Corporate Taxes Are Broken—But Don’t Look to Smaug (I mean, Trump) for the Fix

2017-04-27 – So we’ve now got an outline of tax reform according to Trump.

There’s nothing really new here. It’s standard Republican tax reform. Huge breaks for the hoarding class sweetened with an increase in the standard deduction to throw a couple hundred dollars at the peasants. But don’t worry, Smaug (I mean, Trump) has ways to get more than that couple of hundred back.

If you are a fan of the Hobbit, you know that Smaug was a dragon who had invaded the dwarf kingdom of Middle Earth. His main characteristic was plundering the gold of the kingdom. Smaug didn’t create jobs with the gold. Instead he amassed in in a great pile and slept on it.

Trump is merely the latest GOP dragon to attempt tax reform aimed at increasing the pile.

With that background, I want today to talk about reforming corporate taxes. Trump proposes to reduce the corporate tax rate to 15%. This would be down from a top rate of 35%. A Yuge drop.

Considering how I introduced this topic, you might think that I am totally opposed to this. But I’m not. The system of taxing corporate profits is quite weird and efforts by corporations to minimize their taxes make it even weirder. The system needs to be reformed. The Obama administration thought corporate taxes needed to be reformed, but given the politics at the time, there was no chance of that happening.

Here’s how corporate taxes work.

If a corporation makes a profit, it pays a tax on that. If it has a loss, of course, there is no tax; no profit, no tax. It can then take that loss and apply it to past years to get a refund of past tax or to future years to eliminate or reduce taxes in those years. It’s called a “net operating loss carryover.” The overall effect of the tax and the net operating loss carryover on corporations is to reduce the swings in their after-tax incomes—it reduces profits, in the year of profit and it reduces losses in years of loss.

Now, let’s say the corporation made a profit and pays the tax on that. When it pays dividends to its shareholders, the dividends are taxed. People who are opposed to taxes call this “double taxation” because the money was taxed once at the corporate level and a second time on the shareholder’s individual tax return.

Needless to say, there are a ton of deductions and credits that allow corporations to manipulate the amount they end up paying. For many large businesses, a favorite strategy is to park their profits outside of the United States so they won’t be taxed.

There’s one other thing you need to know. Smaller businesses can skip all this entirely. They can declare their corporation to be an S corporation and the profits and losses of the corporation are “distributed” to the shareholders who report them on their individual tax returns and pay tax if there is a profit. With an S corporation, there is no corporate-level tax.

The reasons I mention S corporations is to say that a corporate tax is not even necessary to collecting taxes on business profits. They can be taxed at the shareholder level.

And maybe it would be better to tax them at the shareholder level. Smaller investors might do better if that were the case. Of course this all depends on the tax rates. In the world of taxes you can spin out theories and then ruin it all if the tax rates are at the wrong level.

Right now, the corporate tax rates are at the wrong level. Businesses that play every angle and govern their business decisions by how they can screw the government tend to pay little or no taxes. Businesses that don’t pay more. Lower overall corporate rates could reduce the gaming of the system.

But Smaug doesn’t want to reduce the gaming of the system. In the bizarre world of the GOP, reducing taxes are about hoarding. They say it’s to stimulate the economy, but it has been proven time and time again that it doesn’t work that way. Don’t expect the reduced tax rate to improve fairness. And don’t expect any compensating measures to ensure that the government gets the revenue it needs. Smaug’s proposal would suck the value of the Iraq and Afghanistan wars out of the U.S. treasury and put it into the pockets of the tax cheats like him. And make it that much more difficult to recover from the plunder once he’s out of office.

Just because the corporate tax system is broken doesn’t mean that Smaug is going to fix it for anyone’s benefit but his own.

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