Cap deductions only for interest and depreciation, not for investment (inv) financed by retained earnings (earlier profit). Corp tax favors debt finan

Transcription

1 35% tax on net income over $10 million, lower rate on lower incomes. Some states also charge tax (up to 10%). Less than 7% of total US governments' revenue. Taxable income = total income minus costs of paid inputs (labor, materials), minus interest paid, minus allowed depreciation of capital (cap, durable inputs). Economic depreciation = decrease in market value of owned durable good (hard to measure if input is not regularly traded) Tax depreciation is a part of the purchase price of cap input that can be deducted from pretax income. It may be bigger or smaller than economic depreciation.

2 Cap deductions only for interest and depreciation, not for investment (inv) financed by retained earnings (earlier profit). Corp tax favors debt finance. No deduction for some intangible inputs. Favors physical cap. Who bears corp tax burden? Efficiency of the tax? Economic profit = revenue cost of cap use other input costs Cost of cap use interest rate + economic depreciation. Cap deduction cost of cap use if capital is debt financed, with tax depreciation economic depreciation. Then corp tax is tax on economic profit. Effect on input and output levels?

3 Cap deductions only for interest and depreciation, not for investment (inv) financed by retained earnings (earlier profit). Corp tax favors debt finance. No deduction for some intangible inputs. Favors physical cap. Who bears corp tax burden? Efficiency of the tax? Economic profit = revenue cost of cap use other input costs Cost of cap use interest rate + economic depreciation. Cap deduction cost of cap use if capital is debt financed, with tax depreciation economic depreciation. Then corp tax is tax on economic profit. Same input and output levels that maximize total profit maximize 65% of profit; so under these conditions, corp tax has no effect on currrent inputs, outputs, inv. It taxes past innovation, good organization, luck leading to current profit.

4 Tax on luck is efficient; provides insurance. If investment leading to innovation, good organization is not deductible, the tax reduces incentive for this kind of inv. But part of this inv is deductible as labor cost; and disincentive is reduced by inv and research tax credits. Investment tax credit (ITC) reduces tax liability by 10% of inv. Research+experimentation credit: up to 20% of qualified costs; Cap bears some tax burden when it is financed by retained earnings or sale of shares (getting no interest deduction). Then not all cap cost is deductible; corp tax raises cost of cap. Cap bears less burden if its supply is elastic (it leaves corp sector or US). Then deadweight loss of the tax is higher. If cap use and inv fall, labor bears part of burden. Research credit temporary since 1981, always extended. Less efficient than same size permanent credit. Why?

5 Cap cost formula in text ignores adjustment cost and irreversibility of investment (capital usually adapted to firm, depreciates after purchase due to adverse selection). These factors help explain large inv swings (30% drop in '08-09) Why not all debt finance? Bankruptcy risk. Net earnings taxed and taxed again as personal income if paid in dividends (div). Current qualified personal div tax rate 15% (next yr taxed at same rate as labor income if law unchanged). Incentive not to pay div, so cap kept in older firms with below average returns (Mueller 1987, Spulber 2007). Puzzle: Why pay div? Without div, share value is a bubble. Div signals future profitability.

6 Variations in div tax rate have small estimated effect on inv. Theory says main effect is reduction of startup capital: Capital expected to be trapped in corporation. Treatment of foreign earnings Territorial system: pay tax where money earned. Global system used by US: Pay home country; deduct tax payments to foreign govs. Tax due only on repatriated earnings (sent to US parent); firms limit and delay repatriation from low tax countries. Input transfer pricing within firm puts income where tax lowest. Example: $3.4 billion tax settlement by GlaxoSmithKline for deducting large R&D royalty to UK parent. Separate current case for $1.9 billion more. GE 2010 tax expected to be under 5% of $5.1B income.

7 Why tax corp income? Corp is entity using public inputs; Corporations now unrestricted in political campaign finance. Corporations vs. other firms: limited liability. Without tax, personal income tax can be reduced by accumulating earnings in firm, getting cap gains. Efficiency of corp tax depends on capital finance: less efficiency cost in older firms with debt financed inv. Distortions toward debt finance, low dividends. CBO 2006 estimated 50% deadweight (dw) loss in static model, assuming all investment financed by retained earnings % dw loss in more realistic models (Fullerton, et al 2006) Proposed reform: integrate corporate and personal income tax to remove double taxation of dividends (div deductible from corp income, div treated as ordinary personal income).

8 Tax Reform, G 25 High rates raise incentive for evasion, estimated 3-5% of GDP. Enforcement returns over 5x enforcement budget; corp audits return over $9000 per auditor hr, 35x ave cost. Costly complexity: filing time estimated 3 billion hrs; Slemrod Mainly due to adjustments, deductions, special provisions. Major reform proposals 1. Consumption, sales or value added tax (VAT). Could be progressive via income tax, with savings deductible. 2. Flat tax (wage tax), rate of 24% raises same revenue as current income tax. Much more burden on middle incomes, less on top incomes. Could be made more progressive. Consumption tax at the same rate on all goods, is equivalent to a wage tax in the long run. But in the short run they are different: Elderly pay more under consumption tax.