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New York Daily News

 

A Better Way To Tax Corporations

June 12, 2012

By Luigi Zingales

Here’s one reform that can satisfy both parties

The U.S. is the developed country with what is, at least on paper, the world’s highest corporate tax rate. The list of economic distortions this creates is nearly endless.

A high corporate tax rate discourages business from incorporating and locating in the U.S. It favors the diversion of profits toward countries with lower rates, like Ireland. It often encourages interest expense deductions and unsustainable borrowing by businesses. Finally, it encourages corporations to exert significant effort in lobbying for tax exemptions and loopholes. This generates a very unfair outcome: Large, politically powerful corporations pay a much lower effective tax rate than smaller ones.

In spite of all these problems, the corporate tax rate has remained high — in part because the deficit crisis makes it politically costly to push for a reduction in any tax. Furthermore, the growing attention on income inequality and the rising resentment of large corporations’ political power make it very politically costly to push for this agenda, even for Republicans.

Yet a simple solution exists that can achieve the goal of a substantial reduction in corporate tax rates while addressing all the above concerns. To understand it, we must first appreciate the fact that there are two layers of taxes levied on corporate income: a dollar of profits is taxed 35 cents at the corporate level, and then another 9.75 cents (a 15% tax on the remaining 65 cents) when it is distributed under the form of dividends or realized as capital gain.

This double layer of taxation is mostly a vestige of a distant past when it was difficult to assess taxes at the individual level. Taxing corporations was much more efficient because large corporations were easier to locate and audit.

Today, the problem is reversed. While from a technical point of view, it is almost as easy for the IRS to tax the income of an individual as that of a corporation, from a political point of view, it is much easier to resist the lobby of a few individuals than that of very large corporations. These corporations stand to gain so much from tax loopholes that they are willing to spend vast sums on lobbying — an option not available to most individuals.

For example, in 2003, Tyco paid lobbyist Jack Abramoff’s firm $150,000 a month to fight legislation aimed at subjecting the company, which had reincorporated in Bermuda, to U.S. corporate taxes. The proposed legislation would have cost the company about $4 billion. The legislation failed; Tyco’s strategy succeeded.

Or consider the American Jobs Creation Act of 2004, which allowed U.S. multinationals a one-time opportunity to bring home foreign earnings, paying taxes on only 15% of this repatriated income. A study finds that the 93 public firms engaging in lobbying for this provision spent $282.7 million on their persuasion — and won $62.5 billion in tax savings. That’s a 220:1 return on investment.

The simplest solution to this problem is to move most of the burden from the corporate level to the individual level. If corporate taxes were just 15% and dividends and capital gains were taxed at the personal tax rate (35%), the total amount of taxes paid on a dollar of corporate profits would not change.

Yet there will be several advantages. First, small corporations struggling with liquidity problems will see their cash flow increase — and so will their investments and hiring. Second, corporations, which are highly sophisticated at lobbying, will find it less profitable to do so, reducing the creation of tax loopholes. Last but not least, all personal income will be taxed at the same rate, eliminating tax arbitrages among different forms of income.

This swap would also have an extra benefit: to make tax returns like Mitt Romney’s less politically controversial. Most of Romney’s income, which comes in the form of capital gain, appears as taxed at only 15%, when in fact it is taxed at a 44.75% rate (That’s the corporate rate plus the capital gains rate.)

In fact, the real scandal is not that Romney pays "only" a 44.75% tax rate on income; it’s that Joe the Plumber, if he invests in stock, pays a very similar rate, despite being much less wealthy. My proposal would eliminate this inequity.

To complete the reform, one would have to eliminate the deductibility of interest expenses. Doing so could easily help lower the corporate tax rate to 10% without reducing tax revenues.

Republicans should like this solution, because it simplifies the tax code and reduces marginal tax rates on corporate income. Democrats should like it because it reduces the tax burden on lower-income investors. If you think out of the box, a bipartisan solution to corporate tax reform is possible.

Original Source: http://www.nydailynews.com/opinion/a-better-tax-corporations-article-1.1093804

 

 
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