Thursday, December 2, 2010

Double Taxation in Bowles-Simpson Tax Reform Plan Vitiates Lower Corporate Tax Rate

Erskine Bowles and Alan Simpson released their revised report, entitled “The Moment of Truth,” on December 1, 2010.  Section II deals with tax reform.

Most tax reform plans aim to broaden the tax base by eliminating tax expenditures (deductions, exemptions, credits) and lowering marginal tax rates.  Bowles-Simpson fits this mold.  The illustrative fully phased in individual and corporate tax reform plans appear in figures 7 and 9.

The individual plan calls for three brackets of 12%, 22%, and 28%; the latter is a reduction from the current top marginal rate of 35% or 39.6% if the Bush rate reductions are permitted to expire on December 31, 2010.  Lower rates reflect the elimination of itemized deductions and reductions in the tax benefits of employer provided health care insurance, mortgage interest, and charitable giving.  Taxes would rise on capital gains, dividends, and interest (municipal bonds), which are treated as ordinary income.  (Other details are discussed in the report.)

Corporate tax reform establishes one bracket of 28%, down from the current 35% for large enterprises.  Another benefit is that corporate taxes would be assessed on a territorial system, which means that income of foreign subsidiaries is not subject to U.S. tax.

The international competitiveness of a lower corporate rate is not what it appears to be.  A corporation is simply a legal entity that allows the income of the owners of the business to be taxed and collected at the business level.  Taxing that income at 28% means that after-tax income is 72%.  If the corporation pays all its income as dividends, that income would be taxed a second time, as high as 28% for top-rate taxpayers.  Multiplying 28% times 72% yields another 20% in tax, for a total of 48%.  Similarly, if the business retains all earnings, capital gains tax of 20% is the equivalent of a second tax on retained earnings (72% times 20% equals 14.4%), yielding a potential top rate of 42.4% on corporate income.

The current top rate on corporate income is 35% on profits.  The preferential treatment of capital gains, assuming all earnings are retained, is 15% (individual capital gains rate) times 65% (after-tax income), which equals another 10%, for a total of 45%.  The same calculation applies to dividends if all after-tax earnings are distributed.

For top-bracket taxpayers, the Bowles-Simpson combined corporate and individual reforms do not improve the after-tax return on corporate income.


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Jmanlefty said...

Sir, you're mulling corporate taxation with individual taxation! You talk about "double taxation"? Corporate tax is mainly paid by "customers of the corp", not that much by execs, employees, and shareholders! Treating "individual investment income" as ordinary income, is a good idea!

Getting rid of loopholes and subsidies for corporations, yet lowering their rates, creates jobs. Bowles/Simpson is a good plan!!

Your combining and compounding "corp tax" with "individual tax" is the great fraud, perpetrated by neo-cons for years!

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