Sunday, January 31, 2010

Corporate Tax Reform

At the risk of sounding like a liberal, I am advocating a major overhaul of our corporate income tax system with some minor changes to our individual tax system. Recent history of corporate growth has demonstrated that failure of Corporations can have a devastating effect on all stakeholders, thus the notion of too big to fail. The solution I advocate is to encourage some of them not to exist.

The affairs of state should be financed by all and accordingly be borne proportionately to each entities means or abilities. Think of a small town or city living on a river bank when a devastating flood is imminent. Would you not expect every able body to help with a new dyke. Would not the 250 pound muscular football player be expected to fill more and bigger sandbags than the feeble elderly wheelchaired or infant child. This is why we have a progressive tax system and hopefully will remain so for some time as long as both sides of the equation are fair and not too cumbersome. Our income tax system has generally followed the simple formula of I x R = T (Income times Rate equals Tax). The clearest part of the formula for both Corporate and Individual tax is the Rate side and only requires a few pages in the tax code. The complex side is the “I” side. Volumes of codes are expended here and inconsistencies further included as the “soak the rich” crowd inflict their disdain for prosperity.

Currently, federal tax revenues come from Individuals about 79% Corporations 19% Estate taxes 1%. Within the 79% individual portion there is an undetermined percent attributable to sole proprietors and Subchapter S Corporations. I see no reason to change this overall distribution burden but we need some long term tinkering that would help economic growth and fairness. However, the current provisions for the alternative minimum tax for both corporations and individuals should be eliminated.

My Suggested Corporate Brackets

Bracket      Over                   But not Over                      The Tax Is                    Of the Amount Over
1st           $0                          $500,000                                5%                                    $0
2nd       $500,000                $5,000,000                    $25,000 + 15%                         $500,000
3rd     $5,000,000              $25,000,000                  $700,000 + 25%                      $5,000,000
4th    $25,000,000            $100,000,000               $5,700,000 + 40%                     $25,000,000
5th   $100,000,000          $1,000,000,000           $35,700,000 + 55%                   $100,000,000
6th  $1,000,000,000                                          $530,700,000 + 70%                  $1,000,000,000

Present Corporate tax brackets:
1st           $0                         $50,000                                  15%                                            $0
2nd       $50,000                  $75,000                           $7,500 + 25%                                 $50,000
3rd       $75,000                  $100,000                        $13,750 + 34%                                 $75,000
4th       $100,000                $335,000                         $22,250 + 39%                                $100,000
5th       $335,000             $10,000,000                     $113,900 + 34%                                $335,000
6th    $10,000,000           $15,000,000                     $3,400,000 + 35%                           $10,000,000
7th    $15,000,000           $18,333,333                     $5,150,000 + 38%                           $15,000,000
8th    $18,333,333                                                     $6,416,667 + 35%                          $18,333,333

The proposed new definition of corporate taxable income would allow for the deduction of dividends paid to investors. At the same time all interest earned on federal securities would be exempt from taxation for all investors. This change would encourage a reasonable return of 2% +/- plus inflation rate on federal securities driven by a free market as opposed to an irrational discounted rate as is currently offered. Our debt would be less attracted to foreign investors who pay no taxes but this country should have the wealth to finance our own debt. Furthermore, the 70% exclusion of dividends should be ended except for wholly owned (or consolidated) corporations and those entities that required funded investments for ongoing long term liabilities or reserves for unearned premium and losses such as insurance companies or funded warranties. These changes would enable the dropping of the 35% excess accumulated earnings provision which is never enforced in the first place probably due to vast array of loopholes.

The proposed 4th through 6th brackets could be adjusted up or down once the Congressional Budget Office scores the over all impact on federal revenues The amounts within each bracket could be changed every 5th year based upon the cost of living index or inflation. If the above bracket system is adopted the following changes should occur as the business community understands the impact.

First, most Sub S corporations will elect (and should be allowed to immediately elect) to be treated as a regular (Chapter C) corporation.

Second most new jobs, innovation, research come from the small and medium size companies who are in the first four brackets, Generally the management in these companies understand their products, processes and service far better than the super large multinationals and can react to change much quicker as the latter group become too bureaucratic and as governmentally inflexible. Some of this group like GE liken themselves as partnering with the world governments. Business has to have confidence that reasonable regulations and tax policy will continue not only in the current administrations but beyond before committing to expand the workforce and to make capital commitments. When this confidence resumes in our capitalistic sector unemployment will shrink to the lowest level realistically expected.

Thirdly, the stockholders and directors will, see that spinoffs of unrelated activities is in the best interest of all stakeholders. Just as the breakup of AT&T resulted in many new successful enterprises even while letting the weakest new entities like Agere and Lucent fail, the results was an explosion of new consumer products and no bailouts or governmental recues were required.

Fourthly, corporate governance will start thinking long term again instead of quarterly results. Sadly, the powers that be in large corporations like GM convinced themselves that they could operate best by turning their workforce over to unions. Most successful new companies see the value of treating their employees well. They then try new approaches like automation first by studying the best practices of those like the Asian auto makers. They avoid unsound accounting practices like booking as an asset future tax savings from unrealistic operating loss carryovers. These companies do as little research as possible preferring to grab like vultures the assets of start up companies like Oni Medical Services, Inc (Maker of innovative MRI for extremities that will cost about 1/4th their own MRI). What is GE protecting? They surrender to political correctness as opposed to educating the public on products that will benefit society as a whole, while making big profits on both extremes (Wind and Nuclear energy)

Finally, companies like Berkshire Hathaway will on their own cease to exist. Mr. Buffet likes to stress that his secretary’s combined income and payroll tax rates is greater than his own. Indeed that is true, for his game through Berkshire is like a mutual fund that isn’t required to pass through to investors earnings and realized capital gains. His entity exist to accumulate wealth that will be passed on to the investor heirs or causes that they supports. Few jobs are created or consumer prices decline because of that kind of growth. Yes Berkshire does pay taxes about 29.7%, and his stockholders can use their investments with him as collateral for low interest loans if they have the need for leveraged funds. They do not pay taxes on Berkshire dividends as none are ever paid. The original founders of the small closely owned organizations like Nebraska Furniture Mart & Borsheims Jewlery will always be able to cash in by either going public or find other deep pockets willing to invest or even Employee Stock Ownership Plans (Peter Kiewit & Co) Burlington Railroad will not have to pay any dividends and I doubt if our nation will sees any reduction in fright cost due to this latest megapurchase.

The Estate and Inheritance taxes are about to expire in 2011. Some advocate that this tax should cease all together. I would prefer that it continue but with much higher exclusions for individual beneficiaries . Either index for inflation or using a multiple of 60 times the individual poverty level for each named beneficiary. Restricted Foundations should be limited to $10 Billion. Then the taxable estates should be taxed using the last three brackets of 40%, 55% and 70%. These funds would be ear marked to fund retired Medicare recipients who will need to be weaned from that ill begotten program and who start their own Medical Health Savings accounts by accepting 75% of average current Medicare Advantage plan contracted “subsidy”!.

On the individual side the same last three brackets should be applied to individuals whose income reached those levels. I am sure George Soros and his fellow hedging managers would not missed the tax or perhaps they would rather have the 91% bracket reinstated. Ownership of domestic corporations could be encouraged by allowing these savers to exclude dividends for the initial amount equal to the current poverty level.