by Linda Beale
U.S. Chamber and corporations fighting for low preferential capital gains rates
A coalition of the U.S. Chamber of Commerce and large multinational corporations such as Altria Group Inc. and Excel Energy Inc. is trying to pressure Congress to retain the extraordinarily low current tax rates on unearned income that will expire at the end of 2012 without action.
The alliance sponsored a report by Robert Carroll and Gerald Prante of Ernst & Young that develops the idea of an “integrated tax rate on dividends” that includes the taxes paid by the dividend-paying corporation, the federal income taxes paid by the recipient, and the state taxes paid by the recipient. See Carroll & Prante, Corporate Dividend and Capital Gains Taxation: A Comparison of the United States to other developed nations (Feb. 9, 2012), Higher Capital Gains and Dividend Taxes Would Put U.S. Further Behind International Competitors, Alliance press release (Feb. 9, 2012); Richard Rubin, Corporate Coalition Says Obama investment taxes Near World High, Bloomberg.com (Feb. 9, 2012)(republished on the Alliance website). The report claims that the U.S. has an “integrated” rate of 50.8%. The report claims that such a rate “discourages capital investment, particularly in the corporate sector, reducing capital formation and, ultimately, living standards.” Richard Rubin, Corporate Coalition Says Obama Investment Taxes Near World High, Bloomberg.com (Feb. 9, 2012).
Robert Carroll is a former Bush administration official who regularly presents on behalf of corporatism’s Holy Grail of lower corporate taxes, lower dividend rates, and/or change to a territorial tax system for U.S. corporations. See, e.g., Charting a Course for Tax Reform–Moving the U.S. Towards a Territorial Tax System (Jan. 2012); Considerations for a Value-Added Tax (July 26, 2011) (arguing that a VAT-type consumption tax could permit lowering corporate tax rates). Carroll’s VAT article makes the same argument as here–that taxes hurt investment and therefore jobs.
Greater reliance on value-added taxes, or other consumption-type taxes, to fund government can help improve economic performance because consumption taxes do not tax the return to saving and investment. By not taxing the return to saving and investment, these taxes reduce the cost of capital and lead to greater investment. Greater investment means more capital formation, and, ultimately, higher labor productivity and living standards than otherwise. Id.
But these arguments ignore the distributional impact of shifting taxes from corporations and wealthy stock traders to everyday Americans who make 30,000 or 50,000 or 75,000. The drive by the GOP and big corporations to save the wealthy from paying much in taxes shows no concern at all for the fact that the tax burden would be shifted to low-income Americans.
Not surprisingly, the tax rate analysis in this “for hire” E&Y report is highly misleading. Let’s note the reasons, yet again.
- The report assumes that shareholders bear the full brunt of the corporate income tax. Yet there is no conclusive evidence about the incidence of corporate tax. Many shareholders such as pension funds are tax exempt and pay no tax on the corporate dividends.
- The report assumes that corporate income is taxed at the federal statutory rate of 35%, whereas in reality the vast majority of corporations pay zero federal income tax and those that pay tax pay an average around 24% effective tax rate (with many lower). Aggressive tax planning, cross-border tax credits, and various deductions (including greatly accelerated depreciation and expensing compared to actual economic wear and tear) allow corporations to reduce their tax liabilities much below the nominal statutory rate. While a chart on page 4 (showing a $100 income amount suffering the 35% corporate rate, an average state corporate rate, a 15% shareholder federal tax and a 4% assumed average shareholder state tax) indicates this is the “top” rate, most of the report discusses this “integrated” rate as though it were the actual rate paid.
- The report disregards the fact that capital gains are also earned outside of corporations (as Dan Shaviro noted in the Bloomberg piece). It suggests that the corporate level tax will impact “each worker”:
With less capital available for each worker to work with, labor productivity is lowered, which reduces the wages of workers, and ultimately, Americans’ standard of living. Report at 5.
Yet much of the work done in this country is not done for major corporations. There are partnerships and S corporations and sole proprietorships all operating businesses and providing capital gains in appropriate contexts. (And of course most of the capital gains that are being taxed aren’t earned from money that was invested in corporations but rather from corporate stock bought in the secondary market. All this talk about capital for workers is irrelevant to those secondary market trades. See this point below.)
- The conclusions disregard the fact that investors can defer taxation of capital gains indefinitely by choosing when to sell, and that many gains are never taxed at all over multiple generations, since heirs receive corporate stock (and other assets) with a step-up in basis. (Text accompanying footnote 5 merely mentions that the effective rate “might” be lowered by this fact; the footnote notes that “common practice” for determining the impact would give an integrated tax rate of 43.1%.)
- Chuck Marr, at the Center on Budget and Policy Priorities, also indicated that “the report also ignores the total tax burden around the world. In 2009, U.S. tax revenue of 24.1 percent of gross domestic product was 9.7 percentage points below the unweighted average of countries in the Organization for Economic Cooperation and Development.” As a result, “the United States is actually a very low-tax country compared to all these other countries.” Richard Rubin, Corporate Coalition Says Obama Investment Taxes Near World High, Bloomberg.com (Feb. 9, 2012).
- The report purportedly compares top integrated tax rates among the developed countries. But does it really include all the relevant taxes for other countries? It is not clear that the VAT, for example, has been included in countries where a VAT is a significant addition to regular income taxes: the report mentions only corporate income tax rates and dividend tax rates in discussing other countries’ “integrated” rates.
- The report ignores the fact that there is at best a very slim correlation between the transfer of funds to a business entity for use in running the business and capital gains taxation. Most corporate stock is purchased in the secondary markets, not at IPOs. Most of the gains that are taxed are therefore just accretions in value as corporate stock changes hands from one investor to another. There is no benefit of capital formation for the corporation from the trade–the money goes into the pockets of the one who sells, possibly to be reinvested offshore in an emerging market economy or to purchase the stock of another U.S. MNE.
- The report assumes that half of any increase in dividend taxes is absorbed into share value but the other half “influences investment decisions”. n.12. This is one of those “anything goes” assumptions that is so annoying about supposedly empirical work that tries to “predict” how behavior will be affected by taxes.
- The report discusses a “marginal effective tax rate” and suggests that corporate capital will be reduced by that rate, resulting in less expansion and less job creation. But that rate as shown here includes the statutory tax rate on the corporation’s profits and the shareholders’ tax rate on its unearned income from holding corporate stock. Even if one thought that using the statutory rate to discuss corporate tax burdens was reasonable (which I do not), this mingled rate is not the relevant rate that the corporation would consider in determining whether it was profitable and could expand and add on workers or jobs. The corporation may retain its profits and use them to expand or provide working capital, and not pay dividends to shareholders. Many corporations have in fact foregone dividends and instead invested in share buybacks, which give a perceived benefit from reducing the total number of outstanding shares. Interestingly, while the report uses this mingled rate to argue that taxes are bad because it will keep corporations from investing and hiring (pp5-6), it also argues that taxes on unearned income of shareholders from corporations will mean corporations will retain those earnings and “overinvest” in the corporation (p7). Talk about trying to have your pie and eat it too.
- The argument that fungible investor capital will necessarily flee the country if capital gains rates are allowed to go back to at least the level they were under Clinton, as GOP representative Peter Roskam from Illinois suggests, id., simply misundersands what drives investment decisions and the way our tax system works.
- Many other factors drive investors to purchase stock, whether in IPOs or in the secondary market, including the stability of a country’s markets, the vigorousness of economic growth, the price-earnings ratios of corporate stocks, the economic outlook for particular industrial sectors, etc.
- Americans are taxed on their worldwide income, so they don’t avoid the US tax on capital gains unless they expatriate.
- Taxes are just one factor, and in fact corporate stocks traded quite well when capital gains taxes and dividends taxes were much higher than they are now. Many experts think that removing the preferential rate for capital gains would be the most reasonable way to level the playing field for workers and managers/owners, while raising billions to offset the federal deficit.
- The distributional effects of very low capital gains tax rates are detrimental. Most of those who benefit from the preferential capital gains are the wealthy who own most of the financial assets, with about 2/3 of the benefit going to millionaires, according to the Tax Policy Center. Id.
Taxes on earned income–salary and wages–are graduated, rising to a maximum of 35% for top income earners. Taxes on unearned income, such as dividends from qualifying corporations or gains from sales of corporate shares, are only 15%. This significant disparity in rates (35% compared to 15%) means that the wealthy who own most of the financial assets and have most of the capital gain income enjoy an extraordinarily preferential tax rate. The result is that wealthy individuals like Mitt Romney can end up paying a significantly lower tax rate than construction workers, firefighters and schoolteachers. That’s unreasonable: the nation would be better served by eliminating the capital gains preference and using those funds to rebuild public infrastructure.
Alliance Statement on Capital Gains and Dividends Tax Provision in the Republican Jobs Committee Proposal (Nov. 2, 2011) (same assertions as in the E&Y report that lowering taxes on unearned income will have wonderful trickle-down effects on the economy)
originally published at ataxingmatter