A Way to Tax Corporations That They Cannot Escape

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Wednesday, 29 May 2013 05:18

Eduardo Porter has a column discussing the increasing ability of corporations to escape income taxes. The idea is that they can play games on where their income originated so that it always shows up in countries with the lowest tax rates.

There are different possible responses to this problem. One is to follow the lead of many state governments which tax companies in proportion to the share of total sales that occur within the state. That seems like a reasonable path, but I remember an even surer route to collecting tax that was proposed some years back. (I apologize to the person who came up with this one, who I cannot remember.)

Suppose we give companies the option of giving the government an amount of non-voting stock (I would suggest something like a 30 percent stake) which would be treated exactly like the company's common stock, except without the voting privileges. This means that if the company distributes profits to the shareholders through dividends, then the government's shares get the exact same dividend. If it buys back 10 percent of its shares, then it also buys back 10 percent of the government's shares.

The beauty of this approach is that there is no way to escape the implicit taxation. In addition it has the enormously beneficial effect that there would no longer be any money in playing tax games. Companies could focus on doing business -- making better products or providing better services -- rather than gaming the tax code.

The share option can even be voluntary. If companies want to keep trying to play games with the tax system, they can refuse to go the route of giving shares to the government. Of course everyone will then know what these companies are doing, but that's their call.

Okay, this is too simple to ever make any headway in Washington, but it is something for the rest of us to think about.

 

Addendum:

A few additional items. Jonathan Cohn pointed me to E.F. Schumacher as the source of this share idea. Glad to have that tracked down.

Next, on the issue of companies not paying dividends, so what? The shares will rise in value in accordance with whatever the company keeps as retained earnings. We don't need them to pay it out as dividends.

To get to the more fundamental issues of how taxes work and why they are necessary, we want to reduce someone's purchasing power to leave room for what the government needs to spend. This system does exactly that. Money that otherwise would have gone into the pockets of other shareholders is instead pulled away from them by the government: mission accomplished.

There are issues with companies operating across national borders. If a U.S. company decides to invest heavily in Europe or Latin America then it will presumably be subject to taxes on its earnings in those countries. It then is effectively taxed on its after-tax earnings through this share ownership system. That doesn't really trouble me -- that is the way the tax code is supposed to work now. The structure of incentives created will encourage companies to invest overseas if it would be profitable after deducting whatever foreign taxes they would be forced to pay. That is what we would want.

Suppose foreign countries adopted the same system? I don't see a downside. They can offer an option of paying taxes or giving stock equal to some percentage of outstanding shares. Obviously a firm that just has a small operation in another country will never choose the share option. In terms of state taxes, they can tie their tax collections to the federal collections (dividends plus capital gains) using something like the unitary tax system.

Anyhow, I'm sure that there will be some twists on this one -- that is what corporate tax accountants exists for -- but I haven't heard anything to suggest that this is not workable.