Since the Republicans announced their tax reform plan a few days ago, most of the attention has been centered on individual reforms in reporting. Understandably so, since the vast majority of people work for someone else and are not directly affected by corporate reforms. However, corporate reforms have a very significant effect on individuals in the jobs market and the economy overall. So, since most people are discussing individual reforms and their merits, I am writing on corporate reforms in the plan and their merits. It isn’t that I discount the individual reforms or their effects, I just prefer to dare to be different.
There are some very significant changes being proposed by the GOP, but some changes, in typical political fashion, remain to be spelled out. There’s always the, “We have to pass it so that you can see what’s in it,” mentality. However, there are a lot of important details that are spelled out. I believe most of them will have a very positive impact economically.
The broad strokes include the following reforms:
- Reduce corporate income tax rates from 35% to 20%.
- Reduce pass-through income tax rates from 39.6% to 25%.
- Reform corporate expense allowances for write-offs (not specified).
- Move to a territorial system of taxation for multinational corporations.
- Create a one-time lower tax rate for multinationals to “Bring Back” their income.
The average corporate income tax for the so-called developed world is around 22.5%. Decreasing the US rate to 20% puts it below the average. However, there remains some nations with a corporate rate of 0%, making those nations particularly attractive for multinationals.
The presumption with multinationals is typically that they are very large corporations, like Apple, which has an estimated excess of some $50 billion in cash offshore, or Google, which has an estimated some excess of $35 billion offshore. However, many are small companies that have elected to shelter much of their assets in offshore accounts by electing to operate in the US while being domiciled offshore. All of those assets might even reside right here in US banks, but cannot be accessed by their owners for use in the US, lest they be hit with not only US income taxes, but also tax penalties for bringing that money back – in a manner of speaking. Estimates of offshore corporate income are actually very understated. In fact, it’s nearly impossible to estimate just how huge these offshore assets are.
Lowering the corporate rate makes things a little more enticing – perhaps not as enticing as 0% – but entices many funds to be more accessible to US owners. It is also more enticing to legitimate foreign businesses to invest more assets in the US.
In addition to the advantages derived from lower overall corporate tax rates regarding multinational competitiveness for the US, the plan calls for a territorial treatment of multinational companies rather than the current treatment, and a one-time lower incentive rate of an unspecified amount to encourage multinational businesses to bring home their funds. Territorial treatment means that rather than paying US rates, multinationals can be taxed at foreign rates for funds derived outside the US. This incentivizes multinationals domiciled in the US to maintain their status as a US tax payor. It also incentivizes foreign domiciled corporations to make an election to be taxed as a US corporation if they have significant operations in the US.
Also, multinationals are rewarded for bringing funds back home to the US. While no incentive rate has been specified, the number typically being discussed is 10%. In other words, rather than pay the current rate of 35%, with additional penalties, when money is brought back home, a sort of safe harbor is being offered to allow those moneys to be taxed at a drastically lower rate on a one-time basis in order to provide a significant incentive for corporations to flood cash into the US economy.
Pass-through tax rates are rates on income that is passed through some partnership and individually owned businesses to the owners. Examples might include small businesses, like smaller law firms and doctor groups, as well as property ownerships and trusts, oil well investment groups, etc. This allows many smaller businesses to keep more of their earnings. A huge portion of US businesses are set up this way, and the impact on the economy is enormous. Well over half of all people work for a small business, and over half of those businesses are pass-through entities. A dramatic decrease in their taxation is a dramatic influx of money into the economy. A mention is given in the GOP plan of establishing rules to eliminate owners in pass-through entities from placing part or all of their personal pay into lower corporate taxation, but they have not spelled out any of their plans on how to accomplish this. My question would be, why? In pass-through businesses, the ownership and owner-employees are usually the same people. Sure, there would be a lot of shuffling of business set-ups and how money is distributed, but so what?
The plan also calls for reform in what a business can write off as an expense against taxes. Mostly, they promise to eliminate a lot of write-offs with the effect of increased income taxes. So, we don’t know if all these rate decreases are off-set by these write-off reforms or whether we actually have real lower rates of taxation. It is possible that after everything is said and done, this plan doesn’t cut corporate taxes at all. But, we don’t have that information yet. Perhaps if we pass it, we can know. What a ridiculous waste of the paper it’s written on!
However, while not specified officially, there have been some discussions of allowing businesses to write off capital expenditures in the tax year in which they are taken, which could really offset a large portion of any write-offs that are disallowed. Capital expenditures are money spent on hard assets that are required to operate a business, such as real estate and heavy equipment required to produce goods. If this is the case, then many businesses would enjoy a huge tax advantage in the coming few years, with incentives to invest heavily in such assets spurring on large segments of the economy. It also addresses a certain unfairness in the way profits are derived in corporations. Tax accounting allows for a lot of games to be played in how capital assets can be expensed through various forms of depreciation. Allowing capital expenses to be written off all at once puts things closer to being taxed like individuals and the way individuals think of income.
All-in-all, if the GOP really plans on having true rate decreases like the ones being outlined, then this could be a very positive thing for the US economy. Like so many things, the devil is always in the details, and we don’t really know the details, making it difficult to figure out whether this is all a good deal or just a waste of time with playing a shell game in decreasing rates here while eliminating write-offs that raise them right back up over there.
I am hopeful, though.
When businesses and business owners have more money, they have to do something with it. Usually a large portion goes into building the business. If they are not reinvesting in their business then they have no faith in their business, which means the business would need to close anyway. Business re-investment causes expenditures throughout the economy, and it hires more people – dropping unemployment. If you want to create jobs, then there is no better way than to allow those who produce jobs to keep more of their hard-earned income to hire more people. It is not a question of “How do we pay for this?” Rather, it is a question of can we afford to continue to lose out on economic activity that places the US at an unfair disadvantage to the rest of the world?
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