After hearing the drivel that president Obama put forward today about how to start the economy, I thought it was time to bring out again some of the ideas about how we could actually achieve that. I have written about many such items in the past, but each deserves another view. First on the list is changing corporate taxation from an income tax to a consumption tax.
In order to understand why we need to change corporate taxation, you need to know a few background facts.
1) The American corporate income tax is extremely complicated. There are a myriad of provisions. Those provisions have loopholes, and those loopholes in turn have exceptions. The code has developed over many decades, during which time armies of lobbyists have snuck one or another items into law. There are provisions that apply only to one company whose lobbyists were successful. Often, two companies in the same industry get different tax treatments just because one had better lobbyists in the past. Because of the complexity, no one really understands the entire tax law.
2) Each year, the US imports about two and a half trillion dollars worth of goods. This is equal to about 18% of GDP.
3) Many privately held corporations are taxed under Subchapter S of the tax code which means that taxes are paid on the individual income tax returns of their owners. The effect of this is that the earnings of private companies are taxed once while the earnings of public companies are taxed first at the corporate level and then again when dividends are paid to the owners. The dividend rate is currently set at a 15% maximum.
4) Companies that operate outside the country pay taxes in the places where they do business. If the after tax profits are then brought back to the USA, they are taxed again, this time by America. As a result, an estimated one trillion dollars is held by American companies overseas. It is kept outside the USA, so that no tax need be paid to Uncle Sam. As a result, this money can only be used for futher investments abroad. In short, the US tax policy encourages these companies to create jobs anywhere but in the USA.
5) There are treaties which prohibit or regulate certain kinds of taxes. Probably the most common limits are on tarrifs, i.e. taxes on imports.
So what is the proposal? Let's do away with the American corporate income tax and replace it with a business consumption tax. This tax is akin to the value added tax which is prevalent in Europe. Basically, each time that a company buys goods or services, it will pay something like a sales tax on the value of what it buys. I will not go into all of the details as to how the tax is structured; suffice to say that all businesses would pay the tax and that it would be set at a level that could actually increase the revenue obtained beyond that which came from the corporate income tax. There would be no exceptions; every business would pay it.
Here are the benefits of such a tax.
1) All of the loopholes and gamesmanship incorporated into the old corporate income tax would be gone. General Electric could no longer earn billions while paying no taxes. Everyone would be treated exactly the same. The system would be very simple.
2) There would be a big benefit to items manufactured in the USA. Right now, imports are sold in the USA with no tax being paid. If a company buys parts manufactured in China, those parts enter the country tax free. If the same company buys the same parts manufactured in the USA, the manufacturer pays 35% of its profits in taxes. This gives the Chinese company a big advantage over its American rival. In essence, the current tax structure subsidizes foreign companies that compete with Americans. The consumption tax would immediately end that advantage for the foreign manufacturer. This change alone should lead to increased growth in the US economy.
3) Since some of the revenue would be coming from taxes on 2.5 trillion dollars of imports each year, the taxes that come from activities in the US could be reduced. Even with that reduction, however, the government could take in more revenue from the bigger tax base provided by including the imports. The change would promote economic growth while also increasing government revenue.
4) Exports from the US would not be subject to the tax. This would also promote the growth of exports manufactured in the USA.
5) Since there would no longer be a corporate income tax, there would be no need to have subchapter S taxation. As a result, the current advantage to private companies would be gone; all would be equal. Also, the current mixing of business and individual taxes would be removed. Changes to the individual rates would no longer impact the small businesses of America as is currently the case. It would make simplification of individual taxation a much easier task.
6)The trillion dollars held abroad would now be able to come home to the US without penalty or tax. This would provide a ready pool of investment cash which would, in part, find its way into investments in America that would promote growth and increase jobs.
7)The consumption tax is proper under all of the international treaties.
So, here is one piece of a plan that ought to be put forward by a responsible leader in Washington. It would have far reaching and positive effect on the US economy. It would help close the federal deficit both by bringing in higher tax revenues and by promoting growth. It would be much fairer to everyone by erasing those gains achieved in the past by companies with crafty lobbyists. It would simplify the tax code and reduce the costs that companies spend for compliance, another major benefit.
I doubt that I will hear that Obama is in favor of such a deal. After all, it does not depend on a class warfare view of taxation. Rather, it is a change that would benefit all Americans. Nevertheless, one should always keep in mind that there are many such ideas that could be put into place to help the economy. Not everything is tax cuts or spending increases.
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