Tax Code Reform

[Superman]

Fellow Board Members, Glenn has some silly idea about redistribution of wealth in our country, but it reminds me of the lucid and creative ideas I have on this topic, so here goes. How 'bout if the first $50,000 in personal income were tax exempt, and the tax rate on income in excess of that amount were ten percent with no loopholes. This way, taxes paid by ordinary, simple, humble, responsible, modest individuals like myself would pay substantially less in taxes, while the sociopathic, mean spirited, greedy rich folks would have no tax shelters to hide behind. Of course, this assumes that an individual earning, say, a quarter-million dollars a year could afford to pay $20k in taxes. Is that a bad assumption? And isn't this the kind of plan that would actually increase tax revenues, allowing our country to invest in much-needed infrastructure repairs and improvements?

[mudman]

But what about Social Security (Just kidding)(isn't that an oxymoron anyway?)
-Jeremy

[island911]

Originally posted by Superman
. .. How 'bout if the first $50,000 in personal income were tax exempt, and the tax rate on income in excess of that amount were ten percent with no loopholes. This way, taxes paid by ordinary, simple, humble, responsible, modest individuals like myself would pay substantially less in taxes, while the sociopathic, mean spirited, greedy rich folks would have no tax shelters to hide behind. . ..

Uhmm. . . isn't that how it all started, back in WW2?

[RickM]

$50k means different things in different parts of the country.

...you're basically putting a starting point on a Flat tax.

[turbo6bar]

Your idea sounds good, but you're also stereotyping. Robert Kiyosaki states it is wrong to blindly say "The rich are greedy." He promotes "The rich are generous." I grew up in a humble background, and in my experience generosity is repaid well. I am by no means rich, but being in real estate investing, it's just a matter of time.

Wealth does strange things to people, but don't put the wealthy in the same basket.

Sure, tax reform is would be wonderful, but I will go back to another Kiyosaki saying,"Money is power." Those with the green make the rules...

[304065]

Look at this link:

http://www.irs.ustreas.gov/pub/irs-soi/01in01ts.xls

From the sheet you can see that there were 128,817,051 returns filed for tax year 2001. The top 25% of those taxpayers had an AGI of $56,085 or higher. Now go to the bottom of the table, and note that the same group paid 82.90% of the tax revenue. Note also that this group paid, on average, 18% of AGI in tax. Note that I say on average, because you probably know that the tax code provides for increasing rates as AGI increases.

So my answer is, bring it on! Eliminate progressive tax brackets above the $56k baseline! You lose $151 billion in tax revenue from the people below the line, who don't pay any more federal taxes! You lose another $71 billion by reducing the average rate on the top 25% of filers from 18% to 10%! That's $222 billion you have to make up. That's about 10% of the federal budget. I'll take $50bn from defense if you will take $50bn from entitlement programs, fair?

Now let's look at your supply-side assumption. You have an extra $222 billion that's available for investment and consumption spending. Let's assume that half of that is pure consumption, which yields a net pretax margin of, lets's say, 20%? Assuming you continue the corporate tax at 40%, you just made $9bn back in tax revenue from the effect of additional consumption in that year. Let's assume the other half is invested with a pretax margin of 40%, and you set capital gains taxes at 20%. There's another $9bn. So you make $18bn back the first year in tax revenue, so your annual (additional) deficit drops to $104bn.

What about expansion of the economy and tax base as a result of the reallocation of those dollars to consumption and investment? Do you think that a 5% increase in Gross Domestic Product is reasonable? Can we assume that that increase will be reflected in tax collections? So if tax collections increase by 5% of our now-reduced collection of $1,953 billion, there's $97mm. Dismantle the IRS and you're there.

[Superman]

Ummmmm, so whaddya think, John?

[cegerer]

"..... Dismantle the IRS and you're there."

OK, now we're gettin' somewhere! But if we have to keep the IRS, I would like to see checkoff boxes on the return. These would allow the person who is having their money stolen from them .... er, I mean "taxpayer" ..... to pick and choose where his dollars go. If you want your money spent on the military, check that box. If you want your money spent on a government bureaucrat, check that box. etc. It would sort of double as a referendum on what we should be spending money on as a country. Vote with your money.

[Superman]

And if you don't check the "transportation infrastructure" box, then you must ride a horse, on private land only?

[304065]

Super, I think I was pretty unequivocal above. I could dial up some stridency & ad hominem to fit in better here

I dont' wish to offend any members of "The Service" as my tax prof used to call it, but the fact is that our economy is saddled by a couple hundred billion dollars of what is referred to as "compliance complexity," from professional fees payable to interpret revenue rulings and the many thousands of pages of The Code (which, by the way, are ALL modifications and exemptions to the fundamental principle of income tax, which is, that every transaction is taxable). The trouble is that any time you try to propose a flat percentage tax on income, everybody has to modify the proposal to suit their particular special interest. Enough modifications and guess what, we're back at the IRC as it stands today. 10% flat tax on income means no itemized deductions, credits, adjustments or otherwise. Income from all sources, broadly defined, all fed in to the top line of a postcard, divide by ten and that's your tax.

Do you know what I would REALLY love to see? A national VAT, a sales tax on all goods and services provided in the economy, at about 17%, coupled with the elimination of the personal income tax. You consume, you pay tax. You save, you invest, you don't. Critics cry foul because it's "regressive" insofar as that 17% represents an unreasonably large chunk of the income of low income persons. What they really mean is that flat taxes eliminate the concept of "fairness," which is to punish with increasing severity the generation of wealth. Why do you think that is? Is it a religious/theological aversion? Guilt? Envy? Fear of individuals accumulating too much power?

No less a personality than V.I. Lenin proposed that imperialism would inevitably result from the need for capital to generate increasingly higher returns. Lenin didn't come up with that idea himself: he borrowed it from Schumpeter, Hilferding, Luxembourg and others, but for an old dead guy he's right: Capital, like electricity, follows the path of least resistance. Do you think it's possible to reverse the export of capital from the United States by reforming the tax climate? Could we lighten the burden on the corporate taxpayer sufficiently to the point where the return on capital was equivalent to the return with outsourced manufacturing and services?

I'm getting off the point here and into the other thread about the perils of outsourcing and protectionism, but the one thing I dont' see anyone in the Bush administration, or the loyal oppostion for that matter, articulating, is that legislation and collective bargaining DON'T work to reverse capital flight. The only thing that guides capitalists are market forces, and if you want to steer commercial activity back home, you have to use market forces to do it.

Wanna hear my theory about the impact of socialized medicine on our civil liberties? It's based on the implied consent doctrine. . .

[beepbeep]

What about 25% VAT, and progressive tax starting with around 30% for low-income and growing progressivly to around 50% for high-rollers... ?

[304065]

Is the Swedish tax climate that loose? I thought you had marginal rates as high as 90%? Could you share with us the basic structure?

[CamB]

No reason why, but this raises a flag for me:

Assuming you continue the corporate tax at 40%

I get the feeling there is some negative affect from having such a wide gap between corporate tax and personal tax rates. But I don't know why. I am thinking strange incentives.

[beepbeep]

Originally posted by john_cramer
Is the Swedish tax climate that loose? I thought you had marginal rates as high as 90%? Could you share with us the basic structure?

Nope, taxes are generally around 34% for normal middle class growing to around 50% for very high incomes.

It's all in the definition. I'll brake it down:

Assume I earn 3000$ a month. My employer will have to pay 32% of 3000$ for social security, so my brutto cost for employer would be around 4000$. Of that 3000$ I would need to pay 36% in taxes (depending on where i live), leaving me 1920$ in my pocket on the end of each month. When I go out to buy a tire for my car, I'll pay 25% VAT on that.

Company that sold me the tire owns goverment that 25% VAT or it can quit scores with VAT it payed to it's suppliers. They have to pay their employes and bills. What is left is profit and is taxed 30%. That's about it. There are intricate tax technicalities but you get the picture.

So in the way, effective taxation is high depending on how you count.

[304065]

Cam, welcome to the discussion. I agree that it looks a little strange to maintain the top corporate rate at 40% while the income tax rate goes to 10% for 25% of the filers and zero for the other 96 million filers.

The corporate tax has long been a "double" tax: you are taxed first at the entity level, and then, to the extent the corporation generates excess profits and issues a dividend, again at the shareholder level. You bought, with your after-tax dollars, a share of stock in a corporation entitling you to share in the profits of the enterprise, but first you pay the government 40%, and then you pay the government again at the dividend tax rate.

If you eliminate or significantly reduce personal income tax rates on dividends, I would argue that the double taxation either goes away, or is largely alleviated. So the shareholder doesn't feel so aggreived about being soaked on his dividend or any capital gains that result.

The flat tax has implications for corporate governance, also. In the current environment most corporations don't issue dividends, they plow back excess profits as retained earnings and reinvest in the business. You're an investment banker, right? So you have probably run the model that shows the impact on equity value of distributing the dividend vs. retaining it and committing to a positve net present value project. With a tax on dividends, the corporation makes the decision FOR YOU-- the earnings yield on an internal project doesn't have to be as high for you to realize the equivalent return from appreciation of equity value as you would have gotten if the corporation dividended out the excess cash. Does that make sense? (I'm sincerely not sure it does?)

Anyway, consider the effect of a zero tax on dividends in empowering the shareholder to be more active in reviewing the actions of the board, and the activities of management. . . Joe shareholder says, if you can't find a way to increase EPS, then give me my damn money back and I'll go find somebody who will! Management wakes up and realizes that they had better come up with some positive NPV projects or they are going to find the well drying up real fast.

The common shareholder might just start paying attention if he thought he would be getting a check every three months. Might even vote his shares differently, and a shareholder who pays attention is a damn good thing to have in the post-Enron world.

[304065]

Goran, thanks for that information. With our April 15th tax payment deadline rapidly approaching it eases the pain somewhat to consider the tax climate in the rest of the world. And given what I know you pay for gasoline and the price of a car, a Swedish Porsche owner MUST be a true enthusiast!

[beepbeep]

Yeah...a Swedish owner of rattly 930 is also know as masochist

Price of fuel around here is 5 bucks a gallon.

[CamB]

The corporate tax has long been a "double" tax

I was not aware you guys still had the double tax - we have imputation credits (called franking credits in Australia), with any dividends paid being able to carry tax credits up to the rate of the corporate tax (to the extent it was paid by the corporate). In essence, the dividend is tax free (to a level of 33%) to the investor. Probably explains why our market has a gross dividend yield of about 7%.

If you eliminate or significantly reduce personal income tax rates on dividends, I would argue that the double taxation either goes away, or is largely alleviated.

Very true.

The flat tax has implications for corporate governance, also. In the current environment most corporations don't issue dividends, they plow back excess profits as retained earnings and reinvest in the business.

Presumably as (a) there is a double-tax penalty to distributing profits, and (b) lets them build a bigger empire

You're an investment banker, right?

Sorta. Yeah. Just me and another guy now (no more big bank) so I work less. I'm investment banking-lite. I guess I'm writing a prospectus right now (when not reading this, haha), so I must be a big important investment banker Dressed in jeans and a t-shirt.

So you have probably run the model that shows the impact on equity value of distributing the dividend vs. retaining it and committing to a positve net present value project. With a tax on dividends, the corporation makes the decision FOR YOU-- the earnings yield on an internal project doesn't have to be as high

I am pretty sure this is right. Easiest way is to imagine if they instead paid the dividend and asked you to reinvest the funds in the same project (after being clipped for tax). You are obviously worse off.

Anyway, consider the effect of a zero tax on dividends in empowering the shareholder to be more active in reviewing the actions of the board, and the activities of management. . . Joe shareholder says, if you can't find a way to increase EPS, then give me my damn money back and I'll go find somebody who will! Management wakes up and realizes that they had better come up with some positive NPV projects or they are going to find the well drying up real fast.

Interesting line of thought. It could raise the bar for the company WRT to the positive NPV projects. I wonder what it does to expected returns (eg CAPM).

I think it is important to make the distinction as to who actually owns the assets - and in particular who is the marginal investor (the one in the company's mind when it makes its decisions). I see a few possibilities:

- 0% tax payers (unlikely - they don't have the money to be, in aggregate, a material owner of the stock market)
- 10% tax payers - possibly.
- mutual funds etc ----> I don't know what tax they pay? Corporate tax? Tax related to their investors?

This could make mutual funds tax inefficient if they pay the corporate rate. There could be a huge shift in the investment base.

Another thought

I guess I am also thinking about small companies etc too. Is there a strange incentive to avoid company structures to avoid tax? Does an owner/employee just pay themselves a dirty great big wages cheque and reintroduce as capital (if they want to grow the business rather than withdraw cash), rather than have positive profits and retained earnings in the company?

I guess I just get the feeling there would be some unforseen effect causing a dramatic decrease in the amount collected as corporate tax. We all know we'd start looking for loopholes if there was such a huge gap...

[campbellcj]

Today in the US, corporations pay only about 7.4% of the total federal income taxes collected, as compared with about 1/3rd forty years ago.

As a small business person I can attest to Cam's thought that many/most small corporations pay little or no taxes -- especially when one is on cash-basis accounting, it is simple to manipulate income and (deductible) expenses so as to create no taxable profits at year-end.

However, any excess salary or bonuses paid are taxed as personal income to the payees and the other mechanisms for legally "disposing" of operating profits are long term investment oriented such as Defined-Benefit plans and other tax-deferred pension vehicles.

Personally I would love to see a simplified tax structure based on a flat income tax and some kind of non-regressive consumption tax that is not severe enough to penalize healthy levels of consumer spending.

Above all, I would like to see a clear and honest accounting of where my tax dollars go!!! I paid a huge amount in personal and business/payroll taxes last year and really have no solid grasp of where it ends up, in light of our massively over bloated budgets.

[304065]

Cam, excellent point about the profile of the equity owner. Something like 75% of all equities in the US are owned not by individuals but by institutions. Most have their own buyside analysts and are light years more sophisticated than the retail investor. But our integrated disclosure system protects everyone despite the compliance costs involved.

You have convinced me on the point that a huge disparity between corporate and personal taxes wouldn't work. Nothing like the tax code to change individual behavior.

Does an owner/employee just pay themselves a dirty great big wages cheque and reintroduce as capital (if they want to grow the business rather than withdraw cash), rather than have positive profits and retained earnings in the company?

There's the rub. The corporation owner pays himself a salary of $49,999, expenses it at the corporate level so he pays no tax, then reintroduces the same dollars in the form of additional equity investment in the company. It only works if he has the control necessary to do it, however. We also have flow-through entities here- the partnership, which "flows through" the profits of the enterprise to be taxed at the marginal rates of the individual members of the partnership-- and our LLP and LLC, and "Subchapter S" corporation qualify for the same tax treatment. We would either have to eliminate those entities from the code, or run the risk that our corporate tax collection would be a lot lower than expected due to the loophole.

Hmm, this flat tax stuff requires quite an overhaul of the way we do things. What started out as a political bait has become a global finance discussion!

Hmm, I'm looking out the window at the Empire State building from 42 floors up wearing a necktie that's too tight, you are writing a prospectus wearing a t-shirt! What does it take to get a Visa to work THERE?