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The Strenuously Hushed-Up Fundamental Flaw In The Tax Code
Wolf Richter www.testosteronepit.com
“Corporate Tax Dodging In The Fifty States,” a report that the CTJ released today, found that the largest corporations paid little or no state income taxes in any state for the years 2008-2010. In a prior report, the CTJ found that some of the most profitable US corporations paid no federal income taxes over the same period. Both reports point at one of the major problems dogging the US economy: the tax code—and its most fundamental flaw that not even tax reformers dare to mention.
The Internal Revenue Code serves two functions: raise money for the government; and dole out benefits and subsidies to industries, companies, pet projects, individuals, shrimp fisheries, etc. in return for campaign contributions, votes, and fringe benefits such as free plane rides, bundles of cash, sweetheart mortgages, or well-paid jobs for staffers when they move on. It’s the congressional bread and butter. And the economy pays the price.
Tax reform has been in the air in greater concentrations recently. The proposals address some of the symptoms of what’s wrong with the tax code (tax rates, inequality, constraints on business growth, complexity, etc.). But none address the most fundamental flaw that impacts every aspect of the tax code applicable to businesses: the separation of tax accounting from financial accounting.
For example, for the three years from 2008 through 2010, Well Fargo reported $49 billion in earnings, based on Generally Accepted Accounting Principles (GAAP), but it paid zero federal income taxes—it received a refund of $681 million (CTJ). GE reported $14 billion in income in 2010, of which $5.1 billion came from operations in the US. Income taxes? None. Instead, it claimed a refund of $3.2 billion (New York Times).
That these companies were legally able to tell investors that they made a ton of money while telling the IRS that they lost money shows just how absurd the system has become (not to speak of the absurdity that they received hundreds of billions in bailout money from the Fed and from TARP, plus a host of other taxpayer-funded benefits and guarantees).
This whole debacle could be avoided if the portions of the tax code as applicable to businesses were replaced by a single paragraph that states that income taxes are to be paid at x, y, and z rates on income as reported to investors under GAAP.
GAAP allows companies to seduce investors in a myriad ways with inflated profits and asset values. In fact, it incentivizes companies to engage in economically unproductive activities simply to make their numbers look better.
The tax code does the opposite. It encourages the very same companies that reported inflated income and asset values under GAAP to report little or no income to the IRS. The tax code incentivizes companies to invest heavily in economically unproductive strategies, such as massive lobbying or shifting income-producing activities offshore.
Making GAAP the accounting system for tax purposes would have a number of beneficial consequences. Among them:
- Tax rates could be much lower than current rates because the income they’re applied to is the same inflated income that investors get dished up on a quarterly basis. Rates could be low enough to incentivize companies to re-shore profitable activities.
- Companies would face a choice: inflate profits and asset values to look good but pay higher taxes as a consequence; or report realistic numbers and pay less in taxes. As an unintended consequence, financial reporting might become more reliable for investors.
- Companies would have some certainty about income taxes and could commit to long-term investments with less risk.
- The corporate tax profession could be shifted to productive activities. At GE, for example, the third-grade daughter of one of the employees could spend a few minutes every quarter doing GE’s income taxes (rate tables applied to reported income). Um, I’m being facetious. There will still be issues for professionals to tear their hair out over, such as international activities. But most of the tax professionals now on staff could be retrained to do productive work. IRS personnel would also be retrained, and auditors would follow GAAP in their audits.
Though the list of economic benefits is long, the noise from tax professionals and lobbyists would blow out the national eardrums. Profitable companies that pay no income taxes might dig in their heels. And unemployment might briefly edge up as tax professionals merge into other activities. Yet, the business and economic advantages of using one accounting system for tax and financial reporting, along with much lower tax rates, would be enormous. Alas, as ugly, complex, and dysfunctional as the current tax code is, it remains the congressional bread and butter—and that might never change.
Another ode to our lawmakers: a Cheneyesque banana-republic law would allow the military to imprison Americans for life.
Wolf Richter www.testosteronepit.com.
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Good luck with that...
In the final analysis, corporations don't ever really pay taxes. Any tax collected from them is ultimately taken out of their customers' hides.
Absolutely positively true. And the cost of regulatory compliance, etc. All costs are part of the finished product. If you disagree, you've never worked at a company or are just plain stupid.
Also to a large degree, taxing the "rich". Because the rich own most of the income-producing assets, when you raise their taxes, they raise prices. A perfect example would be raising rents on commercial or residential real estate. If you can't figure out how this trickles down to the common citizen (the consumer), as I said, you're just stupid.
flat tax
lots of countries have adopted a flat tax code - only good results, except for the tax lawyers, of course
when a new tax law has thousands of pages, you know everybody is going to be screwed, except for those who wrote it
The other problem being that overseas tax payments can be credited in the financial year paid, but no US tax is charged on those overseas profits until the money is brought home. Which it never is until Corporate America gets (Just one more) one time opportunity to repatriate profits tax free. So as to create jobs and investments in the US. Yeah right, the evidence from previous "One time" tax free repatriations of overseas profits does NOT suuport that actually happened.
Realistically, however, US Corporate tax rates are amongst the highest in the world, so they do need to be revised down because Corporations will always be able to find loopholes somewhere in the world.
I would suggest:
1. A flat Corporate tax based on GAAP earnings at a rate of 26% reducing to 20% over five years for US earnings. The US then becomes competetive and has an equal shot at inbound investment on competitive terms.
2.Tax rates on overseas earnings treated the same with foreign tax credits booked only when the earnings are repatriated not in the tax year incurred.
3. NO other deductions or credits.
Under such a system, tax collections would increase, the need for tax accountants (A whole Organisation at GE) would be eliminated, tax submissions would shrink from thousands of pages to tens of pages etc. etc.
Which leaves only the problem of Transfer Pricing of profits into tax havens, which is partially addressed by the lower tax rates on profits earned overseas, but only for countries with tax rates higher that the new US tax rates because "US Corporate think" is not to pay ANY US tax so if there is no tax paid overseas in tax havens, and therefore no US "Offset", why should we bring the money home and pay any tax here? Transfer pricing is an issue which MUST be addressed Internationally, as it was once attempted and failed.
Incorporate yourselves in FL, NV, TX etc. and do the same. Be a contractor.
If you are not self employed, ask your employer to hire you through your company, pay you a bit more and forego the benefits. Most will do it. Then you start deducting everything from your pass through company. Car, gas, home, insurances, travel, you name it.
And since these states have no income tax, as a minimum you save these taxes.
I do not know the exact law of the US but it is very important to see someone who does:
Usually, there is the snag that the IRS will demand that you can document working for several, i.e. more than 2, diffferent companies over "a reasonable period", else they will "reset" you back to employee status and claw back all your previous deductions (and good luck with getting your benefits out of your employer).
I know of people in the UK and the DK getting busted working as self-employed contractors through agencies; the IRS randomly claims that the agency by finding work and managing customer contracts, is really their employer and therefore they must be employees who must pay income tax. The impression is that the IRS simply "culls the herd" whenever contracting becomes too popular.
This only works if you are also working in those states. Doing business in another state needs to be registered if you want legal standing in any legal action to defend your LLC or whatever passthrough you are using. I am not sure it is as easy to avoid say NYC taxes just because your LLC is in TX and you are working in NYC and most of your credit card transactions are in NYC and you have no residence in TX except a PO BOX and and and and... I am pretty sure NYS will come after you and collect a few pounds of flesh.
Good idea, but won't work. According to IRS rules, if you look like an employee and act like an employee, you are taxed like an employee-- even if you and your employer call you a contractor. The IRS will then go after your employer for big penalties.
Good luck having that house deduction stand up to audit or in court. I see striped clothing in your future.
Can we have a website to explain this in more detail? Thank you!
Next thing you know, you get a visit, not from the IRS but from some politician that is willing to help you save more money cause whatever it is that you are doing is in the national interest, like making wooden arrows. We still have tax carve outs on the books from the spanish american war.
It distorts the market, it makes us the joke of the world. Its like Kissing King Georges' pinky ring. It takes brain cycles away from true entrepenuership, inovation, and paying some taxation for the shared services you do use.
But what do I know. I am a poor old man and Mitt Romney is running for president.