Sunday, March 17, 2013

Jordan Weiss in Tax Notes with similar thoughts

March 25, 2013
A Tax Increase Republicans and Democrats Should Embrace
by Jordan P. Weiss
Summary by Tax Analysts®
Jordan P. Weiss lauds David Cay Johnston's approach to revising the accumulated earnings tax, calling it a "common-sense approach," and offers a few suggestions of his own for further tax reform.
Full Text Published by Tax Analysts®
To the Editor:
I woke up this morning to yet another newspaper article bemoaning the accumulation of offshore earnings of United States corporations. A few weeks past, David Cay Johnston gave readers a common-sense approach to the accumulated earnings tax to, in part, ameliorate the issue. Johnston, "How the Accumulated Earnings Tax Can Stimulate Growth," Tax Notes, Mar. 11, 2013, p. 1265 2013 WTD 47-21: Viewpoint. An approach he concluded would provide better returns for investors, more jobs for Americans, and encourage entrepreneurial spirit. While common sense is increasingly uncommon in the current tax debates, everyone seems to agree that we need to bring the cash held offshore by American corporations back home. In that spirit, I offer the following suggestions (to be coupled with Mr. Johnston's proposed accumulated earnings proposal):
·         Make the dividend of the offshore foreign earnings tax deductible to the corporation.
·         Impose a 30 percent final withholding tax on the dividend, even to 401(k)s and tax-exempt organizations.
·         Eliminate the foreign tax credit on the dividend.

If the dividends of the foreign earnings held offshore are deductible to corporations, essentially we would have eliminated corporate tax on such earnings. Corporations would be hard-pressed to complain about the high United States tax rate on such earnings.
A 30 percent withholding tax, call it the "Buffett tax," would apply to the dividend, which ought to make even the most hardened Democrat support the tax. It would be fairly easy to draft mechanisms to make sure we are only subjecting the foreign earnings to the withholding tax.
We would have corporate integration (a single level of tax) on such foreign earnings which ought to make even the most hardened Republican support the tax.
The tax-exempts might complain; however, they are getting a larger distribution because of the lack of corporate tax on such earnings.
Shareholders will certainly demand the cash dividends, and corporate boards will hold onto such cash at their peril.
Corporate raiders will eye the cash hoards and merger and acquisition activity would be enhanced.
Capital reallocation to its most productive uses will occur.
The tax would be borne mostly by "millionaires and billionaires" who own most of the stock.
And as concluded by Mr. Johnston, we would provide better returns for investors, more jobs for Americans and encourage entrepreneurial spirit.
It might just bring some of those earnings back home!
Very truly yours,

Jordan P. Weiss
Mar. 19, 2013

Saturday, March 9, 2013

Shared Economic Growth: Discouraging Corporate Misdeeds, Empowering People

Making Corporations More Responsive

Transparency

Enron. WorldCom. Global Crossing. One could fill a page with the names of corporate scandals in which companies fooled investors and left employees without jobs or pensions. The Sarbanes-Oxley accounting controls legislation was supposed to help with this problem, but try downloading the annual report for a corporation and see if you can tell whether or not the corporation is truly profitable. There is one foolproof way to tell, and that is by asking the same question that led truly savvy investors to spot Enron's troubles well before the company's collapse: Is the company generating cash? The Shared Economic Growth proposal would require any company seeking the benefit of the dividends paid deduction to pay its taxable earnings, in cash, to its shareholders. It would be impossible to hide behind complex accounting or confusing jargon - either the company would have the money, or it would not. If a company wanted more cash to invest, it would need to convince the public to buy new stock. Any company that had failed to respond to previous investor demands to "show them the money" would need to do some serious explaining in order to persuade anyone to invest their hard-earned cash in it. Wouldn't that increase your confidence in your investments?

Responsiveness

We have all read the stories of corporate CEOs who were paid $50 million while their corporations tanked. In some cases, the executives' poor performance had no consequences at all. In others, CEOs were forced out, but with additional huge severance packages to soothe the pain of parting. What can shareholders do in reaction? They can refuse to vote for the director candidates that the corporation offers, but they cannot vote for alternatives. They can sell their shares and take a loss, but the corporation still keeps its cash. The shareholders, for the most part, are effectively powerless.

The same holds true when a company abuses its employees, creates an environmental disaster, cheats the U.S. government, or otherwise misbehaves. Except in the rare case where a government agency imposes a truly serious fine, there is no effective mechanism for the American people to force corporations to be good citizens.

Under the Shared Economic Growth proposal, however, corporations would lose 35% of their earnings unless they paid them out as dividends. That would create heavy pressure for a company to give up its cash. If it wanted more cash to invest a grow, the company would need to go to the market and convince people that it deserved their investment dollars. It would come to you, an investor, and ask you to trust it with your money.

If a corporation wasted its investors' money on under-performing executives or if it was caught doing something evil, would you invest? The public would finally have a real source of control. Companies that misbehaved would see their funding dry up.

Wouldn't that be a good thing?

Shared Economic Growth: Why Changing a 35% Tax Increases Returns on Savings by 54%

How a 35% Tax Takes Away a 54% Opportunity

The U.S. corporate income tax is imposed at a 35% rate. So, for $100 of pretax earnings, a corporation will pay tax of $35, leaving $65 to pay to its shareholders.

To see the real impact of removing this burden through a dividends paid deduction, however, you need to turn these numbers around and look at them from the point of view of the shareholder currently receiving $65, or from the point of view of the corporation currently earning $65 after tax from its U.S. operations. If you receive $65 after tax now, removing the U.S. corporate tax burden will allow you to receive $100. That is an increase of $35 over the $65 you had before. That's a 54% increase - the amount of money you receive will increase by more than half.

If that is money flowing into your pension fund or tax free college fund, your earnings will grow much faster.

From the point of view of a corporation today, it means that it can boost its profits by 54% just by firing its American workers and 
moving the operations abroad. Trying to address this problem by repealing deferral, as some have suggested, would not work, because then we would have a situation where a foreign corporation would be able to earn an automatic 54% profit by buying a U.S. corporation, firing the old U.S. headquarters staff, and making it a foreign owned corporation. Only Shared Economic Growth will reverse this insane incentive and encourage companies to create good jobs here in America.

Wouldn't that be best?

Shared Economic Growth: Attract Valuable Jobs, Don't Force Them to Be Sold

Eliminating Deferral Is A Bad Idea

The current American corporate tax system, like the corporate tax systems of most countries, taxes corporations more lightly on their foreign earnings than on their U.S. earnings. Most of our competitor nations have what is called a territorial tax system, under which foreign earnings are never taxed. We have a deferral system, under which most foreign subsidiary earnings can be protected from U.S. tax until they are paid up to the U.S. parent as dividends. This, of course, provides a
bad incentive. All U.S. corporations have an incentive to move their high value, high profit activities out of the U.S. in order to enjoy a lower tax rate, and earn up to 54% more profit. For this reason, some people in our government have proposed getting rid of deferral and taxing the worldwide income of U.S. corporations currently.

This may sound like a nice idea, but think it through. The U.S. is not unique anymore. We no longer have all the money - in fact, we are heavily indebted to other countries. We no longer have our gigantic technical edge - that lead has faded and we now import more goods of all kinds, including high technology goods, than we export. If our corporations are unable to compete, they will be forced into bankruptcy or will be bought out by foreign rivals.

Consider both common sense and experience. Consider a company that currently has significant foreign activities in tax friendly countries. Suppose that we now end deferral and subject all of its worldwide income to a 35% tax. Suddenly, the corporation is 35% less profitable than it used to be. Put another way, suddenly the corporation would be
54% more valuable if it were owned by a foreign parent. Do you think it will survive as a U.S. owned corporation, or will it be bought out and have all its U.S. headquarters jobs eliminated?


Eliminating Deferral in the Real World

Now consider experience. Our country has seen two cases where deferral was eliminated for particular industries or parts of industries, and in both cases, the results were exactly what you would expect.

First, in the insurance industry, U.S. based companies must pay full, current U.S. tax on all income from insuring U.S. risks, even if they reinsure those risks with a foreign affiliate, i.e. even if a foreign subsidiary takes on the risk of loss. Foreign based insurance companies insuring U.S. risks don't have that problem - they reinsure with a foreign affiliate and avoid U.S. tax. A coalition of insurance companies recently sent a letter to the House Ways and Means Committee leaders that did not ask for relief from taxation for the companies in question, but instead that tax be imposed on profits
earned by their foreign competitors from insuring and reinsuring U.S. risks. The coalition pointed out that the current system puts them at an intolerable disadvantage that is destroying the U.S. based companies. "For example, White Mountains Group, EverestRe Group, Arch Capital and PXRe Group LTD moved their domiciles offshore into a no-tax jurisdiction and continue to cover US-based risks. Other US companies and lines of business have simply been acquired by foreign insurance companies domiciled in low-tax or no-tax jurisdictions."

A similar experiment in the shipping industry had comparable results. A recent letter from the Federal Policy Group, a tax lobbying organization, that was printed in Tax Notes, Sept. 10, 2007, p. 997, summarizes the effects of ending deferral on shipping income in 1986 and restoring it in 2004:

"The results of the 1986 act 'experiment' were dramatic. Much of the decline was attributable to the acquisition of U.S.-based shipping companies by foreign competitors not subject to tax on their shipping income. For example, Signapore-based Neptune Orient Lines in 1997 acquired U.S.-based American President Lines, then the largest U.S. shipper. In 1999 Denmark-based A.P. Moller Group acquired the  international liner business of Sea-Land Services, Inc., a subsidiary of CSX Corp. and previously the largest U.S. shipper of containers. By becoming foreign-owned, these shipping businesses were able to shed themselves of crippling subpart F taxation and compete again in the global markets. Of course, the movement of these businesses overseas meant the loss of headquarter jobs and related employment in the United States.

"Fewer U.S.-based shipping companies also meant fewer potential investors in the U.S.-flag "Jones Act" domestic trade, which is limited to U.S.-owned enterprises. Thus, one should not have been surprised that the number of U.S.-flag ships also declined following the 1986 act change. Over the 1985-2004 period, the U.S.-flag fleet declined from 737 to 412 vessels, causing U.S.-flag shipping capacity, measured in deadweight tonnage, to drop by more than 50 percent... A 2002 Massachusetts Institute of Technology study expressed concern that the [Effective US Control] fleet, eviscerated following the 1986 act changes, was not large enough to satisfy U.S. strategic needs.

"The 2002 MIT study pointed directly at the loss of deferral as the culprit.

"The combination of U.S. tax laws passed in 1975 and 1986 resulted in a business environment where EUSC shipowners could no longer avoid paying tax on current income. This change put them at a major disadvantage to their foreign competitors who often paid little or no income tax... Consequently, EUSC shipowners have greatly reduced their investment in EUSC ships since the Tax Reform Act of 1986... The impact of the deferral's restoration on OSG, the leader in urging the 2004 legislation, was nearly immediate. In 2005 OSG posted exceptional financial results, earning $465 million in net income, a company record attributed in large part to the 2004 legislation. OSG had gained the confidence needed to take investment risks and again become a growing enterprise.
In January 2005, just three months after enactment of the 2004 legislation, OSG acquired Stelmar Shipping, an Athens-based international shipper of crude and petroleum products, thereby reversing the trend of foreign takeovers of U.S. shipping companies. The acquisition of Stelmar increased the size of OSG's foreign-flag fleet by 80 percent, from 50 to 90 vessels.

OSG also began committing itself to a major expansion of its U.S.-flag fleet. Before enactment of the 2004 act, OSG's U.S. fleet had been declining in size. In 1996 OSG's U.S.-flag fleet consisted of just 16 operating vessels, and by 2004, the fleet had shrunk to just 10 operating vessels. In June 2005 OSG ordered 10 new Jones Act tankers to be built at the Aker Philadelphia shipyard, today an employer of approximately 1,300. And in February and March 2007, OSG announced plans to commission six new U.S.-flag vessels to be built at the Aker Philadelphia shipyard and Alabama's Bender shipyard."



A Better Solution

The threat to U.S. corporations from repeal of deferral is not just a bogeyman. Experience shows that it is real, and that makes sense. Corporate tax makes a huge difference in the value of a corporation. If we suddenly inflict a huge value drop on our U.S. corporations that can be undone simply by having them acquired by foreigners, they will be acquired. That is life in the real world in the 21st century.

Fortunately, we have a better option. The Shared Economic Growth proposal gets rid of the incentive to export U.S. operations in a manner that actually gives U.S. corporations a competitive advantage. We can easily afford it, and our economy needs it.

Wouldn't that be a better idea?

Shared Economic Growth: Corporate Tax Hurts Wage Earners and Middle-Class Savers

Who Pays Corporate Tax?

The direct burden of corporate tax, of course, falls on the shareholders, including people who invest in stock through their pension savings accounts. But over time the burden of corporate tax also falls on employees through lower wages and upon consumers through higher prices.

How does this work? Corporate managers do NOT say "gee, corporate tax rates have just been lowered, let's give our employees bigger bonuses and cut our prices!" Instead, it works through the way corporations make decisions.

Corporations compete against each other for investment capital. If a corporation does not provide a certain level of return to its shareholders, then people will tend to sell the stock of the under performing company and buy shares in other companies instead. So, when a corporation is deciding whether or not to make an investment, it first produces a set of projected economics to judge what kind of risk weighted, after tax return it is likely to make on the investment. If the projected return is above a cut-off number, commonly known as the hurdle rate, the corporation will make the investment. If the projected return is below the hurdle rate, the corporation will hold on to its cash instead.

Say a given investment will earn $100 before tax on an investment of $85 (i.e. it will get a return of its $85 investment plus another $15 in profit), and that the corporation has a 15% hurdle rate. If the corporation was not subject to tax, it would make the investment. It will make $15 beyond its $85 investment, and $15 is more than 15% of $85, so it will go forward with the deal. But now suppose that the corporation is subject to a 35% tax. That tax will only apply to the net profit of $15, but still it will be $5.25. So, now the after tax profit will be only $15-$5.25=$9.75. $9.75 is only 11.5% of the $85 investment, well below the 15% hurdle rate. So, with tax, the corporation will not make the investment.

Why do we care? We care because every corporation out there is making similar decisions. If corporations operating within the American economy were not subject to tax, they would decide to invest capital in many projects that they would not invest in today. Those projects would compete for employees, and they would provide goods and services that would compete against each other in the marketplace.

What does that mean to you? If more companies have more projects in America seeking to hire American workers, that increases the market power of each worker. That means that the corporations will have to share some of that profitability with their workers in the form of better wages and benefits. The
income stagnation that the middle class has seen for the last 30 years due to their shrinking market power would be reversed. Working Americans would get a bigger piece of the bigger economic pie. What the globalized labor market has taken away, the energized labor market created by Shared Economic Growth would give back.

If more companies are willing to take the risk of entering the market to produce competing goods, that heightened competition will result in better products at lower prices. The average person's dollar would go farther, again helping to undo the effects of income stagnation.

Both of these effects would get a boost from the general efficiency gains that the Shared Economic Growth proposal would produce. By stimulating corporations to pay their earnings out as dividends, investment dollars would be freed up to flow to the best new investments in the overall economy, instead of the best investment that happens to be available to a particular corporation (or the best foreign investment available to that corporation). By eliminating the incentive for corporations to move their technology out of the U.S., Shared Economic Growth would help us to become the world's innovation powerhouse again. By providing American workers with their fair share of the benefits of their labor, Shared Economic Growth would stimulate worker enthusiasm and involvement, boosting real productivity.

Thus, while the benefits of Shared Economic Growth would initially fall to the shareholders, including the pension funds that own 28% of U.S. shares, as the new investments matured it would flow out to the workers and consumers across the economy. The burden of corporate tax falls on all of us, and lifting that burden in favor of shareholder level taxes would make everyone better off.

Wouldn't that be more sensible?

Shared Economic Growth Reveals the Myth: Americans Have Been Fooled into Thinking Corporate Tax Is a Tax on the RichShared Economic Growth Reveals the Myth: Americans Have Been Fooled into Thinking Corporate Tax Is a Tax on the Rich

The Stealth Tax

Corporations are not living things, they are the collective investments of a group of people. They do not bear the burden of tax . Instead, corporations pay tax on behalf of their shareholders. Absent the corporate tax, the shareholders would earn 54% more on their investments. That applies equally to every shareholder, rich or poor, including those who hold their investment through an IRA, 401(k), or other supposedly tax free retirement fund.

If high income shareholders received the corporate earnings directly, they would pay tax on them at a 35% rate (which will go up to 39.6% once the Bush tax cuts expire at the top end). Middle class shareholders would pay tax at a rate of 28% or less. Compared with direct taxation, then, the corporate tax is not
progressive, because it taxes everyone at the same rate.

Worse than that, though, it taxes people's supposedly tax free pension savings. This is where the math becomes interesting. As explained in the 
draft bill and summary, if we eliminate special capital gains rates, if we stop giving U.S. corporate shareholders credit for foreign taxes the same way that foreign countries have stopped giving their corporate shareholders credit for U.S. taxes,  and if foreign investors are held tax neutral, then once the individual rates go back up to their prior levels, a dividends paid deduction would pay for itself except for the fact that a little over 28% of all U.S. stock is held by IRAs, pension funds, and other retirement accounts which don't pay tax on the dividends they receive. To offset this revenue leak, the Shared Economic Growth proposal would put a new 7.65% tax on individual income in excess of $500,000 per year - a figure equivalent to the employment taxes that apply to the full wage income of ordinary workers but that does NOT apply to income in excess of $106,800 per year. That offset is actually generous, but it leaves room for the inevitable political compromises.

But think about what this means. If the special provisions that cause capital gains to be more lightly taxed than wages are eliminated, then the only cost of permitting corporations to have a dividends paid deduction is that a 7.65% marginal tax needs to be imposed on very high income taxpayers  solely to make up for removing the hidden 35% tax on pension savings. When the dividends paid deduction has been raised before, policymakers had exactly that discussion. "A large portion of the dividends go to non-taxable pension funds. People are not complaining about pension investments being subjected to a 35% tax, because they don't understand it. But if we impose a new individual level tax to make up for that loss, people will complain.
So let’s just forget about the dividends paid deduction."
Congress and the American people have a straightforward choice: Is it better to impose a 35% tax on the income from the pension savings of all working Americans, or to impose a 7.65% tax on individual income in excess of $500,000 per year?. If Congress prefers the 35% tax on pension earnings, then Congress should impose that tax in an open and straightforward way rather than by sneaking it in as a "corporate" tax and pretending it is a tax on the rich. If Congress thought that the American people would support that choice when it was clearly put to them, then Congress would be free to tax the pension income directly rather than to impose the AGI tax. Either way, though, there is no reason not to enact the dividends paid deduction and remove the tremendously harmful burden that the corporate tax places on the American economy. While one may grant that politicians may sometimes legitimately hide the ball a little on subjects that are difficult to explain to the public, surely no lawmaker could comfortably say, "I want to impose a 35% tax on the pension earnings of working Americans, but I don't want them to realize that I am doing it, so I am going to hide it behind a smoke screen that makes U.S. operations 54% less profitable than foreign ones and that seriously reduces the efficiency of our economy. It is important enough to fool the taxpayers into believing that we don't tax their pension earnings that the resulting huge cost to the U.S. economy from this smoke screen is worth it." Yet that statement, in essence, is the only argument for opposing a dividends paid deduction. Until now, this is the choice that both political parties have been making.

The Shared Economic Growth proposal would get rid of the stealth tax. It would bring taxes out in the open where they can be seen, and it would make the tax system simpler so that people could understand what everyone actually pays.

Wouldn't that be more honest?

Shared Economic Growth: Capital Gains - Unstable Speculation vs. Solid Cash Earnings

"That all the capital employed in paper speculation is barren and useless, producing, like that on a gaming table, no accession to itself, and is withdrawn from commerce and agriculture where it would have produced addition to the common mass: That it nourishes in our citizens habits of vice and idleness instead of industry and morality: That it has furnished effectual means of corrupting such a portion of the legislature, as turns the balance between the honest voters which ever way it is directed."

-Thomas Jefferson on speculators
 

Are Capital Gains Rates Necessary?

 

There are several valid arguments for limiting tax on capital gains. Likewise, there are good arguments for never imposing any tax on anything. But if we are to have a workable society with a government that can afford to provide the security, infrastructure, and enforceable ground rules needed for a healthy economy and a good life, we need to tax something. The question is which balance of taxes is least harmful overall.

The primary arguments for limiting taxes on capital gains are

1) Capital gains may not be real gains: they may simply be a product of inflation. (Given the overall structure of our tax system, though, this is a bit of a childish whine. If someone makes an investment that pays current interest or dividends, most or all of that income is just making up for inflation, but all of it is taxed nonetheless, and the taxpayer pays the tax currently. If someone instead invests in such a way that the income accumulates as a capital gain, the taxpayer at least gets to defer the tax bite until the capital gain is realized, so the taxpayer has already come out ahead. Proponents of the inflationary gains argument are in effect saying that this deferral advantage is not enough, that they also need to get special protection from tax on the part of the income that corresponds to inflation. Why? They are not contributing any more to the economy than the person who invests and takes interest or dividends. Further, special capital gains rates are a very poor instrument for trying to account for inflation. Most stock investments grow in value at a rate well above inflation. So, Shared Economic Growth has the right solution. Induce corporations to pay out their earnings as dividends currently, and then the type of long term investors who care about inflation will pay tax on their income year by year just like everybody else. They won't have any right to complain.)
2) If capital gains taxes are high, asset owners may be reluctant to sell their assets and trigger the tax. Therefore, they hold onto the investment, resulting in an inefficient allocation of capital that reduces growth.
3) If returns on capital investments are reduced by high taxes, the owners of available capital will be less willing to invest it rather than spend it on consumption, again reducing economic efficiency.

On the other hand, the downsides of low capital gains tax rates are significant, including

1) They cause income from passive investment to be taxed less heavily than income from productive labor, diverting intellectual talent into investing activities that are largely parasitic rather than into activities that create new, real value.
2) Ownership of capital is by definition skewed towards people who are already wealthy, so low capital gains rates cause the wealthy to be taxed less heavily than the working middle class, undermining our progressive tax system.
3) Low capital gains rates can actually lock in inefficient investments and create other inefficiencies by providing incentives to structure income as artificial capital appreciation rather than just taking the income currently.
4) Given a choice between working the family farm or small business and being taxed at ordinary rates on the income or selling it and paying tax at the lower capital gains rates, there is a strong incentive to sell out, undermining the base of small farmers and entrepreneurs that balance our economy and invest for the long term. It is good to encourage the free flow of capital, but there is a difference between that and having a system that puts a premium on getting a short term value spike and turning a quick profit at the expense of long term profitability.

The Shared Economic Growth proposal offers a way to get most of the benefits of low capital gains rates without the burdens:

1) Inflationary gains on stock would become less relevant because earnings would be paid out and taxed on a current basis.
2) Corporations would be pressured to pay out their earnings back into the economy, preventing cash from getting locked into a corporation where it is only available to go to the best investment available to that company rather than the best investment available in the economy, thus increasing efficiency without distorting the tax system or undermining progressivity.
3) By eliminating double taxation of corporate equity (once at the corporate level and then again at the shareholder level), Shared Economic Growth would make capital investments much more attractive and would give corporations many investment opportunities that are
not economical for them today.
4) By eliminating the tax penalty for
U.S. investments and jobs, Shared Economic Growth would make much more capital available for investments in the United States, greatly stimulating the growth of our economy.

Shared Economic Growth would accomplish all of this while improving the progressivity of our tax system, eliminating incentives to spend effort on siphoning off value rather than creating value, and providing incentives to keep the family farm or business rather than selling out.

Isn't that a better way to do it?

Shared Economic Growth: Wealthy Financial Speculators Should Not Pay Lower Rates Than Working Professionals

Enforcing Our Progressive System

In taxation, as in many things, the way the system is supposed to work is not the same as the way it actually does work. We are supposed to have a progressive tax system, in which people who earn more income pay tax at higher rates than those who earn less. In practice, many people with high incomes pay much less than you would think, which means that the working middle class pays too much.

The idea behind the progressive tax system is that the burden of providing government services should be distributed based upon the ability to pay and the relative financial benefit that people receive from being able to do business in the stable environment that our government supports. The ability-to-pay concept is a notion of economic efficiency: If the government needs $1,000 and can take it either from someone who earns $20,000 per year or someone who earns $200,000 per year, the population is better off if the government takes the $1,000 from the person who earns $200,000 because she will (on average) suffer less pain from the loss. In other words, society is better off overall if the government collects relatively more from higher-income individuals than from lower-income individuals.

Relative social benefit is a notion of fairness. If you took two babies born in a poor nation, such as Chad, and auctioned off the right for one of them to grow up in America, the child who was destined to become Bill Gates would presumable be willing to pay more than the child who was destined to become a Wal-Mart cashier. The latter child certainly is still much better off in America than in Chad, on average, but the child destined to become Bill Gates would be better off to the tune of $30 billion. The progressive tax system runs that auction retroactively, effectively saying, "Bill, this country has been very, very good to you, so we're going to ask that you give a little extra in return." This concept does not mean that talented, hard-working people should be prevented from earning and keeping a lot of money. It just means that efficiency and fairness both dictate that those wealthiest individuals should pay a relatively larger share of the cost of running our society - the society in which they have prospered and have been able to use their talents.

Parts of our tax system are not progressive at all. All workers pay 7.65% of their wage income in employment taxes - in fact, double that amount if you take the view (as most economists do) that the employer's share is passed through to the employee as lower wages. However, 6.2% out of that 7.65% does not apply to wages above $97,500. As a result, people earning more than $97,500 in salary actually pay employment taxes at a relatively lower rate than people who earn less than that. Furthermore, people who receive their income from sources other than wages do not suffer any employment tax on that income.

Similarly, sales taxes are not progressive. Given that everyone in a particular town generally pays sales tax at the same rate and that people with very high incomes generally do not ever spend all of their money, higher-income individuals may pay relatively less sales tax. Because of this effect, a family earning $40,000 a year will spend about 10% of its income on state and local taxes (state income, sales, property, gasoline excise, etc.), while a family earning over $100,000 a year will pay a little over 7%. Families earning more than that pay a progressively smaller percentage.

Nevertheless, the progressive income tax part of the system operates, for the most part, in the way that you would expect. In 2005, looking at adjusted gross income (that is, income before personal exemptions and itemized deductions), families earning $20,000 paid federal income tax at an average rate of 5%, families earning $40,000 paid it at an 8% rate, families earning $100,000 paid 13%, and those earning $200,000 paid 20%. At that point, however, the progressivity curve starts to flatten out. The rate of tax on families who earned over $500,000 in 2005 hit 24%, a relatively small increase over the $200,000 group, and the rate of tax dropped to 23.5% for those earning over $5,000,000 and to 21% for those earning over $10,000,000.

Why are top rates so low? In large part, it is due to the special low rates that apply to
capital gains and dividends. Families earning less than $50,000 a year derived about 1% of their income from those sources in 2003 (and another 11% of their average income from pensions and IRAs, for which these favorable rates provided no extra benefit), while families earning over $1,000,000 obtained 35% of their income from those sources. Recently we've learned how the "carried interests" trick allows wealthy hedge fund managers to pay tax on their income at a rate of only 15% - a far lower rate than what their secretaries pay. That's just the latest in a long line of devices by which people manage to pay less tax than you might think.

So, a family earning $40,000 a year pays, on average, 7.65% (or 15.3%, depending on how you look at it) employment tax, 8% federal income tax, and about 10% state and local income tax when they spend their money, for a total of about 25.65% (or 33.3% if you take the view that an employer passes its portion of the employment taxes on to its employees). A family earning $4,000,000 a year, or 100 times as much, pays employment tax of about 0.62%, state and local tax of perhaps 6%, and federal income tax of 24%, for a total of some 30.62%. That may or may not be progressive at all, depending again on how one views the employer portion of the employment taxes. At best, it's certainly not very progressive.

The Shared Economic Growth proposal would get rid of the special favorable rates for capital gains and dividends, shutting down a string of schemes such as carried interest taxation and causing all income to be subject to the same progressive rate structure. It would also impose a small supplemental tax of 7.5% (not much more than the 6.2% portion of employment tax that does not apply to income over $97,500) on income over $500,000. That would make our system about as progressive in reality as the rate tables make it look on the surface.
Progressivity and Growth

Data spanning the full history of the American income tax shows that progressive tax rates are not inconsistent with healthy growth. To the contrary, sharing the rewards of work a bit more broadly appears to help growth. As the chart above shows, overall growth was strong while top marginal rates were high. As the chart below shows, income growth for the top 1% is not linked to income growth for the bottom 99%. Enforcing progressivity, if done in the context of providing fair opportunity to the 99% rather than providing handouts, seems to promote growth.

Wouldn't society's overall happiness be maximized if families earning $40,000 a year were taxed at a lower rate than families earning 100 times that much? If we give more working Americans a chance to earn healthy after-tax income for their efforts, wouldn't that be the best way to give everyone a real incentive to work hard and contribute to society? Wouldn't it be more fair if, for the benefit of living in the American economy, a two-earner family earning $40,000 paid a lower percentage of their income than a family earning 100 times that much? The Shared Economic Growth proposal would make progressive taxation a reality.

Wouldn't that be better?

Shared Economic Growth: Making America the Most Attractive Place to Locate Desirable Jobs


The Government Should Not Pay Companies To Export Good Jobs

We all know that globalization is hurting a broad group of American workers. Given a choice between paying U.S. level wages or paying workers in a developing country $1.00 an hour, companies will tend to choose the latter. Even if a company would prefer to hire American workers, they are competing against other companies that will use the cheap foreign labor, and eventually it must fall in line or fail. In industries that rely heavily on manual labor, this trend cannot realistically be reversed. America cannot and should not try to compete for low wage, low skill, low value jobs. Trying to do so would end up causing us to sacrifice standards that are important to our society, such as the minimum wage. Instead, we must seek to obtain the promised upside of globalization, good new jobs in higher value industries that can afford to pay U.S. wages.

Those industries are tax sensitive. They earn high profit margins relative to the cost of manufacture, and so tax is a major consideration in where they locate their activities. Does the U.S. tax system attract those activities here? No, exactly the opposite! For a given operation that earns $100 of profit before tax, the corporation will keep only $65 if the operation is located in the U.S., but it may keep the full $100 if it is moved abroad. That is a 54% increase in profit just by moving the operation and jobs out of the United States. This is insane. The U.S. could afford such a system back when we were far ahead of everybody else, with greatly superior technology, an elite workforce, and relatively great wealth. But we can't afford it now. We are now a debtor nation. We have lost much of our technical lead and are fading fast, and we are no longer able to retain these jobs in the face of foreign competition when corporations are punished for operating here.

Imagine that you represent a German corporation that wants to build a factory to supply the U.S. market with a particular product. You are deciding whether to locate the plant in the U.S. or in the Dominican Republic (“D.R.”). What are the trade-offs?

U.S. –
· Wages will be relatively high.
· A big chunk -- 35% -- of your net profit would be taken away by U.S. federal tax (plus a percentage for state income taxes, too).
· Sales taxes on the equipment and raw materials you purchase will be high.

D.R. –
· Wages will be about $1 an hour. 
None of your profit will go to income tax.
· Like most countries, it has a value-added tax (“VAT”) rather than a sales tax, and businesses don’t bear any cost from the VAT charged on equipment or raw materials.

Which jurisdiction would you choose? Absent especially high shipping costs, the financial answer is clear. The fact that the U.S. retains as many plants as it does is a testament to the fact that U.S. corporations, on the whole, have a substantial degree of loyalty to their home country.

Now say you are a U.S. corporation trying to compete against a German-owned rival. Your plant is in the U.S. The German company’s plant is in the D.R. All else equal, will you be able to compete? Even if you can, suppose the German rival looks at your business and says, “If I buy them, I can move the production to the D.R. and save on labor costs, plus instantly increase the after-tax profit by more than half due to the elimination of the income tax.” Do you think the U.S. company will resist being acquired and having both its U.S. headquarters and its U.S. factory eliminated?

These examples show why the U.S. has maintained a policy that permits the international operations of U.S. companies to be somewhat competitive with their foreign rivals. If a U.S. company puts overseas operations into a foreign subsidiary, the income from those operations won’t be taxed by the U.S. until it is brought home as a dividend. So, rather than being acquired by the German rival and having its U.S. headquarters eliminated, the U.S. corporation can move its own plant to a D.R. subsidiary and avoid current tax on the profits.

However, the U.S. corporation is still not fully competitive with the German rival, because it still must pay U.S. tax on its profits sooner or later. Further, the U.S. corporation is discouraged from reinvesting its profits in the U.S. economy, because it will lose more than one-third of that profit to tax as soon as the cash hits the U.S. Likewise, when the U.S. corporation is considering how best to expand, it sees that an investment of $100 in foreign operations will have the same net earnings cost as an investment of $65 in the U.S., because the foreign cash is pre-tax dollars while the U.S. cash is after-tax dollars. (In other words, spending $65 in the U.S. requires the corporation to bring home $100 and lose $35 to tax.)

Because of these limitations, some commentators have advocated moving the U.S. to a territorial tax system, which is what most of our competitor nations use. Under a territorial system, income earned outside of an enterprise’s home country is exempt from tax, and earnings can be freely repatriated for investment in the home country. However, such a system still makes it financially difficult for a U.S. corporation to decide to locate its plant in the U.S. rather than in the D.R. Wage rates aside, the D.R. plant will be over 50% more profitable than the U.S. plant. It is tough to ignore that difference.

Further, enacting a territorial tax system in the U.S. still would not encourage that German rival to locate its plant here. The German firm would also realize that a plant in the D.R. would be over 50% more profitable than a U.S. facility. Since the company would have no loyalty to the U.S., it is clear where it would choose to build the plant. Under the Shared Economic Growth proposal, the corporate-level tax on U.S. operations would be reduced to zero. Under that system, there would be no tax penalty to either the corporation or its shareholders for building a plant in the U.S. rather than in the D.R. In fact, if the D.R. imposed any income tax at all, then there would be an incentive to build a U.S. plant instead.

Doesn’t that make more sense?

Shared Economic Growth: Helping the Market to Restore Our Strong Middle Class


How Shared Economic Growth Builds Middle Class Market Power 

The global economy, or more specifically mobile investment, is hurting a broad group of working Americans. Given a choice between paying U.S. level wages or paying workers in an emerging country significantly less, companies will tend to choose the latter.  It doesn’t have to be like this.  It is possible to change the competitive equation that drives corporate investment decisions so that jobs are attracted to the U.S. again.

First, consider how the market is operating now. If working Americans organized and got higher wages, sooner or later the corporation will be motivated to just shut down the U.S. plant and move the operations to a lower wage (and generally lower tax) environment. Like it or not, most companies will not pay their workers more just to be nice. Even if a company would prefer to hire American workers, they are competing against other companies that will use the cheap foreign labor, and eventually it must fall in line or fail. In fact, any corporation that didn't seek to reduce costs and increase profits would usually lose out to its competitors and would be acquired or go bankrupt. To remain viable, corporations must minimize their overall costs.

In industries that rely heavily on manual labor, this trend of moving to the lower wage locations cannot realistically be reversed. America cannot and should not try to compete for low wage, low skill jobs typically associated with low profit margins. Instead, we must seek to obtain the promised upside of globalization, good new jobs in higher margin businesses that can pay wages sufficient to maintain the living standards of an advanced economy.  But those industries are tax sensitive. They earn high profit margins relative to the cost of manufacture, and so tax is a major consideration in where they locate their activities. Does the U.S. tax system attract those activities here? No, exactly the opposite! The U.S. could afford such a system back when we were far ahead of everybody else, with greatly superior technology, an elite workforce, and relatively great wealth. But we can't afford it now.  The world has changed and we are no longer able to retain these jobs in the face of foreign comptetion.

To understand the impact of mobility on jobs and wages under our current tax system and the power of the Shared Economic Growth proposal to correct it, let’s consider an example with some simple math. For most corporations, deciding where to put their operations is a matter of arithmetic. To choose between two countries, they consider the cost of manufacturing (or providing service or performing research) in the one versus the other, considering the cost and availability of adequate labor, raw materials, shipping costs, energy, etc. That allows them to compute their profit before tax for each of the competing jurisdictions. They then layer in tax. Whichever jurisdiction yields the highest after-tax profit wins. 

So, say the choice is between a Chinese factory and an American one, and that the company would have to pay 25% tax in China (the full statutory rate) and 35% in the U.S.  Say it sells bowling balls for $20 in the U.S., and that it would cost $8 to make them in China and ship them here, but $10 to make them in the U.S. The cost of labor associated with making each bowling ball is  $5 in China and $7 in the U.S., but all other costs are the same, $3.  What's the math? Under current law the decision is obvious. If they choose China, they make $12 per ball ($20 sales price less $8 cost), pay tax of 25% on that or $3, and clear 12-3= $9.  If they choose the U.S., they make $10 per ball ($20 sales price less $10 cost), pay tax of 35% on that or $3.50, and clear $10-3.50=$6.50. Obviously theymake the bowling balls in China, and China gets the jobs.

If U.S. workers accepted a pay-cut to secure the jobs, how much of a pay-cut would they have to accept to attract the investment to the U.S. instead of China?  Answer: U.S. workers would have to accept a pay-cut greater than 55% or about $3.85 per ball to secure the jobs.  Again, let’s look at the numbers. Assuming a $20 sales price less U.S. wages of $3.15 and $3 for other costs,  an investor in the U.S. would make $13.85 before taxes.  Then, the investor would pay U.S. tax at 35% on the $13.85 or $4.85, and clear $9, the same as in China. Because of our current tax system, the pay-cut required to attract the jobs to the U.S., at least $3.85 ($7-$3.15), is nearly double the $2 wage differential between the U.S. and China.



   China

                        U.S.
Description



Without

With 

%




Paycut

Paycut

Change
Unit Sale Price

$20.00

$20.00

$20.00


Less: Unit Labor Cost

-$5.00

-$7.00

-$3.15

-55%
Less: Unit Other Cost

-$3.00

-$3.00

-$3.00


Pre-tax Profit per Unit

$12.00

$10.00

$13.85


Less:Corporate Income Tax

-$3.00

-$3.50

-$4.85


After Tax Profit per Unit

$9.00

$6.50

$9.00













Sometimes working Americans are openly offered pay and/or benefit cuts to remain employed. Sometimes jobs simply disappear and the displaced workers, particularly in the manufacturing sector, must accept significant pay and benefit cuts at new jobs. And sometimes the jobs are never created here in the first place. Whatever the case, the fact is that pay and benefits in the U.S. are limited because investment is mobile and it is moving to lower wage and lower tax locations abroad. Less U.S. investment (whether from domestic sources or from abroad) means that there are simply fewer good jobs around, leaving many working Americans with limited market power to negotiate better wages.

The impact of this trend is not limited to unskilled or semi-skilled workers in the manufacturing sector either. As emerging countries develop highly skilled labor and adopt technology, the same scenario is playing out for highly- skilled workers in the U.S. Ultimately, this process affects all working Americans, eventhose whose jobs are not mobile including skilled service providers such as doctors, electricians, lawyers, plumbers and so on because the displaced labor eventually creates an oversupply of candidates for those jobs.

In a global economy where capital investment is highly mobile but workers are not, domestic workers are bearing a greater proportion of the corporate income tax burden in the form of limited job opportunities and reduced wages. In fact, recent estimates suggest that approximately 70% of the corporate income tax actually falls on domestic workers. Through the corporation, shareholders can effectively escape the corporate income tax burden by simply allocating or reallocating their investment to lower cost locations abroad. Additional corporate profits derived from investing in lower cost countries flow to shareholders, many of whom do not have to compete with foreign labor (including semi-skilled factory workers and increasing numbers of skilled graduates from top universities in India or China) for jobs. By encouraging foreign investment over U.S. investment, the corporate income tax is effectively exporting good jobs and subsidizing foreign workers at the expense of working Americans. This is why the great majority of Americans who rely upon wages rather than capital as their primary source of income have experienced income stagnation and have failed to benefit from the growth in the U.S. economy over the past three decades. The corporate income tax has become a ball and chain secured to the ankle of every working American. This is the last thing working Americans need as they confront fierce global competition from low wage countries abroad.

The solution is simple: If it moves, don’t tax it! Let’s go back to the example above and see what happens if we implement Shared Economic Growth so that U.S. corporate tax effectively drops to zero. The company still would make $12 pretax in China versus $10 in the U.S., but now look at the after tax results. If they go to China they still clear $9, but if they make the balls in the U.S. they clear $10. Obviously they now make the bowling balls in the U.S., and the U.S. gets the jobs. It is worth $1 per ball for it to do so. Now the company needs to hire workers for the factory. But the U.S. has a high rate of employment - we have lots of jobs, they just aren't the same kind of relatively high paying jobs that we used to have. So, the factory will have to lure employees away from another company by offering higher pay, better benefits or better conditions. It will thus bid up wages by up to 99 cents per ball or about 14% if it needs to in order to get the necessary workers. Suddenly, instead of trying to hold on to their jobs in the face of competition from low wage foreign competition, working Americans would be in a position to make competing employers bid for their services. In many cases, there would be substantial room for wage growth. 


              U.S. 
              China
Description
SEG
               25%

No Corporate Tax
 Corporate Tax Rate
Unit Sale Price
$20.00
$20.00
Less: Unit Labor Cost
-$7.00
-$5.00
Less: Unit Other Cost
-$3.00
-$3.00
Pre-tax Profit per Unit
$10.00
$12.00
Less: Corporate Income Tax
$0.00
-$3.00
After Tax Profit per Unit
$10.00
$9.00
                                               

Because U.S. (and foreign) companies have had dramatic increases in productivity over the last 30 years, the labor cost per unit of product produced has fallen greatly.  If the labor cost associated with producing a given product is relatively small as compared to other costs, working Americans will be able to demand a greater percentage increase in their wages and still attract the investment for a plant here rather than in China.  Assuming the labor costs in our example were reduced by $3 and other costs were increased by $3, yielding the same profit for the company under Shared Economic Growth, U.S. labor could demand a 25% increase in wages and still attract the investment and jobs here rather than China.

Of course, a single example cannot convey the fact that different kinds of operations will come out differently. If a product has a high labor cost and a low profit margin, it will still go to China. But products with a high margin - usually innovative, high tech products - will come to the U.S.  The role of tax in the analysis is magnified for such products. The point is that for years we have been told that globalization would make life better for everyone by creating more low skill jobs in developing countries while creating more high skill jobs in the U.S. But we haven't seen that play out, and the reason is largely that our tax policy has interfered by pushing companies to shift BOTH low margin, low skill operations (for cost reasons) AND high margin, high skill operations (for tax reasons)  to other countries. That has caused globalization to result in a race to the bottom, where corporations follow low wages and taxes but leave working Americans effectively underemployed.  We need to bring developing countries up, not have them drag us down. 

We cannot change the fact that investment is mobile or the fact that most Americans are competing for jobs with lower wage people all over the world. Unless we adapt to these developments, the standard of living of the majority of Americans will fall as investment and jobs continue to migrate to lower-cost locations abroad. As individuals and as a nation, we will not have the resources to address the problems of retirement and health care, nor will we be able to provide our children with the very education and skills they need to succeed in this new age.  To adapt, we must change our tax system so that the jobs that either move abroad or are suppressed because of low wages abroad are replaced with better jobs in high-margin knowledge based activities in the U.S.

By effectively eliminating the corporate income tax, Shared Economic Growth dramatically increases the attractiveness of the U.S. as a manufacturing and services location, encourages economic growth and allows working Americans to negotiate for a bigger piece of a growing pie. Globalization really could work for everyone's benefit. Developing nations would continue to attract investment and jobs and develop their own innovative industries but working Americans would be able to compete for good jobs and pay as well.  Shared Economic Growth is about enabling working Americans to compete, not about protecting working Americans from competition abroad. Working Americans can compete and prosper if we just cut through the corporate income tax chain that holds them down. 


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