Reduce Corporate Taxes with Tax Neutrality

Why do we always want to kill the Golden Goose? Short-term thinking; stupidity; swayed by big money?

Let’s first look at the building of America and Canada in a historical perspective, then try to figure out who is controlling whom?

The Industrial Revolution in England and Europe was well under way at the time immigrant populations moved to North America, bringing inventions, vitality and the spirit that would ultimately create two new nations, Canada and the United States.  With new populations arriving labor was abundant, and once farming was able to produce a consistent food supply, surplus labor turned to trade shops and new factories.  Business corporations had already been operating for more than a century (the oldest; still operating corporation in the world, The Hudson Bay Company that now owns Saks Fifth Avenue, and others, was registered May 2, 1670 in London, England).  With the birth of a new country and a framework of laws, new businesses started to flourish; and with a new central bank providing stability, the modern corporation emerged.

So, what is a corporation?  It is a legal entity where any group of owners can get together and act as a singular person, and that singular person can do almost any thing that an individual can do. That singular person we call a corporation, and it can enter into contracts, loan or borrow money, hire employees, own assets, pay taxes and it can sue or be sued.  A corporation is considered a legal person, with the primary difference being that it enjoys a “limited liability”.  What that means is the owners of the corporation are not responsible for the acts of the corporation and are not held personally liable for the company’s debts.  The owners or shareholders have the right to participate in the profits through dividends and the appreciation of stock value, and their total risk is limited to their investment.

As the country grew so did the growth of corporations, being the preferred legal structure to operate almost every type of business.  Today, government employees at all levels and corporations that range from small personal corporations to the multi-nationals employ the largest segment of our economy.  We are salaried employees, and corporations are our employers, so until some better concept of working and living comes along, we need to preserve and protect that relationship.

Selling and distributing product also required we expand our transportation and infrastructure systems.  This meant we needed to expand government in order to build bridges, roads, water, sewage and electricity.  Those projects require money and to pay for it we brought on ourselves a personal income tax that started in 1913 in the United States, and 1918 in Canada.  Then we remembered the corporation is also a legal person, so we decided to tax it as well.

As sales grew for our corporations, they were able to pay their employees, spend more in plant expansion, develop new methodology, train new workers and after all expenses were in, they paid tax on their profits.  Just like an individual.  These after-tax profits could stay in the company bank account as reserves to be used during economic downturns, or to expand their business by building more plant and equipment.  The cost of that new plant and equipment can be deducted from future sales, so the original investment from profits is not taxed again.  As the company grows and as it accumulates more reserves in the bank than it needs, the company will ultimately start paying dividends to its shareholders.

A profitable company usually has significant value, and along with that wealth comes economic power to the owner or major shareholders.  The wealthy are usually better connected with their bankers and politicians, and their voices are heard when they lobby for policies that make things easier for their business interests. It is little wonder then, that preferential taxation rates on capital-gains and dividends have survived every attempt at tax reform, as major investors argue that since the corporation pays tax, the investor should not be taxed again.

We will come back to individual taxation of dividends and capital gains, but let’s first look at corporate tax issues.  Corporate tax rates went up to about the fifty percent level in the early 1950’s and stayed there until approximately 1985, near the middle of Ronald Reagan’s term as President (1981-1989).  Until that time there was virtually no linkage between corporate tax rates, corporate profitability, or jobs.  However, linkages began to shift around the 1980’s, for several reasons.  Prior to the 1980’s, corporations and their managers were in closer touch with their employees as well as their shareholders, and that made them better corporate citizens.  Computers the size of telephone booths were becoming more affordable and available to businesses by the mid 1970’s, and when Bill Gates introduced MS-DOS in 1981, giving birth to the early desktop computers; this change in technology began to have an impact on corporate business decisions. President Ronald Reagan (1981-1989), and his “Trickle Down” economic plan for increased globalization started a trend that has seen the largest loss of America’s industrialization.  High interest rates had finally broken the back of inflation, and rates began their decades long decline after hitting the peak in June 1981.  These factors and a few others became a perfect storm.  Corporate tax rates fell to thirty-five percent in the U.S., however they remained there while most other countries in the world were reducing corporate tax rates.

A new breed of corporate executives were coming out of MBA programs and they began running businesses based on numbers, and computers gave them the answers they wanted to see.  This became the birth of financial engineering, as technology and government policy allowed products to be easily produced offshore, with greater profits flowing to the bottom line.  Before long it became a game of moving corporations offshore to take advantage of lower corporate tax rates.  A shell game, one step ahead of everchanging regulations.  As of 2016 the U.S. corporate tax rate at thirty-five percent is the third highest in the world, and that is a significant incentive to move to another country.  Canada is not far behind as their provinces add their own corporate tax, which together add up to about thirty-two percent. Corporations no longer have allegiance to any country, as MBA managers are now global in their thinking.  Citizenship means nothing to the corporation.

When a corporation moves to another country, we kill the Golden Goose.  Investment in new plant and equipment flows to that new country.  Jobs are at the factory and stay out of the U.S.  Profits that remain offshore are not taxed in the U.S. until the money comes back to the U.S., usually in the form of dividends.  Apple Corp. a couple of years ago wanted to pay a significant dividend to it’s U.S. shareholders but didn’t want to pay the tax on it.  They felt with interest rates still fairly low, that they would borrow one-half billion dollars and use that money to pay the dividends.  I don’t know why the Treasury Department would allow borrowed dollars be substituted for profit dollars; probably more financial engineering.  I suspect Apple’s strategy is to repatriate those profits and pay off the loan at some future time when U.S. corporate tax rates are lower, which President Trump has promised to do.  If that happens, I hope it would be a permanent reduction and not another short-term amnesty like President Bush instituted in 2004-2005 when he temporarily reduced the tax rate to 5.25 percent.  That plan was sold to Congress as the Homeland Investment Act, with the intention of stimulating investment in America, building plants, increasing research and development and creating new jobs.

As any Business 100 student will tell you, corporate managers do not make long-term investment decisions based on a short-term change to the tax code.  The result was predictable, with approximately 92 percent of the $300 billion that came back to the U.S. being spend on corporate share buyback programs and increased dividends.  Making matters worse, wealthy shareholders still received a preferential tax rate on the dividend, and the middle class with most of their stock held in 401(k) plans, couldn’t get the same advantage.

Interest rates during this period were coming down, but they remained high for some time and with inflation under control, wages were not going up.  Without wages going up workers didn’t feel they were getting ahead, but an open border policy with Japan and later China under the guise of free trade that was really unfair trade, kept prices low and some prices going lower.  Politicians felt if slow growth was stagnating salaries, that cheap foreign products would keep their constituents happy as they were able to maintain the same standard of living.  U.S. trade negotiators sometimes shot themselves in the foot as they make a trade deal trying to stimulate an industry, that ultimately put another one of our industries at risk.  The Japanese at that time had the equivalent to the economic Gatling gun; highlighted in the novel ‘The Level Playing Field’ …a shameless plug I know, but a lot more interesting to read than this non-fiction on taxes.

Part of the solution in bringing jobs and corporations back to the U.S. and Canada, is to eliminate the primary factor that is keeping them away; high punitive corporate taxes. Don’t tax the Golden Goose; tax the income received at the individual level.

To illustrate the power of that one change, we need only look at the recent history of Ireland.  At the start of the 1990’s Ireland was a poor country by Western European standards, with high poverty, unemployment, inflation and low growth.  By 1995 and through the year 2000 the annual growth rate was almost ten percent, and it still grew by over five percent per year through 2008, before the global recession hit.  The cause of Ireland’s sudden transformation into one of Western Europe’s wealthier nations during that period, is subject to some debate, but the catalyst was most certainly a targeting of foreign direct investment and a low corporate tax rate of 12.5 percent.  Being a part of the EU didn’t hurt either, but with friendly business conditions they were able to attract many international corporations to move their head offices into Ireland, and with an English speaking educated workforce, manufacturing grew as well.

Corporate citizenship can be changed with a lawyer’s pen, and if we push them out of country, we are taking away jobs and hurting our constituents, ourselves.  Bottom line is that few people enjoy paying taxes, but individuals will pay if they have the income.  Let’s attract more jobs, and make sure we have that income, whether it be by salary, income, dividends or capital gains.

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