The US government should change tax laws allowing all corporations the option to become pass-through entities. Simplified somewhat, pass-through entities (e.g. BDC's, MLP's, REIT's) are those who do not have to pay corporate income tax provided they distribute the majority of their taxable income, usually 90%, to shareholders. These distributions avoid double taxation (corporate taxes + dividend taxes) but the receivers have to pay marginal tax rates on them (typically 28-42%) instead of receiving the lower dividend tax rate status (15-20%). The benefits to our society would be significant:
1.) This would both reduce the machinations companies go through to avoid taxes, and encourage US job formation. Companies hold sizable profits overseas in order to avoid paying US taxes on them. Elimination of the corporate tax allows them to repatriate these funds to the US, returning them to shareholders or using them to fund growth. Shareholders are much more likely to spend or re-invest the funds rather than letting them sit in banks like many companies do. This would jump start the economy by putting the money to work. In economics terms, it would increase the velocity of money. As importantly, companies would no longer have any tax incentives to build factories and transfer patents overseas in order to recognize their profits overseas. This would further encourage US jobs and competitiveness.
2.) In my, and Economist magazine's, opinion pass through entities provide advantages over regular C-corps for the investor. Many studies have shown dividend paying entities outperforming non-dividend payers. Some have even shown higher dividend payers outperform lower dividend payers on both a nominal and risk adjusted basis. Since pass-through entities must distribute 90% of their taxable income they tend to high yield. Furthermore, this effectively means they need to go back to shareholders (or banks) in order to raise funds for large projects. Thus they must be more selective with projects and able to justify large projects to third party stakeholders in order to access funding.
3.) If you believe in a progressive tax system, this would ensure fairness. Warren Buffett for instance would no longer be paying a lower average rate on his taxes than his secretary. This is because 90% of taxable income must be distributed and the distribution from these pass through entities would be subject to the same marginal tax rates as salaried or hourly income. Indeed Warren's average tax rate under this system is very likely to be higher than his secretaries. He would be declaring much more income, so a higher proportion of which would be in the higher brackets. However, it would still likely be close to revenue neutral for the government in the short term. Basically a reduction in corporate taxes, especially those paid by the small business owner, would be offset by an increase in income taxes for the top 10% of earners. Longer term it would actually be revenue positive for the government if you believe, as I do, that the change is very likely to lead to a higher US growth rate.
While passing anything through our legislative branch seems to be a stretch nowadays, I think this is a worthwhile proposal that both could actually happen and would have a significant positive effect on our economy.
Themes: taxes, economy, growth