Posts Tagged ‘taxes’

Taxing the Job Creators

July 28, 2011

In a July 8, 2011 press conference, Congressman Boehner suggested that it would be a mistake to tax “job creators.”[1] It was a great piece of rhetoric. It certainly polls better than a reluctance to tax the rich, which is much closer to the accuracy of what needs to be done, in part, to combat the revenue shortfall being experienced by the U.S. Government. My issue with the statement isn’t just that it’s political spin. It is intellectually dishonest in that it makes a false presumption about taxes in general.

The presumption implicit in the rhetoric is that the wealthy people create jobs. I am not an economist or a CPA, but I am the CEO of a small C-corporation (the same tax structure as the largest corporations), so I have to be involved enough with the tax implications and the math to make financial decisions for the corporation that I head.

There are really two separate tax issues at work here. How do we tax the personal income of wealthy people, many of whom are corporate executives, and how do we tax the corporate income of those corporations headed by those wealthy individuals? A C-corporation is a completely separate fiscal entity that has no direct fiscal relationship to the personal wealth of the executive team. The executives are paid a salary and other compensation the same way (although not in the same proportion) as other workers.

Thus, the first fallacy is readily apparent. Except for nannies, chauffeurs and gardeners, the personal wealth of the corporate executives aren’t used to create jobs. The jobs are created within the corporation for benefit of the corporation’s shareholders. So as a mental exercise – and I am not advocating this – what if we were to tax income above, say, $10 million at a 100%? That would effectively cap salaries at $10 million, so corporations certainly wouldn’t have salaries above that. The money would either stay in the corporation or there would be other avenues, such as dividends, to move corporate wealth into the hands of the executives. There would be no effect on job creation at all because, again, jobs aren’t created from the personal wealth of the wealthy.

So if the issue of taxes on personal income doesn’t affect job growth, surely raising corporate taxes would be a job killer, wouldn’t it? Intuitively, it makes sense. Herein lies the second fallacy.  Most of us are aware of our personal tax situation.  Taxes are based on our revenue, mostly from our salary, minus the few deductions left, such as mortgage interest and dependent children deductions.  The salary minus deductions is the taxable income on which we are taxed.

In the case of a corporation, the basic idea is the same.  Revenue minus expenses is the taxable income (aka “profit”) and the taxes are applied as a rate on that profit.  However, on the corporate side, salaries aren’t revenue like they are for us, they are expenses. The money paid by a corporation in salaries is not taxed. Here’s where it seems backward, but bear with me. Assuming revenue stays the same, if I, as CEO, hire another person, my corporation’s taxes go down because my corporation has more expenses, less profit, so my tax rate is applied to a smaller number.  So as a mental exercise – and again, I don’t endorse this – what would happen if corporations were taxed at 100%? Well, I could give all of my corporate profits to the government in taxes, I could move corporate profits to the salaried employees,… or I could hire another person. As tax rates increase, the corporate executives has a disincentive to retaining profits in the corporation as an asset, but I can’t figure out how that translates into a disincentive to hire more employees.

The reality is that the decision to hire has little to do with taxes. It has to do with whether that employee can generate revenue in excess of their loaded salary, increase efficiencies in excess of their loaded salaries or is necessary for the operational infrastructure of the corporation (e.g. CPAs, lawyers, etc.)  Taxes just aren’t a substantive part of the decision making process.

Well, that’s the basic math at work.  In reality, it’s quite a bit more complicated, but that’s the general sense of what is going on with corporate and personal taxation.  As I said, I am not an economist or an accountant, so I could be wrong. That is just my informed understanding.

So I ask you… can anyone out there explain the mathematics behind the Republican assertion? If so, explain it to me.

References:

[1] http://tinyurl.com/44hofhk

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.