Corporate Taxes – No More Simplistic Solutions!

I was one of those kids who walked around head bent and looking at the ground – even after they discovered I was totally near-sighted and gave me glasses. The reason? I didn’t start out with a lot of self-esteem, and my peers didn’t help the situation any.

Once I was walking downtown and a couple of older girls passed me on the sidewalk. On called back over her shoulder with a laugh, “You look like a simpleton.”

Now, I had no idea what a simpleton was, but I knew enough about tones of voice to know it wasn’t something good. At home I asked my mother. Knowing I was a bright little girl she told me to look it up in the dictionary. So I did:

“A person who is felt to be deficient in judgment, good sense, or intelligence; a fool.” (The American Heritage® Dictionary of the English Language)

An alternative definition is “a foolish or ignorant person”. OK, now you too know what simpleton means. So, how can we not be the simpletons politicians and pundits seem to take us for?

Simplistic solutions

President Obama recently proposed a higher tax on dividends recently. Did you stop to wonder what a higher tax on corporate dividends would mean?

I certainly did. In particular, I thought about the impact on older retired people. Money market funds have never recovered from the financial crisis. In addition, the Fed has been determined to hold down interest rates. As a result, retirees can’t collect interest from savings accounts or Treasury bills or CDs (certificates of deposit) anymore. That leaves only dividends and interest from stocks or bonds.

But the Fed has used every trick in the book including repeated quantitative easing (buying back government bonds) to make government bonds scarce and thus, force the price of those bonds up and their interest rates down). This has driven nearly everyone into buying stocks. That means a tax on dividends from stocks would hit retirees (and their pension funds) right where it hurts the most.

What I didn’t think about was what effect a tax on dividends might have on the value of corporations. And this is key because it shows how simplistic solutions don’t really solve anything.

Here’s what the Lex column pundit pointed out in the Financial Times this week. If the tax on overseas corporate profits of US companies is lowered, the savings to companies could be canceled out by an increase in the tax on corporate dividends. (That’s assuming the corporations pay the tax rather than passing it on to shareholders).

In other words the value of a company goes up if corporate profits are taxed less but it goes down if its dividend payments are taxed more. This kind of “left hand offsets what the right hand is doing” is very common in DC politics. It’s like driving with one foot on the brake and the other on the gas pedal. It gets us nowhere.

President Obama’s test balloon is floated. You might think this is a corporate tax that will bring the government more revenue to spend on America, but will it? If overseas profits of US corporations are given a “tax amnesty” this year so they can come home with no taxes at all on them, the only new tax revenue from corporations will be from taxes on dividends. Corporations will lose nothing from a dividend tax, and they may even gain at the expense of government revenue because multinational US corporations will gain value from their trillions in tax-free overseas monies when they are repatriated back to the US.

Take a look back in your life! How many times have you been fooled by politicians’ and political newscasters’ “simplistic” solutions to complex economic problems?

Finding real answers

Real answers to thorny problems usually require a lot of thought, and they usually involve changing more than one thing in the end.

This week looking for more ideas about corporate taxes, I ran across an editorial by Robert Pozen, a former investment advisor and lecturer at Harvard Business School, “How to tax foreign profits of US companies” in the Financial Times. What a breath of fresh air on the topic! It looks like it could be the real answer to corporate taxation.

Mr Pozen endorses President Obama’s call for a minimum tax on overseas investments by US companies. Pozen notes that even business lobbyists want the US to follow the lead of other countries and adopt the “territorial” system for taxing foreign profits of US corporations.

In other words, companies should be taxed either here and/or there by another government on their earnings. We shouldn’t encourage a “race to the bottom” by letting our corporations pay no taxes at all on foreign profits (especially not now that “corporations are people”).

But how tax foreign profits?

Mr. Pozen spells out three steps that would need to be taken to set up a territorial tax on US corporate profits overseas.

(1) Congress would exempt US companies from our corporate taxes when they are doing business in countries where they paid at least the minimum US corporate tax rate to that country’s government.

(2) Taxes paid to governments of tax havens would not qualify for this exemption unless the company could prove it actually did business in the tax haven country. Foreign earnings of US companies doing business elsewhere and kept in tax haven countries would be taxed at least at the minimum US corporate tax rate.

(3) If the US company did business in a country with a lower tax rate than ours, the company would have to pay the difference between that rate and the minimum US corporate tax rate, e.g., 12% to the foreign government and 8% to the US government to equal a total of a 20% minimum owed for the US corporate tax.

Finally, rather than declaring a tax holiday for overseas dollars, Pozen suggests a low tax rate, for example 8% on repatriated income earned abroad prior to 2012.

That would encourage companies to bring that money home and still bring the US government needed income while the US transitions to a minimum tax rate on all US corporate earnings no matter where in the world the money is earned.

And what about taxing shareholder dividends?

As I’ve written before, I’m in favor of taxing capital gains at a higher rate to slow down speculation in stock investing.

The companies that pay dividends on their stock tend to be established, larger and more conservative companies. I see no reason to tax them on the dividends they can afford to pay out to pension funds, retirees, and others who want a steady long-term income from their investments.

In my opinion, the last thing we need right now is more uncertainty in the financial markets. Nor should we jeopardize the futures of Americans who depend on interest and dividends on either their present  or future income. But I’d love to hear a good argument for a higher tax on corporate dividends.

How not to be fooled by the simplest solution

At the beginning of junior high school when I was 12, I was again plagued by two girls taunting me as I walked to school each day. One of them was much, much larger than I was.

I was miserable and just tried to ignore them. At the winter holiday season arrived however, my classmates and I wrote our names on pieces of paper and threw them into a bowl. The teacher mixed them up and we each drew a name to get a gift for. Guess which name I got?

At home I complained to my mother about the treatment the biggest of the two girl bullies had given me all fall. I really didn’t want to give that girl a gift, and certainly not a nice one.

My wise mother insisted not only that I give her a gift, but also took me shopping and helped me choose the finest lace handkerchief we could find. It even cost a bit more than what we were supposed to spend, but my mother found the money to pay for it.

I did my best to put a positive face on as I handed over the gift to the bully and then fled. A short while later however she caught up with me. She had tears in her eyes when she thanked me. I was so shocked I didn’t know what to say.

No, of course we didn’t become instant friends. And those two girls continued to follow me every day to school. But whenever anyone came towards me that I clearly didn’t want to talk to, they closed up the gap a bit, and that person left in a big hurry. My tormentors had become my bodyguards.

Every winter I think of them and what I learned that holiday season, and I wonder if they too think of me.

Follow Nancy Humphreys on Twitter @brucenomics