Mitt Romney usefully points out that his tax rate is more like 50% than 15%, because the corporations from which he got his capital gains paid a corporate income tax of 35%, more or less. Good point! Anyone whose income comes from the private sector can add 35% to his actual tax rate, and should (of course, Mitt is still in a sweet spot comparatively). But that’s not all; everyone who bought the stuff these companies sold paid income tax on the money they bought it with, so there’s another 20% or so, often sales tax to boot, and their salaries were paid mostly by companies that paid corporate income tax….My God, another 35%: we’re up to 105% average tax on American incomes; no wonder the country is going down the drain.
Of course, government and non-profit worker parasites like me, and folks who work for companies that are losing money, we get an incredible deal, because the Romney multiplier doesn’t apply. And that’s the mechanism that’s driving America into socialist hell!
You read it here first, folks. See you at the barricades.
Author: Michael O'Hare
Professor of Public Policy at the Goldman School of Public Policy, University of California, Berkeley, Michael O'Hare was raised in New York City and trained at Harvard as an architect and structural engineer. Diverted from an honest career designing buildings by the offer of a job in which he could think about anything he wanted to and spend his time with very smart and curious young people, he fell among economists and such like, and continues to benefit from their generosity with on-the-job social science training.
He has followed the process and principles of design into "nonphysical environments" such as production processes in organizations, regulation, and information management and published a variety of research in environmental policy, government policy towards the arts, and management, with special interests in energy, facility siting, information and perceptions in public choice and work environments, and policy design. His current research is focused on transportation biofuels and their effects on global land use, food security, and international trade; regulatory policy in the face of scientific uncertainty; and, after a three-decade hiatus, on NIMBY conflicts afflicting high speed rail right-of-way and nuclear waste disposal sites. He is also a regular writer on pedagogy, especially teaching in professional education, and co-edited the "Curriculum and Case Notes" section of the Journal of Policy Analysis and Management.
Between faculty appointments at the MIT Department of Urban Studies and Planning and the John F. Kennedy School of Government at Harvard, he was director of policy analysis at the Massachusetts Executive Office of Environmental Affairs. He has had visiting appointments at Università Bocconi in Milan and the National University of Singapore and teaches regularly in the Goldman School's executive (mid-career) programs.
At GSPP, O'Hare has taught a studio course in Program and Policy Design, Arts and Cultural Policy, Public Management, the pedagogy course for graduate student instructors, Quantitative Methods, Environmental Policy, and the introduction to public policy for its undergraduate minor, which he supervises. Generally, he considers himself the school's resident expert in any subject in which there is no such thing as real expertise (a recent project concerned the governance and design of California county fairs), but is secure in the distinction of being the only faculty member with a metal lathe in his basement and a 4×5 Ebony view camera. At the moment, he would rather be making something with his hands than writing this blurb.
View all posts by Michael O'Hare
Corporate income tax is on what’s left over after salaries and other expenses are paid.
Thus rendering the term “net income” meaningless. Good show.
Yeah; Corporate taxes are on profits, not expenses; Most of those people you’re talking about are classed as expenses, and thus their income is single taxed.
So, not a particularly factual bit of snark. In the sense of being wildly untrue…
In related news, J. Swift did not actually like the taste of babies.
Oh, come on. Michael clearly was arguing that most people have an effective tax rate over 100%.
Really? So Mr. Romney takes management fees of $13M as carried interest rather than put himself on the payroll of the companies he manages because he prefers to be taxed at 35% + 15% = 44.75% (do the math) rather than at a marginal income tax rate of 35%? How stupid do you (and he) think that everybody is?
Never mind that no profit taxes were actually paid on those commissions, so that they were, in fact, taxed at exactly 15%.
But the larger point here is that conservatives like to argue that the capital gain tax is unjust, because tax has already been paid on that money. And they also like to defend cuts in corporate taxes with the argument that they do not only fall on stockholders by reducing dividends, but also on the labour force by reducing salaries, and on customers by increasing prices. Well, you can make one argument or you can make the other, but you can’t do both.
Depending on the actual incidence of the corporate income tax, Mitt does have a point, although any corporation that pays anything close to 35% of its income in taxes should replace its Tax Department with one that’s, you know, familiar with the numerous opportunities to avoid paying at the 35% level.
I’m not an academic economist, so my knowledge of the literature on tax incidence is really ancient. Is anyone familiar with recent work on the subject?
Finally, if there’s a problem with the tax treatment of dividends under the corporate income tax (and there is), the answer isn’t to kludge up the individual income tax with arbitrarily low rates on capital gains or dividends. The answer is to fix the damned corporate tax. Something like the Irish system under which dividends are deductible to the extent they’re paid out of income that has been taxed seems reasonable to me. IOW, no deduction for dividends if retained earnings on the tax books are negative.
I didn’t read it here first, I read it in Paul Krugman’s blog 10 days ago.
I would add that whatever Romney paid in corporate costs was a deliberate action, taken to save himself money. Corporate personhood is really convenient for people who like to repeatedly declare ‘persons’ bankrupt, loot pension funds and in general skip out on their debts.
Leo says:
“Well, you can make one argument or you can make the other, but you can’t do both.”
Quite true, but of course the flipside is quite true too. You can’t simultaneously argue that corporate income taxes are collected mainly from rich capitalist (rather than lower and middle income workers and customers) AND that we should ignore corporate taxes when calculating the total tax burden of those same rich capitalists.
The funny thing about accusations of hypocrisy and inconsistency is that 80% of the time they expose the accuser of the same sin s - just in photo negative.
Personally, I’d suggest what I’ve suggested every time this argument has come up - slash corporate taxes to zero and tax dividends and capital gains as ordinary income. Such a move would simplify the tax system enormously (all those armies of corporate tax lawyers and accountants would need to find GDP-enhancing work to do), and the overall personal progressivity of the system would be enhanced.
Don K says:
“Depending on the actual incidence of the corporate income tax, Mitt does have a point, although any corporation that pays anything close to 35% of its income in taxes should replace its Tax Department with one that’s, you know, familiar with the numerous opportunities to avoid paying at the 35% level.”
Lots of very successful corporations pay at or close to 35% in corporate income taxes. The difference between the companies that pay 30-35% and the companies that pay 0-5% isn’t usually that the former are dumb and the latter smart, but that the former have business models and are at stages of their lifecycle that allows them to take advantage of lots of quirky deductions, while the latter don’t and are not.
The average effective corporate tax rate in the US is about 25%. So not quite the 35% statutory level, but well above the (almost nothing) that many participants in these debates suggest.
sd, do you have any actual figures to back up these claims about what tax rates corps. are paying?
Sure, but Bain is a partnership, so its corporate tax rate is zero, since it’s not a corporation. So, any money that Bain collected as fees was never taxed at a level above Mitt himself. This is a huge chunk of the income in question given the way that a private equity firm operates. As for the rest of it, Bain and Mitt collected that as capital gains. Unlike dividends, capital gains is not paid out of the coffers of the company, and so *that* was never taxed at a level above Mitt and Bain, either. In the long run, the stock price should converge to the discounted profits of the corporation and so the tax rates will affect the amount capital gains that one receives on the equity. Over the time periods that Bain is holding investments, though, the correlation between taxes paid and capital gains is going to be very small.
Mitt’s claim is complete bullshit.
By God Professor, you’re on to something!
You know, I don’t actually see Mitt’s argument.
I get a capital gain when I buy some stock and then sell it later on for a profit. So, buy a share of stock for $1000, sell it for $2000, get a $1000 gain and pay 15% in tax.
But the $1000 I buy at already reflects corporate taxes. If the company earns $100/share pretax and pays $35 of that in income taxes, so it’s only earning $65/share after-tax, that affects the price per share. Without the tax I would have had to pay more, because EPS would have been $100, not $65. So now it all doubles and I sell for $2000. Of course I could get more if someone would abolish that tax, but so what? That’s irrelevant. The tax situation is the same as when I bought. I invested an amount of money and doubled it, just as I would have had there been no corporate income tax. So how can I say I paid 35% in corporate income tax on top of the tax on my gain?
And doesn’t the same argument apply to dividends? The way to get dividends is buy some stock. But the price you pay is less than it would be without a corporate income tax. So where’s the double tax?
As I said above, it depends upon whether you are talking short or long term. Yes, you pay less for the stock because the corporation pays taxes. However, capital gains is paid on the increase, and the rate at which the stock increases will be lower because of taxes paid. So, there really is an argument there, though even at this level it’s a lot more complicated than first blush.
However, over the short term and the way a private equity firm runs its operation, the argument has no merit whatsoever. What they tend to do is lever up the acquired company with debt and then pay themselves a dividend out of the principal of the loans. Since money acquired by borrowing isn’t profit, it isn’t taxed at the corporate level.
JMN,
the rate at which the stock increases will be lower because of taxes paid.
I don’t think that’s quite right. Certainly it’s not in the simple case where all after-tax profits are paid out as dividends. You may have some argument when it comes to reinvestment, but I suspect that then the deferral washes it out, though I haven’t worked all that through.
It’s true that the gains in earnings will be larger without the tax, but I don’t think the rate of growth of the stock changes as long as taxes are a constant rate. Try this. Suppose there are no taxes. Company X earns a profit of 5% of sales. Company Y earns a profit of 10% of sales. Suppose they have the same sales and the same growth rate. I don’t see why X’s stock should grow more slowly than Y’s. Yet from an earnings point of view X is just Y with a 50% tax rate.
Am I missing something here?
As a general rule, your assumption that these two companies will have the same growth rate is a bad one, if you also assume that they have the same risk profile. For Company X to really be Company Y with a 50% tax rate, they would have to be in exactly the same business, and thus have the same risk. Given this, higher profit margins also give a faster growth rate on average. To understand this, remember that a given investment isn’t considered desirable based upon whether or not it is expected to return an absolute profit. It has to produce a positive return after discounting all cash flows. Given this, Company Y is going to have a much greater ability to turn those profits into further growth opportunities, while Company X would have to pay them out as dividends.
If the two companies have the same risk profile, and thus the same discount factor, you would see Company Y’s stock go up faster than Company X’s even measured by rate of increase. The present value of a growing perpetuity is: PV = C/(i-g) where C is the initial investment, i is the discount factor and g is the rate of growth. If you have two companies where g is different, then not only does Company Y have a smaller denominator, meaning that it has a higher PV at time 0, but it’s numerator increases at a more rapid rate each year you advance.
For instance, let’s give both companies a discount factor of 10%. Company X has a growth rate of 3% and Company Y has a growth rate of 6%. Set the value of C to be 1 for both companies, and then measure the ratio of the PV of each investment at time 0 and time 1.
PV(X) at Time(0) = 1/(.1-.03) = 14.29 PV(Y) at Time(0) = 1/(.1-.06) = 25 PV(Y)/PV(X) = 1.75
PV(X) at Time(1) = 1.03/(.1-.03) = 14.71 PV(Y) at Time(1) = 1.07/(.1-.06) = 26.5 PV(Y)/PV(X) = 1.80
And so on. In order to get a company with the same growth rate at a higher tax rate, you would have to find one that has a higher risk. That would be reflected in a higher discount rate, which would lead to the same result.
JMN,
Well, I understand the growth model, but you seem to be assuming that Company X has no way to finance a growth opportunity. If both companies pay a 10% dividend yield, say, then in order for Y to justify a dividend cut to fund growth the opportunity obviously has to return more than 10% (assuming it has the same risk as Y). So, since it’s a positive NPV project at the market rate for the risk represented by X and Y, it looks like X could finance it externally, or even cut its own dividend.
Of course internal financing might be cheaper (or not) but that shouldn’t be the big difference. We could also assume that X is twice the size of Y, so its actual profits are the same, leaving it with the same internal financing option. I don’t think that would change things.
But even if you are correct here, that would make Mitt’s argument go something like, “The corporate income tax prevented some of the companies I invested in from taking advantage of all their opportunities, because it drained out cash.” But wasn’t Romney in the finance business? Was he unable to attract investment in profitable opportunities?
Sorry, but you’re wrong. You keep making assumptions of equality between the two companies that do not hold. If, for example, you assume that Company X is twice the size of Company Y in order to achieve the same profits, no one would value them anywhere close to the same. You are focusing on return on equity as if it were the be all and end all of corporate valuation. It isn’t. All of your examples postulate that Company X’s return on *assets* is much lower than that of Company Y. Correspondingly, Company Y is going to have a vastly easier time raising money for growth than Company X does.
Your argument would only hold if the two companies were not only producing the same profits now, but also are assumed to be producing the same profits at all future times. If that assumption holds, then you are correct and they will have the same valuation, because they both already have all of the financing that they will need, and return on equity is the only critical variable.
However, if you allow for the two companies to grow (or contract, for that matter), the assumption collapses. While we can set up an assumption that allows for the current investment in the company to be equal, that does not hold for new investment. New investment, be it equity or debt, will find Company Y far more attractive than Company X and it will have far more growth opportunities. That’s because, in order to generate the same amount of profit, you only have to invest half as much money. To put it in terms of profitability, Company Y can offer a 6% yield on new assets, while Company X would be losing money at that rate. This is true whether the project is financed internally or externally.
If we could assume a corporation that was 100% debt financed with no equity, then you would be much closer to correct, given the deductability of interest. However, there’s no such thing as a company financed 100% by debt; there’s always an equity component. Besides, if such a creature existed, it would be irrelevant to this discussion since we’re talking about capital gains, which is a property of equity only.
As for Mitt’s comment, god forbid, he’s right. There are a number of reasons why internal financing tends to demand a lower rate of return than external, some good and some bad. If you take cash from a company, you will restrict its growth opportunities to only those that can generate the higher returns demanded by external funding sources.
I’ll re-emphasize that none of this means that Mitt’s bigger point about his tax rate isn’t complete bullshit. It is.
I don’t see why X’s stock should grow more slowly than Y’s.
Now ask yourself. Given a choice as between the two stocks(all other things being equal, of course), which one has the greater discounted future earnings? Which one would you pay more for in the present? Of course you might just say one of them should put the ball on the lip, behind the hole, but I don’t see how that would help. So you may be correct, but your comparative scenario seems flawed. 🙂 But props to the company that can eliminate or defer a tax burden of 100% of its profits. It’s price should be much, much higher! Cheers!
Is blog-crossing allowed?
The cash dollars I get when I cash my paycheck have been stepped on to the point that my heroine dealer is insanely jealous, so Mitt can go scr@w himself. At his nosebleed absolute income level, his marginal dollar is taxed way less than mine, and it’s due to a political choice that is not justified by economic theory, certainly not the neoliberal marginal utility theory that the Very Serious People are so in thrall of these days.
Can a get the number of your heroine dealer? I’d like to own one of those.
The thread’s gone far too technical. Mitt Romney says corporations are people when it comes to giving money to his campaign regardless of the views of their stockholders. When it comes to taxation on dividends, they are not persons. Flip. Flop.