Posts Tagged ‘corporate profit’

Corporate Profits

April 26, 2011

Corporations shouldn’t make a profit.

I know what your are thinking, “What kind of ultra left-wing garbage is this?”, but hear me out. Corporations should definitely generate revenue, but profit is only one outcome of corporate revenue generation, and we have to look at the others to understand where I am coming from. Corporations, like individuals, are taxed on profit, not on revenue. It’s the mistake that “Joe the Plumber” made during the 2008 elections. He thought because his gross revenue was over $250,000, he would be taxed at the rate of the wealthy. Since he has expenses, his taxable income would be considerably less, and that’s the first place that corporate revenue goes – expenses. They have to pay for all of the things that enable the business to run – from paper clips to the corporate jet.

The second place where a big chunk of money goes is salaries. That includes the compensation packages of the executive team all the way to paying the guy who empties your trash can long after you have gone home.

The third place where revenues can be spent is through dividends. The idea of a corporation is straightforward. People become part owner of the corporation by virtue of buying shares of stock. If the company does well, then then the Board of Directories can elect to distribute some of that success to the owners of the corporation – the shareholders – through dividend payments. You don’t hear as much about dividends as you used to, because fewer corporations feel the need to share the wealth with the shareholders.

So when a corporation pays all of its expenses, including salaries big and small, and still has money left, they can distribute the wealth to their owners – the shareholders – in the form of dividends, but most don’t. What is left is profit. When it is carried over to the next taxable year, that profit is called “retained earnings.” What do companies do with retained earnings, if it isn’t expenses, salaries or dividends?

Imagine a corporate tax structure that didn’t allow corporations to retain earnings across a tax year. What if they were required to distribute excess revenues to its employees and shareholders? Heresy, you say! Socialism! Government over-reach! In fact, not only does such a corporate structure exist, it is the most common form of incorporation for new and/or small businesses. It is the S-Corporation often wrapped in an LLC.  Most big corporations, like GE, Exxon, Google, and a few small ones like mine are C-Corporations.  I couldn’t find any statistics, but I would suspect that a substantial majority of American corporations are S-Corps simply because the majority are small corporations.

When you hear of tax rates on corporations, it is not the same as taxation on your personal income. They have a choice to distribute their success to shareholders as dividends. They have a choice to pay their executives or other employees more. Therefore, the amount of tax a corporation pays is always a choice.

Now I don’t really believe that corporations shouldn’t be able to make a profit. I just said that to get your attention. There are reasons for retained earnings. There may be a stockpiling of money for an acquisition or for a large, long-term capital expenditure such as a new factory. The tax structure should encourage such capital investment. I don’t think the current corporate tax structure is oriented this way, however.

I will ask the question again. So what are corporations doing with their retained earnings? I know what I did with retained earnings from my corporation. Hint. It wasn’t job growth or investment in America.

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