Transcript THE CORPORATION TAX Chapter 19 I’ll probably kick myself for having said this, but when are we going to have the courage.

THE CORPORATION TAX
Chapter 19
I’ll probably kick myself for having said this,
but when are we going to have the courage to
point out that in our tax structure, the
corporation tax is very hard to justify?
President Ronald W. Reagan
19-2
Corporations
• Corporation – A state-chartered form of
business organization, usually with limited
liability for shareholders (owners) and an
independent legal status
• Limited liability
• Corporations are “artificial legal persons”
19-3
Why Tax Corporations?
• Only real people can pay a tax
• Justifications
– Corporations are distinct entities
– Corporations receive special privileges from
society
– Protects integrity of personal income tax
19-4
Structure
Revenue
- Expenses incurred earning revenues
Taxable Income
* Tax rate (15% - 35%)
Tax
- Credits
Total Tax
Alternative Minimum Tax
Treatment of Losses
19-5
Allowable Expenses
• Employee Compensation
– Except compensation in excess of $1,000,000
– Options do not have to be included
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•
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Cost of Material Inputs
Taxes including employer contributions to Social Security
Repairs and advertising
Interest but not dividends
Depreciation
No investment tax credit
– k = investment tax credit
– q = acquisition price of asset
– (1 – k)q = effective price of asset
19-6
Considerations
• Depreciation
– Economic depreciation: The extent to which an asset
decreases in value during a period of time
– Accelerated depreciation: Taking depreciation allowances
faster than true economic depreciation
• Expensing: deducting the asset’s full cost at time of acquisition
• Tax life: the # of years an asset can be depreciated
– 3, 5, 7, 10, 15, 20, 27.5, and 39 years
– Most 5 years
– Intangibles
• Treatment of Dividends versus Retained Earnings
– Double taxation
19-7
General Analysis of Depreciation Tax
Savings
T = tax life
D(n) = proportion of asset that can be written off
against taxable income in nth year
θ = corporate tax rate
Present value of tax savings:
ψ = θ * D(1) + θ * D(2) + … + θ * D(T)
1+r
(1 + r)2
(1 + r)T
19-8
Calculating the Value of Depreciation Allowances –
Straight-Line Depreciation, 10 year tax life
Year
Write-off
Tax Savings
1
2
3
4
5
6
7
8
9
10
Total
$10,000.00
$10,000.00
$10,000.00
$10,000.00
$10,000.00
$10,000.00
$10,000.00
$10,000.00
$10,000.00
$10,000.00
$100,000.00
$3,500.00
$3,500.00
$3,500.00
$3,500.00
$3,500.00
$3,500.00
$3,500.00
$3,500.00
$3,500.00
$3,500.00
$35,000.00
Present Value of
Tax Savings
$3,181.82
$2,892.56
$2,629.60
$2,390.55
$2,173.22
$1,975.66
$1,796.05
$1,632.78
$1,484.34
$1,349.40
$21,505.98
19-9
Calculating the Value of Depreciation Allowances –
Straight-Line Depreciation, 5 year tax life
Year
Write-off
Tax Savings
Present Value of
Tax Savings
1
$20,000.00
$7,000.00
$6,363,64
2
$20,000.00
$7,000.00
$5,785.12
3
$20,000.00
$7,000.00
$5,259.20
4
$20,000.00
$7,000.00
$4,781.09
5
$20,000.00
$7,000.00
$4,346.45
Total
$100,000.00
$35,000.00
$26,535,51
19-10
Effective Tax Rate on Corporate
Capital
• Statutory rate versus effective rate
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–
–
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Interest deductibility
Depreciation allowances
Inflation
Double taxation
• White House and Department of Treasury Report [2012]
– Effective corporate rate = 29%
– Sensitivity of estimate
19-11
Incidence and Excess Burden
• A tax on corporate capital
– Incidence in a general equilibrium model
– Excess burden on a general equilibrium model
• A tax on economic profits
– Incidence and excess burden of a tax on economic
profits
– Actual corporate profits versus economic profits
19-12
Incidence and Excess Burden
Stiglitz Model
G = before-tax value of output produced by machine
r = interest rate
Firm buys machine if: G – r > 0
Assume corporate tax
(1) net income taxed at rate θ
(2) net income = G – r
(1 – θ)(G – r) > 0
19-13
Effects on Behavior
• Types of Assets
– Tax system encourages purchase of assets that
receive relatively generous depreciation
allowances
• Total Physical Investment
– Accelerator Model
– Neoclassical Model
– Cash Flow Model
19-14
Neoclassical Model
User cost of capital = (r + δ)
After tax rate of return = (1 – θ) * (1 – t)
(1 – θ) * (1 – t) * C = (r + δ)
C=
(r + δ)
(1 – θ) * (1 – t)
C = (r + δ) * (1 – ψ –k)
(1 – θ) * (1 – t)
19-15
Effect of User Cost on Investment
• Econometric problems
– Role of expectations
– Elasticity of supply curve of capital goods
– Open economy problems
19-16
Cash Flow Model
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•
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What is cash flow?
Irrelevancy of cash flow in neoclassical model
Cost of internal versus external funds
Empirical results
19-17
Effects on Behavior
• Corporate Finance: How to finance and
whether to retain or distribute profits
– Why do firms pay dividends?
• Dividends as a signal of firm’s financial strength
• Clientele effect
– Effect of taxes on dividend policy
• Empirical evidence – Chetty and Saez [2004]
– Effect on savings
– Debt versus Equity Finance
19-18
State Corporation Taxes
• State taxes have similar incidence and
efficiency problems as federal taxes
• Variation of tax rates across state lines
19-19
Taxation of Multinational
Corporations
• Structure
– U. S. corporations pay tax at standard rate on global
taxable income
– Credit for foreign taxes paid
• Subsidiary status
– Deferral of taxes on income from foreign enterprise
– Repatriation
• Income allocation
– Arm’s length system
– Transfer-pricing problem
19-20
Global vs. Territorial Taxation
• Global Taxation: a system that taxes all income of
a multinational company at the rate of the
company’s home country, regardless of the
nation in which the income is earned
– rf = rUS
– (1 – tf)rf = (1 – tUS)rUS
– Full credit versus limited credit
• Territorial Taxation: a system that taxes the
income of a multinational company at the rate of
the nation in which the income is earned
19-21
Corporation Tax Reform
Full Integration
• Issues
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Nature of the corporation
Administrative feasibility
Effects on efficiency
Effects on saving
Effect on distribution of income
19-22
Effects on Efficiency of Full Integration
• Misallocation of resources between corporate
and non-corporate sectors eliminated
• Tax-induced distortions in savings decisions
reduced
• Remove incentive for “excessive” retained
earnings
• Reduce bias toward debt financing
19-23
Corporation Tax Reform
Dividend Relief
• Allow corporation to deduct dividends
• Exclude dividends from individual taxation
• 2003 legislation – 15% maximal tax rate on
dividends
• 2013 legislation – 23.8% maximal tax rate on
dividends for high income families
19-24
Chapter 19 Summary
• The U.S. Corporate Income Tax of 35%, accounting
for about 10% of all federal revenues, is controversial
due to double taxation arising from the dividend
income tax component of the personal income tax
• Economic analysis centers on the effect of the tax on
amount of physical investment, dividend income
payments, debt financing, state taxes, and tax
avoidance, particularly concerning multinational
corporations
• Tax reforms include full integration of corporate and
personal income taxes, and dividend relief
19-25