would pay $9,124, or 7 percent, more in taxes in 2013. A couple earning $1 million a year in wages and business and investment income would pay $53,350 extra, or 20 percent more in taxes.

“It’s hitting every line item of income,” he said. “It’s phasing in all the way up the scale.” This has made strategies that defer income more attractive than they were in the years when George W. Bush was president and tax rates were historically low. “At the base level, it’s 401(k) plans. Or, for the self-employed person or person who sits on boards, they can defer into a SEP I.R.A.,” a retirement plan for the self-employed, or into one’s own defined-benefit plan, said Christopher Zander, the national head of wealth planning at Evercore Wealth Management. “That’s very attractive. Even if income tax rates are higher later, I think the tax deferral” makes up for that increase.

There are risks, though. People could defer too much into a qualified plan, like an I.R.A., and end up having to pay a penalty if they need the money before they turn 59 1/2 years old. Or they could put too much into a company-sponsored deferred-compensation plan and face two problems. The company could go bankrupt, as Lehman Brothers did, and they could lose that money, or the payout schedule they selected when they put the money in — say 10 annual payments at retirement — may end up providing them with too much or too little income.

CARRIED-INTEREST CONUNDRUM At the very top of the income ladder, the group for whom the changes in the tax code will not hurt as much includes people like hedge fund managers and private equity partners whose earnings come in the form of carried interest. The income for these people comes from the fees they charge and that income will continue to be taxed at a lower rate than ordinary income.

“Carried interest rules are helpful for hedge fund managers, but they’re incredibly helpful for private equity guys,” said Richard A. Rosenberg, a certified public accountant and co-founder of RR Advisory Group, which advises hedge fund and private equity partners. “Private equity funds typically get the stronger treatment because there is less turnover and the holding periods of the funds are longer.”

How the partners’ share is taxed depends on how the underlying investments are taxed. In the case of private equity, many of the investments are held for longer than a year. Through last year, the distributions would have been taxed at the long-term capital gains rate, which was 15 percent. Even now, the rate is still a relatively low 20 percent for an individual earning above $400,000.

Article source: http://www.nytimes.com/2013/01/12/your-money/taxes/coping-with-the-new-tax-law-even-for-the-richest-of-the-rich.html?partner=rss&emc=rss

High & Low Finance: Investment Income Hasn’t Always Had Tax Advantages

Whatever happened to “unearned income”?

That used to be the normal term for income from investments — dividends, interest and capital gains.

For some, that term produced images of “coupon clippers,” another term you don’t hear much anymore. The coupons in question were not the kind that get you 25 cents off on Jell-O at the grocery store. They were the ones that came attached to bonds in a precomputer age. To get your interest payment every six months, you literally had to clip off the coupon and take it to your bank.

More than half a century ago, when President Dwight D. Eisenhower proposed taxing dividends at lower rates than wages, Representative John W. McCormack, a Massachusetts Democrat who later was to become speaker of the House, was outraged.

“The Republican tax bill is indefensible in that portion which gives great benefits to corporations and constitutes a bonanza to stockholders, the larger ones in particular,” he said in 1954. “It is unjust and in my opinion morally wrong to make a person with earned income pay considerably more in taxes than persons with unearned income from dividends.”

That tax fight ended with a benefit for small shareholders, who would escape tax on the first $50 a year of dividends. But annual dividends above that amount remained fully taxable at ordinary income tax rates, which ranged up to 91 percent. Mr. Eisenhower’s proposal to cut the rates on such payouts was rejected.

Not until 2003 were dividend tax rates reduced below ordinary income tax rates. Then they were cut to 15 percent, the same as the capital gains rate.

For most of the history of income taxes in America, long-term capital gains — defined at different times as investments held for minimum periods of as little as six months and as long as 10 years — have been taxed at substantially lower rates than top ordinary income tax rates.

There was, in fact, only one time that capital gains were taxed at the same rates that were paid by people who earned their money by working. That was during the years 1988 to 1990, as a result of the Tax Reform Act of 1986 — a law championed by President Ronald Reagan.

To be sure, he changed his mind about unearned income in 1988. After Vice President George H. W. Bush, then campaigning to succeed Mr. Reagan, endorsed lowering capital gains taxes, the president allowed that might be a good idea. Mr. Bush and the Congress did lower them after he was elected.

These days, the conventional way to look at taxes on investments is to think they should be low to stimulate investment and thus help the economy. It is a view that has much more support in economic theory than in economic history.

Correlation is not causation, of course, but the economy has tended to do the best when taxes on unearned income were high. Economic growth was great during the 1950s, when dividends were taxed at very high levels and capital gains rates were 25 percent, much higher than they are now. Since 2003, tax rates on unearned income have been at their lowest levels ever, and economic growth has been sluggish.

Tax rates are not the reason for that, at least not directly. But it could be argued that low tax receipts now are having a pernicious impact, particularly on state and local governments. Their layoffs have been a drag on the recovery, and the declining quality of infrastructure in many areas has hurt many businesses. If the federal government taxed unearned income anywhere close to historical averages, there could have been a lot more tax money available to help out when the credit crisis hit.

There is no question that tax policy has had a major impact on investment, but its impact probably has been less in the overall level than in the allocation of investments.

Corporate profits, at least theoretically, are taxed twice, once when the company earns them and again when shareholders are taxed on their dividend payments. But interest payments to bondholders are deductible to the corporation, unlike the dividends it pays to shareholders. As a result, there has been an incentive to finance companies with as much debt, and as little equity, as possible. That maximizes return on equity in good times, and allows companies to plausibly claim they will raise profits much more rapidly than sales. But it also makes bankruptcies more likely when the economy falters. The Eisenhower tax policy that outraged Representative McCormack was intended to reduce that incentive a little, by reducing slightly the rates on dividend income. Had it passed, it probably would have had little impact.

Article source: http://feeds.nytimes.com/click.phdo?i=15211d32b2d96fbce8ecbc74fb295833

Why Some Business Owners Think Now Is the Time to Sell

At the time, however, she was not emotionally ready to part with a business she had started in 1997 and built into one of the largest suppliers of services to television crews and casts in Los Angeles. When her husband suggested selling, “I burst into tears and looked at him as if he were telling me to cut off my arm,” Ms. Finkle said. “Then everything changed, and I realized he was right.”

But the recession hit, and Ms. Finkle’s annual revenue dropped sharply along with declining television advertising and production budgets — making it impossible for her to sell. “I’ve had to work really hard the last three years to save my company and get it back, a lot of times working for free,” she said. “It was no longer about building it, it was about keeping it going until things got better.”

Revenue for 2011 is finally back to 2008 levels, about $1.2 million, and Ms. Finkle is eager to sell. For one thing, she purchased another business, an art studio aimed at children, backed in part by a loan from the Small Business Administration. Moreover, the coming expiration of the Bush tax cuts means that by the end of 2012, the long-term capital gains tax rate will increase to 20 percent from the current 15 percent (unless Congress passes legislation extending the lower rate).

Failing to sell before the end of 2012, she said, could cost her tens of thousands of dollars, “and knowing that motivates me to sell in 2012.”

Ms. Finkle is not the only small-business owner looking to the new year as an opportune time to sell. There is a pent-up pipeline of owners who have had to put off selling in recent years because of the economy. And now that many of these companies have at least one year of profits on the books, they are more attractive to potential investors.

“A lot of these companies are having record profits because they reduced their overhead in the downturn and now sales are coming back,” said John D. Emory Jr., chief executive of Emory Company, a Milwaukee-based investment banking company that specializes in selling businesses with $10 million to $100 million in annual revenue. “A lot of owners have told me they want to start a sale process in the first half of 2012, hoping to complete the sale before the end of 2012. Many owners, especially the leading edge of the baby boomers, wanted to sell in 2008, 2009 or 2010 and would have sold in those three years had the economy stayed strong.”

Those looking to sell are taking steps to appeal to buyers: trimming costs, diversifying revenue, upgrading financial statements and making the chief executive’s role less essential. And they are braced for the sales process to take longer than they would like.

For most owners, the business represents their largest asset, and taxes constitute their largest single expense, said Mackey McNeill, a certified public accountant in Covington, Ky. “The ability to negotiate the best possible selling price and to minimize taxes determines the owner’s financial fate,” Ms. McNeill said.

To illustrate the impact of the expiring capital gains tax cut, Ms. McNeill created hypothetical companies that would sell for $5 million and $10 million each, assuming typical values for equipment, depreciation, real estate, inventory and good will. According to her calculations, and assuming Congress does not act, the owner would save $150,000 in taxes by selling a $5 million company in 2012 instead of 2013. For a $10 million business, the savings would be $325,000. These assumptions cover both S corporations and limited liability corporations, Ms. McNeill said. They would not be valid for a company operating as a C corporation.

The tax savings are an important factor in Joel Lederhause’s quest to sell a majority stake in DiscountRamps.com, a retailer of loading, hauling and transport equipment based in West Bend, Wis. “We won’t continue to grow 15 to 20 percent a year unless we have some outside capital influx,” Mr. Lederhause said. “We want some money to go into the company to accelerate its growth, and take a portion of our sweat equity off the table.”

The company, which projects $22 million in sales this year, keeps about $6 million in finished goods in its warehouse, which limits its growth potential. DiscountRamps.com offers 11,000 different products, and keeps at least one of each item in stock. With an infusion of capital, Mr. Lederhause said, the business could grow to more than $100 million in five years by expanding its product lines into promising new markets.

Article source: http://feeds.nytimes.com/click.phdo?i=92965a9f2de5b751ebf17ae4f595ab20