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Nonsense Proposals by Pres. Obama and the Republican Leaders Are Over-the-Cliff
Raymond Richman, 11/29/2012

The literate public must be very confused about the position of Pres. Obama whose solution to the federal budget deficit is to raise the marginal rates of personal income tax of those households whose income exceeds $250,000. They are no less confused about the position of the Republican leadership in the Congress whose solution to the public deficit is to eliminate some deductions in calculating income that they believe are unjustified, like the deduction of interest paid on home mortgages.

Economists on the left base their support of the President’s view on the fact that it would make the personal income tax more progressive.  Economists on the right argue that higher progressivity would impede investment and prevent recovery from the depressed economy. Investors, they argue correctly, base their decision to invest on the expected returns after tax which is affected by the rates of tax on corporate income.  What is the effect of elimination of the deduction on mortgage interest? The value of a house is equal to the value placed on its occupancy less real estate taxes, maintenance expenses and depreciation. The deductibility of interest paid on a possible mortgage is a benefit of owning the home. It has the same effect as a subsidy to home ownership; in fact, it is a subsidy to home ownership. Eliminating it would have the same effect as a rise in real estate taxes.

One may conclude that raising the rates of income tax on personal incomes over $250,000 will impede investment in all capital assets and delay recovery while elimination of the deduction of mortgage interest will diminish housing values and reduce the demand for new houses. Older houses will simply have less value and the burden will fall on the home-owner at the time the deduction is eliminated.

A needed real major tax reform without these major impediments to investment would be to integrate the corporate income tax and the personal income tax. The corporate income tax makes us uncompetitive in world markets and is a drag on economic growth and employment. The trade deficits to which the corporate income tax has contributed have caused the loss of millions of manufacturing jobs.

Elimination of the corporate income tax would end the double taxation of corporate earnings, once when corporations pay income tax on their earnings and again when those earnings are paid to shareholders as dividends. Attempts to escape its onerous burden has caused corporations to engage in a multitude of bad economic practices, such as buying back its own shares and financing investment by borrowing instead of equity financing. Payments of interest on the debt are a deductible expense. Under current law, corporations have an incentive to use borrowed capital, debt, rather employ shareholders equity to finance investment. Interest on debt is a business expense and is therefore deductible in determining the corporate income tax. When there is no corporate income tax, there is no tax advantage to incurring debt.

Moreover, it violates a fundamental principle of taxation, the principle of equal treatment of equals. The reform would end the high tax rate of tax on corporate shareholders of moderate income. Their share of corporate income is taxed at 35 percent at the corporate level while they pay personal income tax at a 15% rate under the personal income tax. In effect, their dividends are taxed as though all shareholders were millionaires. The government tried to ameliorate this problem by taxing dividends under the personal income tax at a flat rate of 15 percent, which benefits millionaires, but this does not solve the basic problems of double taxation and overtaxing shareholders of modest incomes.

The beneficial effects of integrating the corporate and personal income taxes include improved incentives to invest in America. The growth of the manufacturing sector is the key to the recovery of the economy.

The reform proposed is to treat corporations as partnerships are treated. The income of the corporation will be taxed as income to the shareholders just as the income of a partnership is considered the income of its partners.

Doing away with the corporate income tax will be of great benefit to the American worker by making American corporations more competitive in international trade and lower prices domestically. The tax burden on the shareholders is not a cost of doing business. Under the rules applicable to international trade, corporate income taxes because they are not a cost of production cannot be rebated to exporters. By contrast,  value-added or sales taxes common to all of Aneruica’s trade partners can be rebated under international trade rules.

But one may argue, the shareholder pays an even greater tax since his rate of tax on the earnings on his share of corporate earnings exceeds the former corporate income tax. However, his liability to tax does not enter into corporate decisions as the current corporate income tax does.

How would a unitary income or consumption tax be administered? Just as in the case of  the taxation of partnerships, the earnings of the corporation will be imputed to the partners whether they are distributed or not. Of course if they pass their earnings on to the shareholders as a dividend, the shareholders will have no problem paying their income tax liability. It may be argued that corporations reinvest their undistributed profits which is something to be encouraged not discouraged. By taxing corporate income to their shareholders, corporate managers would be under pressure to distribute sufficient earnings to enable shareholders to pay their tax liability.

This is one of the reasons that we would prefer that savings be exempted from the personal income tax, which would convert the progressive income tax to a progressive tax on consumption. The corporation which has undistributed profits could then  credit shareholders with shares of stock. By exempting savings, the resulting tax can be converted into a progressive consumption tax.

At present, corporations have an incentive to create capital gains for their shareholders by buying back their own shares. There would be no benefit in doing so if the corporate and personal income taxes were integrated. When corporations reinvest their earnings profitably, it creates capital gains. The increased income which created the gain is taxed under the corporate income tax and under our proposal will be taxed under the progressive consumption tax if shareholders realize the capital gain and do not reinvest the proceeds.

There are great economic benefits that will result from the partnership treatment of corporate income and even greater if we convert both the corporate income and personal income tax to a progressive consumption tax by exempting savings from taxation. It would stimulate private investment and spur economic growth; it would simplify the tax system; it would end the multitude of wasteful practices caused by attempts to avoid taxes and convert ordinary income into capital gains. 

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]