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 Richmans' Trade and Taxes Blog

Taxing Corporations As Partnerships Solves the Problems of Inversions and Outsourcing
Raymond Richman, 9/24/2014

Treasury Secretary Jacob Lew announced tightened tax rules to deter U.S. companies from moving their headquarters overseas to lower-tax countries, a practice called an inversion. Inversions sometimes take place to avoid paying taxes on the acquired company’s income which before the inversion paid taxes only to the country in which it has its headquarters. An inversion is not to be confused with outsourcing, the practice of closing factories and operations at home and manufacturing products and parts overseas. Outsourcing not only affects tax   revenue but it also causes massive unemployment here at home, and worsens our balance of trade. Inversions do not. Hardly any jobs have been lost by inversions in contrast with the loss of hundreds of thousands of jobs lost by outsourcing. Oddly, the administration has taken no action on outsourcing.

Nearly all the leading American corporations engage in outsourcing, including Apple, Nike, Honeywell, Caterpillar, Hewlett-Packard, Motorola, IBM, NCR, Lev-Strauss, and many, many others. Most, like Apple, add insult to injury by importing the products they produce overseas, worsening the U.S. trade balance. Inversions have little effect on employment and no effect on the trade balance. Why the Administration’s silence about outsourcing? One might hazard a guess. The Treasury Secretary’s silence perhaps can be explained by domestic politics.  Many of the corporations, their owners, and their trade associations contribute to the Democratic Party and the US Chamber of Commerce and the National Association of Manufacturers officially espouse free trade.

As an illustrative case, take Burger King’s inversion with Jim Hortons of Canada. It does not reduce U.S. revenues at all from Burger King’s and Tim Hortons’ operations in the U.S.. All the Burger Kings and Tim Hortons in the U.S. will continue to pay U.S. and state corporate income taxes. Admittedly, the movement of Burger King’s headquarters will cost the U.S. tax revenue and Canada will gain some. Canada’s top general corporate tax rate is 28 percent (but see below) compared with the U.S. 35 percent, so Burger King would stand to lose from the merger if Tim Hortons’ income were taxed at the U.S. 35 percent rate. The real culprit is a foolish U.S. income tax system.

The U.S. Congress and the Obama Administration in their arrogance want to tax Tim Hortons (now Burger King’s) Canadian operations at 35 percent, the U.S. corporate income tax rate. (In addition, the states have rates ranging from zero to Pennsylvania’s 9.99 percent.) The Canadian general corporate income tax rate is 28 percent but manufacturing and processing corporations are taxed at only 15 percent currently. Canada’s principal provinces levy corporate income taxes of 10 to 12 percent.  Canada reduced its corporate income tax rates from 38 percent to enable Canadian companies to compete with such countries as Ireland which has a 15 percent corporate income tax rate, Canada’s current rate on manufacturing corporations.

Most countries have a territorial basis for income taxation and do not tax the foreign income of their companies; we do. All countries are entitled to tax the income earned within its boundaries. But the exercise of an extra-territorial right to tax income earned abroad appears on its face to be arbitrary and unjustified. An apparent, but inferior solution to the inversion and outsourcing problem would appear to be for the U.S. likewise to adopt a territorial basis for income taxation. That would eliminate the incentive for an American companies to move their headquarters to a lower-taxed country. But Congress and the administration want to avoid reducing the corporate rate to, say, 15 percent to solve the outsourcing problem because it would reduce the revenues from the corporate income tax by more than half. What is wanted is a solution that maintains the total level of revenues. And there is such a solution.

The solution is to eliminate the corporate income tax, which many economists believe to be an abomination anyway (see below) and to tax corporate earnings under the personal income tax, just as we do partnership earnings. A zero corporate income tax rate would be a tremendous stimulus to exports, improve the trade balance, and create millions of jobs. The net effect would be to increase rather than decrease total tax revenues.

The revenue from the federal corporate income tax in 2013 was $384.9 billion and total corporate profit in 2013, according to the GDP accounts, was $1,703.8 billion, an effective rate overall of 22.59 percent. The maximum personal income tax rate was 39.6%, effective at a taxable income of $406,000. The rich, who own most of corporate wealth, would pay much more in taxes if corporate earnings were to be taxed under the personal income tax. Note that dividends are a small share of corporate profits. The taxation under the personal income tax of dividends is one reason why corporations prefer to buy back their shares and pay no dividends at all. The top one percent of taxpayers own 35 percent of all corporate stock and 35 percent of $1700 billion is $595 billion, much more than the $385 billion in corporate income tax receipts.

But there are other reasons for abolishing the corporate income tax besides eliminating the incentives for inversions and outsourcing. One of most closely guarded secrets from the public is that economists believe that shareholders bear only part of the burden of the corporate income tax; some of the burden falls on customers of the corporation and some on employees, the proportion of the burden on each group varying depending on the industry. In manufacturing industries, because they compete with foreign manufacturers, the burden is almost entirely born by the workers.

The corporate income tax is probably a major cause for the making of so many millionaires and billionaires. In enabled Warrant Buffett to proclaim in 2012 that his rate of personal income tax was less than that paid by his secretary.

I am urging that the earnings of corporations be taxed by the personal income tax just as the earnings from partnerships are taxed by the personal income tax. Corporate earnings were taxed as personal income under the United Kingdom’s Income and Property Tax for centuries until they copied the foolish U.S. corporate and personal income tax provisions after WWII. Too bad we did not copy the British instead.

Corporations are, after all, just another name for what is called a limited partnership. Today limited liability partnerships and limited liability proprietorship are legal in most, if not all, states. The nonsensical argument that a separate corporate tax is justified because the corporation is an artificial entity, applies equally to limited liability partnerships (LLPs) and limited liability proprietorships (LLCs). What is “artificial” about them? They are owned by shareholders, partners, and proprietors. 

Eliminating the corporate income tax and taxing corporate earnings as personal income would not only eliminate the incentive to invert and outsource and make the overall tax system more progressive, it would enable a reduction in the rates of personal income tax, U.S. corporations would become more competitive in foreign trade, and foreign investment would be attracted to the U.S..

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Comment by , 11/13/2015:

Correct, but why don't corporations just convert to LLc's?  No new law needed.

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