Personal Tax vs Business Tax and Trickle Down Theory

[Rainsford]

So there was something very interesting that came up in the "fair share" thread, and that frequently comes up in tax policy discussions, that I think deserves a separate discussion.

Almost any time Democrats start talking about raising taxes on rich individuals, Republicans respond by saying that will hurt "job creators" and then talking about small businesses. Ignoring for the moment the validity of Democrats claim that the rich need to pay their "fair share", or the logic behind trickle down economics in the first place; it always seemed to me that Republicans were responding with a total non sequitur...one that almost always goes unchallenged.

The trouble I'm having here is that Democrats are usually talking about PERSONAL income taxes. With a few exceptions, that tax applies to totally separate funds from those used to run a business and employ people. Raising personal income taxes on those in higher income brackets shouldn't have an obvious effect on a business's ability to hire people, since we're almost always talking about different pools of money. It might make a difference if we're talking about a personal gardener or housekeeper for a wealthier person, but I get the feeling that's not what Republicans mean here.

While it's true that those in the higher income tax brackets often have hiring power in their business, whether they hire someone or not wouldn't seem to greatly depend on their own personal tax rate. Even if supply side economics was a valid theory, it wouldn't seem to apply when we're talking about personal income tax rates.

I think an obvious compromise here that should satisfy both sides (in theory) would be to raise personal income tax rates on the rich while lowering those on businesses. This gives a good supply side boost to the tax rates of actual employers, while hopefully balancing revenue. Plus it's harder to dodge with overseas outsourcing. It's easy for Dell to operate a call center in India, I doubt Micheal Dell is going to move to Mumbai to avoid having his personal income taxed.

 

[glenn1]

Not all businesses are incorporated so the owner pays taxes on the business profits as personal income. If anything, this hurts moderately "wealthy" small business owners just starting to make a decent money and barely touches the millionaire CEO who is paid mainly in stock options and deferred compensation.

 

[Fern]

-snip-
The trouble I'm having here is that Democrats are usually talking about PERSONAL income taxes. With a few exceptions, that tax applies to totally separate funds from those used to run a business and employ people. Raising personal income taxes on those in higher income brackets shouldn't have an obvious effect on a business's ability to hire people, since we're almost always talking about different pools of money. It might make a difference if we're talking about a personal gardener or housekeeper for a wealthier person, but I get the feeling that's not what Republicans mean here.

No, Rains. It's quite the opposite.

(Bear in mind you have never seen me make the Repub argument you mention above)

Hundreds of thousands, if not millions, of businesses are held in S-corps, LLC's or partnerships. The businesses do not themselves pay taxes, instead the taxable net income on their tax return 'flows' over to the owners' personal tax return and they pay taxes on them.

And this is very important - the amount of net profit that is put on the owners' tax return has exactly ZERO relationship to how much money that owner took from the business.

(Net income, in the vast majority of cases - and the average person finds this very hard to understand - has very little relationship to how much money that business has in it's bank account at the end of the year. For example, if you borrowed money to buy a business, that loan payment is not a deduction even though you paid it with cash money. I.e., often it looks as though you have more cash money than you actually do.)

If and when you raise taxes on those owners, they'll have to pull more cash out of the business to pay it. In fact, most of us tax accountants calculate the businesses' profit quarterly, then estimate the amount of tax the owners' will have to personally pay on it. We then have the business itself write a check directly to IRS for the owners' account.

That's how the relationship works.

Fern

 

[Spikesoldier]

yeah they will have to reform tax code as far as sole proprietorship or partnership is concerned.

not every small business is a corporation or LLC

 

[Fern]

-snip-
I think an obvious compromise here that should satisfy both sides (in theory) would be to raise personal income tax rates on the rich while lowering those on businesses. This gives a good supply side boost to the tax rates of actual employers, while hopefully balancing revenue. Plus it's harder to dodge with overseas outsourcing. It's easy for Dell to operate a call center in India, I doubt Micheal Dell is going to move to Mumbai to avoid having his personal income taxed.

When people speak of foreign income etc they are speaking of what we in the business call a "C" corporation.

These corporations do pay their income tax. These C corps are primarily large corporations whose stock is traded. You cannot be a publicly traded corporation unless you a C corp (there is an exemption for publicly traded partnerships, they are large investment only type partnerships and they are not nearly as common.)

Fern

 

[Rainsford]

Not all businesses are incorporated so the owner pays taxes on the business profits as personal income. If anything, this hurts moderately "wealthy" small business owners just starting to make a decent money and barely touches the millionaire CEO who is paid mainly in stock options and deferred compensation.

But what percentage of businesses fall into that category, and what percentage of workers work for a business like that? I suspect it's not a very large number, certainly not comparable to the actual number of small businesses (at least in the US) due to how relatively large a "small business" can be.

The millionaire CEO problem you mention can be addressed by making sure we don't make income tax regressive based on the type of income.

 

[Fern]

But what percentage of businesses fall into that category, and what percentage of workers work for a business like that? -snip-

If you follow the info I posted above you'll see that all small business do. I,e,. 100%

The difference between an unincorporated sole proprietor and S-corps etc is, as far as income tax is concerned, merely cosmetic.

Fern

 

[Rainsford]

When people speak of foreign income etc they are speaking of what we in the business call a "C" corporation.

These corporations do pay their income tax. These C corps are primarily large corporations whose stock is traded. You cannot be a publicly traded corporation unless you a C corp (there is an exemption for publicly traded partnerships, they are large investment only type partnerships and they are not nearly as common.)

Fern

The call center is maybe a bad example, and I should probably have left it off. But my understanding is that a business can play a lot of "foreign subsidy" type tricks to ensure that the US C corporation has relatively little income to be taxed.

 

[Rainsford]

If you follow the info I posted above you'll see that all small business do. I,e,. 100%

The difference between an unincorporated sole proprietor and S-corps etc is, as far as income tax is concerned, merely cosmetic.

Fern

The definition of "small business" in the US doesn't say they can't be C corporations, as far as I'm aware. And given that the definition extends to companies that employ up to 500 people, it seems incredibly unlikely that 100% of small businesses are funded by income that's taxed as the owner's personal income.

 

[JS80]

The call center is maybe a bad example, and I should probably have left it off. But my understanding is that a business can play a lot of "foreign subsidy" type tricks to ensure that the US C corporation has relatively little income to be taxed.

That's because the US is the only country in the Universe that tries to tax you on income not made in the home country. This creates an incentive for companies to source revenue to these foreign countries paying taxes in THOSE countries and reducing the tax liability here at home. The law says they only pay taxes when the money is repatriated back to the US, so companies will leave the funds offshore. This is one of the unintended consequences of poor tax laws in the US.

 

[Fern]

The call center is maybe a bad example, and I should probably have left it off. But my understanding is that a business can play a lot of "foreign subsidy" type tricks to ensure that the US C corporation has relatively little income to be taxed.

Well, I was trying to make a different point.

In looking at taxes we have basically 3 different kinds:

1. Individuals who are employees.

2. Individuals who own small business.

3. (C type) Corporations. These are primarily large corporations.

---------

Yes if you are large (Fortune 500 type) corporation you can play some 'games' when doing business in multiple countries. Actually those US companies are merely trying put themselves on similar footing (tax-wise) as all other (foreign) companies.

We are basically the only country that taxes our companies on income earned in other countries.

As I wrote elsewhere recently, there have been ongoing discussions in Washington to have the US change to a tax system like Europe and others. If that happens there will be no more talk of these games because they will become irrelevant and unnecessary. There would be no purpose to them as far as US taxation.

Fern

 

[Fern]

The definition of "small business" in the US doesn't say they can't be C corporations, as far as I'm aware. And given that the definition extends to companies that employ up to 500 people, it seems incredibly unlikely that 100% of small businesses are funded by income that's taxed as the owner's personal income.

No. You can have a small business that uses the C corp as an entity. It's just that there are damn few of them. Because of the complexity, among things, it's a very poor choice and one that hardly ever made since S-corps came into being.

So, sure 100% overstates it a bit. The term "small business" has many definitions. E.g., for IRS purposes it's typically defined by the (gross) revenue ($100 million or less).

The number of employees has no bearing on whether you select to operate your business as a C-corp, or an S-corp or a partnership. It is dictated by primarily by the number of owners and a few other criteria.

Fern

 

[herm0016]

fern did a great job explaining it. i feel as though i have nothing to add.

I would make a guess that of non-public companies 90%+ pay income taxes on the personal level. a C-corp is very expensive to set up and maintain compared to other types of businesses.

 

[Raghu]

That's because the US is the only country in the Universe that tries to tax you on income not made in the home country.

Not true. AFAIK, India taxes the money made outside its borders only when its repatriated.

The trickle down theory doesnt work well because it assumes a pyramid like structure for the money flow. In reality its more like an interconnected network with lot of loops. When these loops are between the rich people, its tends to enrich them even further.

Example - CEO of a car company dines at a 5-star restaurant. The restaurant owner now has profits that he uses to buy a car from the same car company. This means that the money keeps flowing between these 2 rich people, while they can continue to keep their workers at just above subsistence. Trickle down works only when there is a strong reason/incentive to drive the money to the bottom and not keep it circulating at the top.

A minimum income threshold for taxation tries to be a solution.

 

[dmcowen674]

Rain, here is the real truth the rich Republicans on here would never admit to.

No matter what valid argument you come up with those with deep pockets have acquired "power" in their in minds and they don't like giving up any of the money they have accumulated because they feel it is an attack on that "power" they climbed up to.

Here is a good example that I'm sure many of you have seen personally.

A co-worker you have been working side by side with for many years all of a sudden gets a promotion. Instantly within hours of that "elevation in power" they become instant asshole towards you.

They no longer shit the same way you do.

 

[shira]

The argument that higher tax rates are a disincentive to hiring by businesses seems specious to me. Taxes are computed on net profits, so if a company hires 10 new employees, the salaries, benefits, and "burden" of those new employees are deductible business expenses which reduce the company's tax liability. It's not as though the company first pays its taxes and then pays salaries out of what's left over; it's the other way around.

Also, capital expenditures paid out of profits are depreciable, further reducing a company's tax burden.

I do agree that corporate tax rates should be reduced, to bring them in line with the rates foreign corporations pay. But I don't see higher personal income tax rates for the wealthy exerting significant downward pressure on hiring.

 

[Jhhnn]

I came across a fairly radical idea elsewhere, on that seems to make a lot of sense, at least on the surface. Eliminate corporate taxes entirely, tax dividends and capital gains as normal income in a progressive fashion.

It alters the whole perception of offshore subsidiaries and holding money offshore to avoid taxes. The whole flimflam of cheating the IRS to supposedly benefit stockholders would cease to exist. Holding out on the IRS is one thing, and holding out on stockholders is entirely another. Stockholders want their money, and paying higher taxes on it would only make them clamor for more. What's currently seen as good for business would become bad for business virtually overnight, and would likely increase govt revenues at the same time. Corporations would bring their headquarters back home as fast as possible, fold foreign subsidiaries created for tax purposes back into the mother company very quickly, as well.

Changes to corporate & personal income taxes would need to be simultaneous, of course, if govt revenues were to be maintained or enhanced.

I haven't considered all the angles, of course- I'm no financial expert- but I kinda like it.

 

[Engineer]

I came across a fairly radical idea elsewhere, on that seems to make a lot of sense, at least on the surface. Eliminate corporate taxes entirely, tax dividends and capital gains as normal income in a progressive fashion.

That's kind of what we were referring to here....

I don't know...but if a mere $79 billion is kicking our ass on jobs, why not drop it or remove it and make it up in real economic growth of new employes...not sucking on welfare and paying their fare share from jobs. If no jobs, no tax reductions for the next year, etc.

Note: I was wrong with my data on the $79 billion (it' s much more) but the gist is still the same.....

 

[yllus]

I came across a fairly radical idea elsewhere, on that seems to make a lot of sense, at least on the surface. Eliminate corporate taxes entirely, tax dividends and capital gains as normal income in a progressive fashion.

There's a number of OECD research papers that I've seen that agree with this.

OECD Economics Department WP 620 (2008) - Tax and economic growth

This paper investigates the design of tax structures to promote economic growth. It suggests a “tax and growth” ranking of taxes, confirming results from earlier literature but providing a more detailed disaggregation of taxes. Corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxes.

Recurrent taxes on immovable property appear to have the least impact. A revenue neutral growth-oriented tax reform would, therefore, be to shift part of the revenue base from income taxes to less distortive taxes such as recurrent taxes on immovable property or consumption.

The paper breaks new ground by using data on industrial sectors and individual firms to show how redesigning taxation within each of the broad tax categories could in some cases ensure sizeable efficiency gains. For example, reduced rates of corporate tax for small firms do not seem to enhance growth, and high top marginal rates of personal income tax can reduce productivity growth by reducing entrepreneurial activity.

While the paper focuses on how taxes affect growth, it recognises that practical tax reform requires a balance between the aims of efficiency, equity, simplicity and revenue raising.

 

[sandorski]

I came across a fairly radical idea elsewhere, on that seems to make a lot of sense, at least on the surface. Eliminate corporate taxes entirely, tax dividends and capital gains as normal income in a progressive fashion.

It alters the whole perception of offshore subsidiaries and holding money offshore to avoid taxes. The whole flimflam of cheating the IRS to supposedly benefit stockholders would cease to exist. Holding out on the IRS is one thing, and holding out on stockholders is entirely another. Stockholders want their money, and paying higher taxes on it would only make them clamor for more. What's currently seen as good for business would become bad for business virtually overnight, and would likely increase govt revenues at the same time. Corporations would bring their headquarters back home as fast as possible, fold foreign subsidiaries created for tax purposes back into the mother company very quickly, as well.

Changes to corporate & personal income taxes would need to be simultaneous, of course, if govt revenues were to be maintained or enhanced.

I haven't considered all the angles, of course- I'm no financial expert- but I kinda like it.

Yup. Elimination of Corporate Taxes makes sense, although just making them much smaller than Personal Income Taxes would be sufficient. Mainly because Corps do benefit/utilize Public Infrastructure. However, "Trickle Down" makes some sense when talking about Corporate Income Taxes.

 

[Rainsford]

No. You can have a small business that uses the C corp as an entity. It's just that there are damn few of them. Because of the complexity, among things, it's a very poor choice and one that hardly ever made since S-corps came into being.

So, sure 100% overstates it a bit. The term "small business" has many definitions. E.g., for IRS purposes it's typically defined by the (gross) revenue ($100 million or less).

The number of employees has no bearing on whether you select to operate your business as a C-corp, or an S-corp or a partnership. It is dictated by primarily by the number of owners and a few other criteria.

Fern

So I looked around a bit, and I'm having trouble finding stats on S-corp vs C-corp employment. The vast majority of stats of small businesses I can find seem based on size/revenue. I used to work for a publicly traded company that almost fits the SBA/IRS definition of "small business", and it sure as hell isn't an S-corp. Now it's possible that it is an exception, but the importance of small businesses seems greatly dependent on an unclear definition.

I'm not an expert on S-corp taxes, but it sounds like the taxes are applied on net income in any case. Which means the effect of income tax rates on their hiring would be a bit less obvious in any case.

 

[JSt0rm]

Its true. in fact raising their taxes would increase spending in the business as they would want to write off more profits in the way of investment and or jobs.

This is how I operate. The more I invest in my own business the less I can be taxed personally. I dont get a "paycheck". I just get what is left over. By incentives thru taxes I spend on my business. This will only increase the MORE you tax the rich. It will increase money velocity. As it stand now most people can pull cash from their operations without investing in them as much as they could.

What we want to have (ideally in my mind) is a hot potato situation with the money supply. Nobody wants to be holding it in the end. You do this until you can cash out BIG. Reach for the stars.

 

[Fern]

So I looked around a bit, and I'm having trouble finding stats on S-corp vs C-corp employment. The vast majority of stats of small businesses I can find seem based on size/revenue. I used to work for a publicly traded company that almost fits the SBA/IRS definition of "small business", and it sure as hell isn't an S-corp. Now it's possible that it is an exception, but the importance of small businesses seems greatly dependent on an unclear definition.

You answered your question. See bolded part above. As I mentioned above, a publicly traded company can not by law be set-up as an S-corp. Even a business that wants to eventually go public will rarely be set-up as an S-corp (they would have to later convert).

Yes, the definition of "small business" in unclear. There are many definitions, depending upon the govt organization, and in some cases the same govt org will have multiple definitions depending upon the subject/issue/topic in question.

S-corps and LLC's are by far the most common entity of choice for a small business today. Most C-corps I see were set-up that way long ago. Conversion to an S-corp often triggers a taxable 'phantom' gain (i.e., you got no money but owe the tax anyway), so they have been left as C-corps to avoid that.

I'm not an expert on S-corp taxes, but it sounds like the taxes are applied on net income in any case. Which means the effect of income tax rates on their hiring would be a bit less obvious in any case.

Income taxes are always applied on net income.

I'm trying to help you understand why raising taxes on individuals means pulling money of the small business (it has less left over). Your OP claims otherwise.

I'm also trying to help you understand why considering taxes in two groups is incorrect.

It's not (1) individuals, and (2) corporations (businesses).

It is (1) Individuals who are employees, (2) individuals with (small) business, and (3) corporations. The latter are typically large and publicly traded.

Fern

 

[JSt0rm]

I'm trying to help you understand why raising taxes on individuals means pulling money of the small business (it has less left over). Your OP claims otherwise.

And again, while this is true raising taxes means pulling money out of the small business (durr) you are not pulling any money out that was intended to be used in business expenses.

You know this.

 

[piasabird]

It is always the small business that gets hurt. Most corporations can and do invest in operations overseas and instead of bringing the money in as profit just reinvest their capital overseas instead of taking profit. If you look at companies like Dell, even though computers are sold in the USA they are often all built or assembled overseas. That is where they make all the parts anyway. There are very few computer parts made in the USA.

I dont much feel too sorry for businesses. When I have to spend $1.40 for a soda at a convenience store, I just wonder why I stopped there. So I have little feeling for stores that are in business to rip off the public. However, I go out of my way sometimes just to frequent and do business with local merchants I can trust. I often buy meat from a local grocery store butcher. Their family has run the store for about 50 years. When I was layed off the owner would often grab my meat package and mark it down a bit. So till this day I always buy all my meat from them. If more people stuck together, the world would be a better place.