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Burger King Inversion Has No Effect on U.S. Revenues, But the Corporate Income Tax Should Be Abolished Regardless
Raymond Richman, 8/27/2014

The purchase of Tim Hortons, a Canadian restaurant chain, by Burger King, an American restaurant chain, is making news as a so-called inversion, a term used to describe a company’s moving its headquarters abroad to avoid paying U.S. taxes on its foreign income. The Canadian effective corporate income tax rate on manufacturing and processing corporations is 15 percent currently but the provinces levy an additional 10 to 16 percent rate. The top U.S. rate is 35 percent and the states levy corporate income taxes ranging up to 9.9 percent in Pennsylvania and 8.84 percent in California. Burger King does not stand to save anything by moving to Canada but it will avoid an increased tax liability to the U.S. when it buys Tim Hortons by moving its headquarters. At present, the U.S. gets no revenues from Tim Hortons

President Obama and the Secretary of Treasury Lew have called inversions unpatriotic. You be the judge. Inversions cost no revenues. Compare that with out-sourcing abroad which not only affects revenue but causes massive unemployment here at home and increases our trade deficit. Why the fuss about inversions and none about out-sourcing. And nearly all the leading American corporations do it, including Apple, GM, and other administration favorites. But out-sourcing is another story.

All that Burger King, and Pfizer and others appear to want is to avoid paying an increase in the taxes on the combined company than the two pay at present. The administration wants to increase those taxes, a desire to tax American businesses on their incomes regardless of where it is earned. Hypocritically, Congress and successive administrations have granted an exception for individuals (who vote!) who do not have to pay personal income tax on what they earn abroad as long as they are out of the country for eleven months per year. Thanks to the eleven months provision practically none of the employees of cruise ships patronized by Amearicans mostly are Americans!

A solution to the inversion problem would appear to be for the U.S. to adopt a territorial basis for income taxation. That would eliminate the incentive to move one’s headquarters to a country that employs a territorial system. But if the corporate rate is lowered to Canada’s 15 percent or to Ireland’s 15 percent, the yield of the corporate income tax would be diminished to practically nothing. And that is what the administration wants to avoid. So what is needed is a solution that maintains the total level of revenues. There is one.

The solution is at hand. End the corporate income tax and tax corporate earnings under the personal income tax. The maximum corporate income tax rate is 35%, but the maximium personal income tax rate is 39.6%. At present only corporate dividends are taxed as personal income (at a reduced rate of tax!) and retained earnings go untaxed as personal income. The rich, who own much if not most of corporate wealth would pay much more in taxes if corporate earnings were to be taxed under the personal income tax whose rate on incomes above $406,000 is 39.6 percent, 4.6 percent more than the top corporate tax rate. We proposed taxing corporate earnings as the income of the corporation’s shareholders under the personal income tax and have no corporate income tax at all. There is a good case for doing so. And there is ample precedent for this treatment. The earnings of partnerships are taxed as the personal income of the partners on the basis of their share of the partnership’s earnings. And corporate income was taxed in this fashion under the United Kingdom’s income tax for centuries until they copied the foolish U.S. income tax system after WWII.

Corporations, as an artificial entity do not bear the burden of the corporate income tax; the individuals who own it bear the burden and most  economists believe a large part of the tax is passed on to consumers in the form of higher prices and to employees in the form of lower wages. The excuse often cited for the corporate income tax is that shareholders enjoy limited liability but limited liability partnerships and proprietorships now exist in most if not all the states. Why not tax shareholders as we do partners, which in fact they are, co-owners of the business? It works for partnerships. It would work equally well for corporations.

Congress believed that corporate dividends are taxed twice, once by the corporate income tax on earnings and then by the personal income tax on dividends. That is the reason given for taxing dividends at a lower rate than “ordinary” income under the personal income tax (15%). But, in fact, economists are not sure how much of the burden of the corporate income tax is borne by shareholders and how much by consumers of the corporation’s products in the form of higher prices. Some even believe that employees bear some of the burden in the form of lower wages. If these are right and much of the burden of the corporate income tax is passed on to consumers or employees, all the more reason for ending it as a separate tax and for integrating it with the personal income tax, the burden of which we know falls on those who pay the tax.

How do we ensure that total government revenues will not suffer?

In recent years, corporations have engaged in the practice of buying back their own common stock to avoid declaring dividends which are subject to personal income tax. Buying back their own stock raises the price of the remaining outstanding shares and creates an accrued capital gain which shareholders can realize paying the lower rate of tax on capital gains (20%). There would be nothing to be gained if realized gains that are consumed are taxed at the same rate as wages and salaries, interest or rental income. They should be. The conversion of ordinary income into capital gains has become an art form. Corporations often pay their executives a bonus in the form of stock options. This enables them to retain the stock options until the price of the stock has risen, enabling their sale as a capital gain and taxable at the lower capital gains rate. So we need to reform the tax treatment of capital gain. Since more capital gains will be taxed at higher rates, revenues will increase.

Closing some of the loophholes in the current personal income tax would increase the amount of revenues substantially. Following are some of the more egregious.

  1. Realized capital gains that are not promptly reinvested should be taxed as ordinary income and not at reduced rates. The revenue gain from eliminating this loophole would amount to many billions of dollars.  
  2. To reduce current corporate tax liability, corporations are encouraged to take depreciation as rapidly as the law permits. This means that they pay a lesser amount of tax in the early years than they will pay after the asset is fully depreciated. So long as one retains the depreciated asset, the taxpayer will pay more or less the same total amount of taxes over time. But this practice is abused, particularly in the case of buildings such as office buildings, hotels, and other rental properties. When the depreciation allowances end or are about to end, the owner is encouraged to sell the property and realize his depreciation in the form of lower-taxed capital gains, while the buyer is permitted to depreciate what he paid for the building all over again. The Empire State Building has probably been depreciated several times, and hotels frequently change hands and are depreciated over and over again. From the point of view of the economy, depreciation should only be taken once. The revenue lost is substantial, billions of dollars per year.
  3. Under current law, the sale of one’s home held for a period of time usually results in a capital gain, which under current laws is untaxed. If one realizes a capital gain and reinvests the proceeds in another home, the capital gain should indeed not be taxed under the general principle that a capital gain should not be considered realized if the proceeds are promptly reinvested. But if the capital gains is not reinvested in a house, income tax should be paid on the gain. We do not know how much revenue this change would produce but it is believed to be substantial.

Economists have suggested changes in deductions for interest, state income taxes, and gifts that would increase revenues substantially. These are appropriate for Congress to consider.  In sum, there need be no loss of revenue from the elimination of the corporate income tax and its integration into the personal income tax.

And there are other economic benefits arising from the elimination of the corporate income tax. It would make U.S. corporations more competitive internationally and improve our trade balance. It also has the advantage of increasing the progressivity of the personal income tax without interfering with its interpersonal equity. It would end the double taxation of any corporate income. It would satisfy economist’s doubts about who bears the burden of the corporate income tax. It is hard to think of any arguments in favor of a corporate income tax.

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Comment by Jesse, 8/28/2014:

I'm not so sure that the inversions have no effect on US tax revenues.  See for instance

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

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