President Trump and Congress will soon take up the job of reforming the tax code, with particular attention to corporate taxes. Since a substantial portion of the corporate income tax is paid by wealthy shareholders, many of us are concerned that “reform” actually means reducing the tax burden for the 1% — and leaving a larger burden for the rest of us. But the need for true reform is real. Although the corporate tax rate is 35%, companies generally pay around 23%. Giant loopholes save companies money, deprive the government of money, and create money for people in the tax avoidance industry.
Exotic schemes to game the system are constantly in the news. Take, for example, the corporate inversion strategy, in which a U.S. company arranges to be taken over by a foreign company in order to eliminate its liability on overseas profits. These takeovers generate large fees for the accountants and lawyers who engineer the process without improving the broader economy.
“Dead peasant” insurance policies, made famous by the documentarian Michael Moore, are another example. In that scheme, huge companies like Wal-Mart take out insurance policies on the lives of front line workers, such as checkout clerks, to smooth out their profit flows and reduce their tax liability. If a worker dies, the company gets the payout, not the individual or his family. Someone undoubtedly got very rich dreaming up dead peasant policies but, again, this financial innovation does not contribute to economic growth.
Perhaps the greatest scheme of all is the private equity industry, which loads firms with debt. Because the interest on that debt is tax deductible, private equity firms can make large profits even if they’ve done nothing to improve a company’s performance. Incidentally, many of the richest people in the country made their fortune in private equity, including folks like Mitt Romney, Pete Peterson, and many other prominent billionaires or near-billionaires.
If the tax reformers are serious, and I hope they are, here’s one simple way to largely eliminate the gaming opportunities that have made these people rich.
Instead of traditional taxes, the government could require corporations to turn over a portion of their stock, say 25%, in the form of non-voting shares. The government would benefit from any dividends or share buybacks but would have no voice in running the company.
This system would eliminate almost all opportunities for gaming since a company would not be able to deny the government its share of profits unless it also withheld profits from its other shareholders. And we would not call that “tax avoidance” but outright theft – the sort of thing that gets people sent to jail.
Many companies might actually embrace this system. They would save a huge amount of money on accounting and bookkeeping, and they wouldn’t have to take the tax code into consideration when they decided their accounting procedures for long-term investments. They could simply do what makes the most sense for them. (Publicly traded companies could be required to give the government non-voting shares, with private companies allowed to choose between this system or a higher tax rate.)
Don’t bet on the Republicans looking in this direction — the potential losers from these reforms, after all, are probably rich people who vote Republican. It is likely that they have more interest in reducing the taxes corporations owe than in reducing waste and increasing economic growth. But the rest of us should have a
clear idea of what is at stake. The corporate tax code is badly in need of reform and there are ways to make it better.