End Corporate Income Tax? #2

My previous post briefly addressed what would likely happen if the corporate income tax were eliminated. Even lowering the corporate tax rate to the proposed 20% when personal income tax rates are higher can create disparities. The current corporate income tax rate being (mostly) 35% and the top personal income tax rate being 39.6% makes some disparities, but lowering the 35% to 20% makes disparities much larger. Like I said in my prior post, this is likely why proposals to change the taxation of pass-through entities have become a significant part of tax reform.

For example, suppose a C corporation and a pass through entity each earn $10,000 more pre-tax. If the C corp simply retains it, the extra tax is $2,000. If the C corp pays it as compensation, the C corp pays no extra tax and the recipient(s) pay tax on it at whatever rate applies, which could be up to 39.6%. Very likely it will be higher than 20% and in some cases 39.6%. It could be taxed an additional 0.9% (as wages) or 3.8% (as investment income) for Medicare. For 2017 the 39.6% tax bracket starts at $500,000 for each filing status. $500,000 may seem like a lot for personal consumption, but quite often the income is planned for business purposes (link, link). If the C corp opts to pay it as a dividend, the $2,000 tax still applies, since dividends are not deductible, leaving $8,000 as dividends. The recipients pay whatever tax rate applies to dividends, which may be somewhat lower than applies to compensation. 

The tax bills proposed by the House of Representatives and the Senate Finance Committee are yet more complicated because they (a) limit interest deductions in computing income and (b) split income between capital and wage-related and apply a lower tax to the former or exempt a portion of total income (link).

End Corporate Income Tax? #1

Occasionally I read or hear there should be no corporate income tax, “corporations don’t pay taxes, people do”, and similar assertions. Examples:

“As most good economists and knowledgeable others understand, the world would experience a better allocation of resources and more job creation if the corporate income tax was abolished. … The so-called revenue loss would be made up by taxes on the dividend and capital gains increases, and by the extra economic growth and employment that would result from ending the corporate tax.” Link #1.

“Rather, the corporate income tax is actually “paid” by workers in the form of lower wages, and consumers in the form of higher prices. Cut this tax, and workers will both earn and spend more.” Link #2.

Neither source recognizes what would likely happen if the corporate income tax were abolished. With no other changes, it would be foolish to not incorporate and corporations would become tax havens. The corporation could spend its earnings on actual capital investment, pay higher wages, etc., very soon or it could retain the money for any indeterminate use for years. The last one would make an attractive tax haven.  A pass-through entity would not have the last alternative -- the ability to retain earnings. All earnings pass through to the owners, and they pay the income tax on them at whatever rates apply. Profits being retrospective and investment spending plans being prospective compounds the problem.

Under current tax law it’s important that amounts passed through to owners be categorized as dividends, capital gains, ordinary investment income, or compensation (wages or bonuses) because the tax treatment for each is different. For example, capital gains tax rates are lower, and compensation is subject to FICA taxes for Social Security and Medicare, whereas the others are not. (There is some extra income tax that goes to Medicare when income exceeds $200,000 for single filers or $250,000 for married filing jointly.)

The current proposal to reduce the corporate tax rate from 35% to 20% is likely why proposals to change the taxation of pass-through entities have become a significant part of tax reform. I will say more about this in my next post.

By the way, the corporate income tax is not a huge revenue source for the federal government. In 2016 the federal government’s income tax revenue was about 16% corporate and 84% personal. Link #3.

Senate tax bill

The U.S. Senate Finance Committee revealed its own tax bill, and it differs from the House bill (which passed) in several respects. The following are the major differences.

1. The Senate bill has 7 tax brackets ranging from 10% to 38.5% versus the House bill's 4 brackets ranging from 12% to 39.6%.
2. The Senate bill preserves the estate tax while doubling the current $5.49 million exemption for individuals. The House bill ends the estate tax after 2024. Until then, the current $5.49 million exemption for individuals would be doubled.
3. The Senate bill preserves the existing mortgage-interest deduction for home purchases for up to $1 million of debt. The House bill would reduce the maximum to $500,000 of debt for new purchases and would limit the deduction to one principal home, ending the deduction for second homes.
4. The Senate bill preserves the deduction for medical expenses. The House bill ends it.
5. The House bill would not change taxation of capital gains. The initial Senate bill would, and investors protested. Currently, if an investor buys shares of stock in the same company at different times and then sells part of them, the investor can choose which ones are being sold. Selling the highest cost shares would minimize capital gains, and thus the tax. The Senate bill proposed first in, first out, or FIFO, which would in many cases be the lowest cost shares, resulting in the largest gain and tax. This would apply to individuals and mutual funds (including exchange-traded funds or ETFs) selling individual company shares. Individuals selling mutual fund shares would compute the capital gain using the average cost of the shares held.
     An tax annoyance for people who invest in mutual funds is capital gains distributions. This occurs on  "taxable" accounts (not IRAs, 401k's, etc.) when the mutual fund sells shares even if the holder of  the mutual fund shares doesn't sell. The holder gets a 1099 form from the fund or his/her broker reporting the amount of capital gains, which must be included on the holder's next federal income tax return. Such amounts in the future would generally be larger with the FIFO treatment for the mutual fund.
   After protests from some mutual fund companies, the Senate bill was modified to not apply FIFO to mutual funds.

Sources: CNBC, Bloomberg, Fox Business

Battling Alzheimer's

Forbes magazine has an interesting article about efforts to fine a cure for and treat Alzheimer's disease. The main points are:
- Bill Gates recently vowed to donate more than $50 million to fund Alzheimer’s research.
- Gates and the Rand Corporation both say that due to the aging of the population, the population of Alzheimer’s patients is growing so rapidly the healthcare system isn’t equipped to handle it.
- Some drug companies such as Biogen and Merck are working on cures. Biogen has a drug undergoing Phase 3 clinical testing expected to be complete in late 2019. Ditto for Merck except 2020. This page describes the different phases of clinical testing (Step 4 section).
- A PET scan is required to diagnose whether or not a person has Alzheimer's. The current supply of PET scan machines and geriatricians capable of diagnosing the results are low compared to the number of people who could be suspected of having Alzheimer's in the next 20 years or so. Thus Gates' and the Rand Corporation's concern about demand much greater than supply.
- The notion that amyloid is the main culprit in Alzheimer’s has come under question recently. Gates will support efforts to look beyond amyloid, investing his money in the Dementia Discovery Fund, which seeds companies pursuing much different theories about what drives the disease.

Still, there are other forms of dementia. Wikipedia says that Alzheimer's is the most common form, being 50-70% of the cases. Dementia also appears in late stages of Parkinson's disease. Forecasts of the number of people with Parkinson's disease also are high. Science Daily reports that new research shows that the number will soon grow to pandemic proportions.

Guns and Gun Laws

The December 2017 issue of Reason magazine includes an article, How To Talk With Your Kids About Guns. It begins with two statements.
"1. The number of privately held firearms in America has nearly doubled in tthe last two decades while the number of gun murders per capita was cut in half.
2. The number of kids abducted by strangers in 2011 was 105, out of approximately 73 million children in the United States. That's down slightly from 115 two decades ago."

"Too often absent from both sides of the debate are well-parsed statistics. Restrictionists will cite the 33,000 annual gun deaths in America." "Two-thirds of gun deaths are suicides." Next most are young men aged 15-34 killed in homicides, often gang-related. The 1,700 women murdered each year are usually a result of domestic violence.

Attempts to restrict gun sales in order to catch a minority of misusers yield all kinds of unintended consequences.

Every time an incident such as Stephen Paddock killing 58 people at a concert in Las Vegas happens, political demagogues, and like-minded folks, want more legal restrictions on guns. Unintended consequences and the effectiveness of such laws -- including if they get enforced or not -- in preventing future homicides matter very little. What matters most is the advocates' intent. They seem to believe that passing another law with a new provision that conceivably might have prevented the most recent homicide will prevent future ones. Reality just doesn't work that way.

Trump's Tax Plan and Demagogues

I read about the proposed President Trump-Republican income tax bill. The most significant part is reducing the corporate tax rate from 35% to 20%. Personal income taxes get a small cut. It simplifies tax computation a bit, by removing the alternative minimum tax and fewer people will itemize deductions. Republicans say the bill will increase the deficit by $1.5 trillion over the next 10 years. Dividing $0.15 trillion (for one year) by 2018 federal revenues of $3.7 trillion yields about a 4% cut.

Simplifying enough to allow filing a postcard return shown by some Republican politicians is absurd. The postcard doesn't have separate lines for interest, dividends, capital gains, pensions, IRAs, Social Security, and several other income and subtractions from income on current tax forms.

A controversial and complicating part is a special 25% tax rate for "pass-through entities" (usually small businesses structured as a partnership, LLC, or S corporation that report business income on personal returns). The controversy comes from the distinction between "active" and "passive" owners. The tax rate on "passive" activities and the "capital" income of "active" owners is capped at 25%.

I made a spreadsheet to calculate personal income taxes per the President Trump-Republican bill to compare the results to 2017 tax amounts. I did so for $10,000 ordinary income up to $250,000 income and every $10,000 increment between, for both single and married filing jointly. The resulting tax per the Trump-Republican plan was less in every case when the 2017 tax was greater than $0. For most cases the tax reduction was between 2% and 3% of income. Married filing jointly with income less than than $100,000 and filing single with income less than $50,000 showed somewhat smaller tax cuts.

The spreadsheet overlooks a few outliers that have large deductions that will no longer exist under the Trump-Republican bill and were not limited by the alternative minimum tax. However, it is predictably a tiny percent. For lower middle income filers with children, they will lose the extra personal exemptions for the children, but that will be much offset by a higher child tax credit.

Earlier Trump proposed to cut the top rate from 39.6% to 35%, but the latest proposal keeps the 39.6%. Michael Kitces says the bill creates another bracket of 45.6% (=39.6% + 6%) for a segment of income above $1,000,000 (link). It phases out the 12% bracket for those with income above that threshold. Also, earlier Trump proposed ending the favorable treatment of "carried interest." That is not in the bill.  Edit: I later learned that the bill reduces favored treatment somewhat. It would increase the minimum time assets would have to be held to qualify for the capital gains rate from one year to three years.       .

It didn't take long after the proposal was made for Democrats like Nancy Pelosi to trash it. This story from CNANews says: "Pelosi said Republicans are unveiling a tax bill "designed to plunder the middle class" in order to put more money into the pockets of the wealthiest one percent." She obviously has only an iota of understanding of what's in the bill. (Recall what she said about Obamacare: "We need to pass this bill to see what's in it.") Many in the middle class will pay lower taxes under the bill. My spreadsheet shows that "plundering the middle class" is pure, ignorant demagoguery.

CNSNews had another story titled Tax Plan May Kill Deduction Taken by 95% of Itemizers. Well, whoop-de-do! Firstly, only about 30% of tax returns filed itemize deductions, and most that do itemize have higher incomes. The higher the income, the more likely to itemize. Second, the story  ignores the higher standard deduction in the Trump-Republican plan, which will more than offset any lost state and local income or sales tax deduction in many cases. Lastly, per the Tax Foundation, almost 90 percent of the deductions for those who claim it go to those with incomes in excess of $100,000.

The bill eliminates deductions for medical expenses. So far I haven't seen much criticism of this, but it might surface.

The lesser corporate tax rate will, of course, put more money in the hands of producers rather than grubby non-productive politicians like Pelosi and Bernie Sanders and will likely lead to some tax revenue from repatriation of corporate funds overseas partly offsetting the overall lower corporate rate.