The April 15, 2015 Tax Reform Submission Paper to
The Senate Committee on Finance of Tom Pallow and
Third Way Progressives
By Tom Pallow of Third Way Progressives and The Economic of Quality
What is immediately below was not in my paper, “Our Tax Reform Submission Paper to the Senate Committee on Finance,” that I submitted to the Committee on Finance in August of 2013. What follows the new material will be. The new material is a short explanation of the few ways in which Employer Tax Carve Out (ETCO) tax regimes can assist in making estate tax systems more fair and efficient, this because estate taxes are the one area I have yet to discuss in any of my past papers. The new material also explains how a few of the primary features of the recent Rubio-Lee tax plan will make a fantastic foundation for building an Employer Tax Carve Out tax regime that will greatly modernize our outdated business tax system, fashioning it in the most effective and efficient ways to the reality of the repetitively new global economy of the 21st century.
An indirect and positive effect of an ETCO tax regime on federal or state estate tax systems concerns satisfying the desire that overwhelmingly exists across all regions and the political spectrum to preserve family farms, open spaces and other working or business operations that support property of social, cultural or historic significance. We know our estate tax policies have failed when properties are forced to be sold, altered or divided, simply to cover estate tax bills. At the same time, our estate tax system should raise revenues while facilitating the American tradition of all capable adults being productive, including the descendants of the ultra wealthy.
ETCO tax regimes would assist in achieving these goals by more regularizing and enforcing the IRS’s effort to distinguish between Passive and Active income. Of course one of the requirements for being eligible for an ETCO is that income is derived from the Active ownership of a business. This same distinction can work as a seminal distinction within our estate tax systems, with inherited businesses that are still Actively owed and operated within an estate being sparred a tax bill that would destroy or even weaken the viability of that business.
A second and more direct way in which ETCOs could assist our estate tax and overall tax system would be to allow domestic employers to use some or all of their unused Employee Tax Credits, that are exercised to create ETCOs, against any future estate tax bill that their heirs might incur. Since personal income Employee Tax Credits can only be exercised down to the point of the lower ETCO tax rate for US employers, allowing US employers to be able to exercise unused ETCs against an estates latter tax bill would further incentivize even an entire family business to work together to find ways to employ domestically.
Now onto the fantastic opportunity that some of the primary features of the new Rubio-Lee tax plan have given us!
The plans most important feature, that of eliminating the ability of businesses being able to deduct interest payments on the debt they incur in exchange for allowing businesses to be able to expense all of their capital business investments all in one year, this is in reality a great “pro-growth” trade off. However, both personal income and investment income ETCOs would greatly improve this trade off in several ways, and I will get to that. But there is no doubt that, if such a trade off were made, enough businesses would find ways, and especially with an investment income ETCO, to adjust due to what is essentially an increase in borrowing costs, and the ability of business to expense immediately, this frees up more capital to expand when the expansion does look great for the business “owners” who will know best when to expand. Here to, the word “expand” in the last sentence would mean much greater domestic labor market demand with a personal income ETCO tax regime. But nonetheless, the above Rubio-Lee trade off, even without ETCOs, is a brilliant pro-growth idea that will indeed generate enough new and sustained economic growth to generate increased tax revenues. These new revenues will not be enough to pay for all of the tax cuts and increases in tax credits that Senators Rubio and Lee’s plan propose, but they will be able to pay for a few great gifts for the American people that will assist them in creating even more tax revenues, wage growth, and prosperity!
One of the proposals to spend some of these new tax revenues on that are proposed in the Rubio-Lee plan is to lower the top tax rate for C Corporations to 25% and pass-throughs to 25%. These tax cuts would generate enough new domestic economic growth to increase tax revenues, but not enough to pay for these tax cuts, and perhaps not even enough to brake even with revenues from the original accounting trade off that Rubio and Lee make. However, with this same Rubio-Lee accounting trade off and an ETCO tax regime, these rate cuts for all US employers to 25% would be far more than paid for, and with much money to spare. In August of 2013 I sent a below and very detailed tax plan to the Senate Committee on Finance that used less optimistic economic assumptions than Rudio and Lee do, and with a C Corporation top rate was brought down to as low as 20% and the top pass-through rate brought down to 25%, the difference in the rates deriving from how investment income, and C Corporation or Business with Over 500 US Employees income, is fashioned by ETCOs, along with the usual litany of positives that come from personal income ETCOs.
Yet, even as it is easy to show how ETCOs would greatly improve the above two features of the Rubio-Lee plan, the truth is, much of it will not be able to exist without an ETCO!
Below is from page 8 of Senators Rubio and Lee’s, Economic Growth and Family Fairness Tax Reform Plan:
“In order to prevent abusive misallocation of labor income as business income, this plan also creates strong rules that preserve current tax arrangements for partnerships and independent contractors while discouraging abusive reclassifications. We also require that reasonable compensation be paid by pass-through entities to owners that work for the business.”
It is clearly a part of human nature that simply “discouraging” is never enough to restrain “abusive reclassifications”, when such reclassification need to be made easy for other legal reasons mostly having to do with insurance and capital formation, while these “abusive reclassifcations” would also now generate such a financial windfall for the abuser by simply becoming a pass-though and moving from a top tax rate of 39.6% to one of 25%.
Further, “We also require that reasonable compensation be paid by pass-through entities to owners that work for the business.” That type of government micro-managing I believe is no longer possible in the dynamic economy we now have and want to further encourage, along with other problems. (Wait, did a Democrat just express that about a Republican idea; did we ever think we’d see the day!) Another problem with the above solution is that it would eliminate one of the most effective methods of raising capital for small but quickly expanding business, that being a very Active owner of a business taking a pay cut in exchange for a larger share of ownership of the business in the future.
Yet look how easily the above problems would be solved if a personal income tax ETCO were enacted, while at the same time generating far more domestic economic and wage growth and tax revenues. There already exist a very sizable and quickly expanding percentage of tax payers and tax revenues that are, and are derive from, those who are legally organized as some type of pass-through entity yet they do not employ anyone, domestically or otherwise, and with the above Rubio-Lee policy this will only grow. Yet with a personal income ETCO the 25% top tax rate would only apply to Active owning domestic employing business that pay all of both sides of FICA taxes for all employees. Given that the Employee Tax Credit (ETC) that creates the ETCO are always worth less than the employer’s employee side of FICA taxes paid when all FICA taxes are paid along with other such tax credits to employ, it will always still cost businesses and individuals more money to employ than to not employ even with the ETCO, so the ETCO can not be gamed for tax purposes. Again, for details read further below. Therefore, given the Rubio-Lee tax plan structure, if the businesses that were given the tax rate reduction down to 25% from 39.6% where only domestic employers, than the above “abusive reclassification” issue would be solved along with not needing their second solution. Moreover, much more new tax revenues would be raise, and a fantastic tax incentive of as much as a 58.4% lower tax bill, all to employ domestically, will create an increase in the demand for labor in the US thereby increasing domestic economic growth and even global economic growth and thereby raising even more tax revenues!
Another prominent feature of Senators Rubio and Lee’s tax plan that could be adjusted through ETCOs to create an optimal tax efficiency regards the need to eliminate much of the problems of double or even triple taxation of certain incomes concerning an extreme financial disadvantage to an owner of a business that would come from double taxation due to reincorporating under C Corporation status, in other words, the need to create a degree of tax parity between all businesses, or under an ETCO plan, all domestic employers. Senator Rubio and Lee achieve this parity by eliminating the investment income tax altogether, which is somehow all paid for due to the original pro-growth accounting trade off and other growth assumptions much coming from lower cost of capital via the 0% tax rate on investment income they propose. I am much more than skeptical that such a trade off would balance from a federal budget outlook, especially in an economy with interest rates and borrowing costs already so low globally.
But an even more important and structurally problematic policy exists within this parity area of the Rudio-Lee plan. This is due to the fact that Senators Rubio and Lee move in the wrong direction when it comes to solving this parity problem, and of course once again ETCOs are going to greatly improve this area.
When trying to achieve tax parity due to double taxation of C Corporation income, policy makers can either lower the capital gains and/or dividends tax rates or lower the C Corporation tax rate. It is very important to acknowledge why Senators Rudio and Lee are wrong by choosing investment income to lower.
Obviously, once a C Corporation has paid a divided, most all of that capital is now completely out of reach for that C Corps to ever be able to use for any type of expansion. Subsequently, the better tax rate to cut would be the C Corporation income tax rate. In this way the C Corp would have more direct capital to expand, or issue a dividend if it so chose. But the most important point is that the C Corp would have much more readily available capital to invest as they so chose, and who else would know best, in the real word, the physical economy, the place where dividends and capital gains eventually come from anyway. Our course with a C Corporation ETCO tax system this newly available capital for C Corps would be greatly incentivized to employ in the US and in higher compensating manors.
In my very detailed August 2013 submission paper to the Senate Committee on Finance that is below, I proposed a tax plan using much less optimistic economic assumptions as the Rubio-Lee plan, that with some scenarios there exists a possible top tax rate of only 20% for C Corporation income while also lowering the dividend income top tax rate for qualifying “owners” of the C Corporation to 10%. Further elaborations of the tax plan in this paper could drop both rates much further, these reductions coming from further incentives for C Corps and all Businesses with Over 500 Employees to employ in the US in higher compensating manors along with some environmental tax incentives.
Regarding the issue of actually budget scoring any of my ETCO tax plans or the relevant pro-growth features of the Rubio-Lee tax plan, obviously there would exist much disagreement as to how much economic growth and therefore new federal tax revenues would be generated. But what is certain is that, together, they would certainly raise substantial new tax revenues while greatly improving America’s economic, and employment and wage growth and budget problems. Remember, one of the primary purposes of Employer Tax Carve Outs is that they allow personal income tax rates on the wealthy to be raised much closer to historically average rates without adversely affecting the small percentage of the wealthy who are America’s fastest expanding job creators, thus generating and greatly incentivizing far more economic and labor compensation growth and tax revenues. (This last paragraph was added just to this email.)
Moreover, Senators Rubio and Lee’s justifiable concern for keeping the cost of capital low via tax policy is much more efficiently achieved by enacting an ETCO investment income tax policy, and foremost so when it comes to lowering the cost of capital for businesses that want to expand in the US. Once again a detailed investment income ETCO tax plan along with the logic behind the policy exists below. If any of you have any questions at all about any ETCO policies, please feel free to contact me at any time! Also, all my papers can be found in the blog section of my website, ThirdWayProgressives.org.
There is a very great, very obvious and very bi-partisan political compromise that would greatly benefit all American’s sitting right in front of us! I do not know how much of this you all could enact this year. But some of it along with some of the ETCO reforms will need to be enacted this year if anything economically that actually benefits the American people were to be enacted this year, along with a more regular and responsible budget policy! I wish you all the best of luck and God bless, and feel free to contact me at any time!
Third Way Progressives
The Economics of Quality
OUR TAX REFORM SUBMISSION PAPER TO THE SENATE COMMITTEE ON FINANCE
Employer Tax Carve Outs and US Employee Tax Credits, the First Step to 21st Century Prosperity
Submitted by Tom Pallow of Third Way Progressives
Of course, the cleanest, or clearest, slate would be a complete rewrite of Title 26, which is in essence the 1954 IRS Code that was then renamed with modifications in 1986. Fortunately, such a rewrite is not needed even though today’s US economy, as well as the economies of most of the rest of the world, are fundamentally different now than compared to 1954. Since 1954 most of the world has experienced 8 to 12 fold effective increases in foreign economic competition, and especially for the US and most of the more developed nations of the world, declining manufacturing and exporting bases along with persistent trade deficits. Yet, thanks to the great work of the late Ward M Hussey and his team, very fortunately, only a relatively small reorganization and the likely addition of four new Chapters to Subtitle A, and possibly an addition of a new Chapter to Subtitle C are needed to amend Title 26, and therein enact into our tax code an Employer Tax Carve Out and US Employee Tax Credit tax strategy that will thereby modernize our tax code in the most efficient way that is most conducive to the US’s relatively new, highly competitive economy that has experienced an effective 8 to 10 fold increase in foreign economic competition that has coincided with the Kennedy trade round of GATT in 1967 and the end of the Cold War (1).
Most of this paper will regard in concept four new possible Chapters to Subtitle A while building upon a “cleaner slate” in these areas. Most importantly, regardless of how lawmakers decide to reorganize Subtitle A and other parts of the IRS code, and hopefully for this country by the fall of 2013, Congress should be guided by the following description of a specific Employer Tax Carve Out and Employee Tax Credit tax policy that creates a cleaner tax slate and then encompass today’s C Corporation and personal income tax code as well as other related tax reforms. Upon reading below, the four likely new Chapters for Subtitle A will become obvious and pointed out to the reader.
Let us start with Employer Tax Carve Outs and our personal income tax plan.
Employer Tax Carve Outs are achieved through the use of Employee Tax Credits. Employee Tax Credits can be used in this and many other ways throughout the entire economy in ways that will greatly incentivize employment domestically and in higher compensating manors. Employer Tax Carve Outs, due to their extremely simple, transparent, and nearly universal design, accomplish four primary goals. First, and in no particular order, ETCOs protect America’s most prolific job creators from burdensome income tax bills that can leave them uncompetitive with current or future global competitors. Secondly, the deeper the carve out with ETCOs, that is, the greater the difference in effective tax rates between the non-employing wealthy and domestic employers, the greater will be the tax incentive for wealthy non-employers, and especially talented people who find ways to become wealthy regardless, to employ domestically. Third, because such a small percentage of the wealth’s income comes from the direct and active profits of any US employer being taxed as personal income, and also due to the universality of ETCOs, ETCOs allow governments to have the option to raise personal income tax rates on the wealthy to rates much higher than governments otherwise would be able to do in our relatively new, highly competitive global economy without adverse effect on American employers and our economy. Fourth, ETCOs allow for the elimination of many, much more complex, much open to fraud, but much less often used tax credits that now go to the businesses community.
Before closely examining ETCOs and Employee Tax Credits, let us first examine the question of why ETCOs and ETCs at this point in our history.
The most fundamental economic change for the US in our lifetimes has been the effective 8 to 10 fold increase in foreign economic competition that has occurred over the past 45 years, and that has been greatly accelerated by the fall of the communist Soviet Union and the arrival of revolutionary telecommunications technologies. This submission paper will examine the data that proves this change, but first a little history.
When the communist Soviet economy began to slow in the early 1960’s, in a strategic Cold War response, the western democracies conceived of the Kennedy round of GATT. Finally signed in 1967, the Kennedy round created a quantum leap in foreign trade within the western developed economies, and for the first truly organized and collaborated time, trade with the developed west and the developing nations of the world. The next quantum leaps in global trade came with the Uruguay round of GATT in the mid 1980’s and with the WTO in the early 1990’s that fallowed the global fall and discreditation of the socialist and communist economic models. These are models that, unless a nation lives under a lot of oil wealth, quickly lead to repressive dictatorships.
The fall of the communist Soviet Union was of most significance. When virtually all of global communism fell in the late 1980’s, multinational businesses throughout the developed world no longer had to worry about their capital investments in the underdeveloped world ever being nationalized by some emerging socialist government. This change opened up a cheap labor market of nearly 4 billion people to the nearly 2 billion in the western developed world, and with this massive change the global economy truly began. This has been the largest political-economic change in our lifetimes, but we have yet to adjust our tax and many other policies to it!
As you will see in the following data, the period that followed the Kennedy trade agreement in 1967 saw a quantum leap in the level for foreign trade for the US and nearly the entire world. In 1960 US exports were 4.9% of US Gross Domestic Product and US imports were 4.26%. In 1965 exports were 4.8% of US GDP and imports were 4.3%. But by 1975 exports were 8.1% of US GDP and imports were 7.3%. By 1990 exports were 9.2% and imports were 10.6%. By 2010 they were 12.5% and 15.9% of US GDP, which was down from pre-recession levels of just above 17% (2, 3).
Further, although foreign trade as a percentage of GDP began at higher rates than in the US in most of the rest of the world, most of the rest of the world has mirrored the above change. Between just 1992 and 2005, beginning with the first new trade rules that came with the fall of communism, the OECD country average of total foreign trade in all goods and services as a percentage of GDP went from 32.3% to 45%. During the same years the EU 15 nation average went from 36.3% to 50.7% (3), Mexico went from 17.8% to 30.7%, Japan went from 8.8% to 13.6%, and total Chinese foreign trade went from $100 billion US dollars in 1988 to $2.4 trillion in 2008 (4). India’s total foreign trade as a percentage of GDP went from 16% in 1991 to 47% in 2008 (4). Between 1965 and 1999 the world as a whole had an annual increase in gross national product of 3.3%, while exports of goods and services for the world as a whole increased by 5.9% per year. Between 1965 – 99, among developed nations, GNP averaged 3.2% a year while exports increased 5.9% a year. During this same period for the East Asian and Pacific region GNP grow by an average of 7.4% per year while exports grow by 10.1% per year. In Latin America and the Caribbean GDP averaged 3.5% per year while exports grew by 6%. South America alone grew by an average of 4.7% per year while exports grew by 7.2%. Only Sub-Saharan Africa presents an aberration within this data. Their economies grew by an average of only 2.6% per year as exports grew only 2.4% per year (3). These numbers have only increased after 1999.
As expected, mirroring this data, average tariff rates throughout the world have gradually declined over the past 45 years. This decline began in the developed west with the Kennedy trade agreement, and then moved on to the developing world in the mid-80’s through the early 90’s with the Uruguay round of GATT and the WTO.
For example, the average tariff rate in the US in 1965 was 6.7%. By 1975 it was 3.7%. By 1990 it was 2.8%, and by 2010 1.3%. The US’s year to year average tariff rate expresses a very gradual and steady decline. Because of the GATT and WTO trade deals the rest of the developed west nearly mirrors the US’s drop. This is true except for a few agricultural and natural resource driven economies like Australia, Canada, and New Zealand that kept their average tariff rates relatively high up until the mid-80s and early 90’s. (5)
Also beginning in the mid-80s through in the early 1990’s the developing world started to drastically drop their average tariff rates. China dropped from a rate of 42.9% in 1991, to an average of 13.7% between 2000-04, to an average of 4.2% in 2009. Mexico went from 27% in 1982, to 13% in 1991, to 1.9% in 2009. Indonesia dropped from 37% in 1984, to 13% between 1995-99, to 3.1% in 2009. India went from 74.3% in 1981, to 32% between 2000-04, to 7.9% in 2009. South America as a continent averaged 38% in 1985, 13.2% in 1997, then an average, excluding Venezuela, of 4.2% in 2009.
The above data has not been cherry picked. The above examples are indicative of nearly the entire globe. (6,7,8)
The above data that describes the world’s exponential increase in foreign trade is only half of the equation that explains America’s 8 to 12 fold increase in foreign economic competition. As foreign trade has increased, correspondingly the percentage of Gross Domestic Product that is in sectors that are directly engaged in foreign trade, particularly in the most traded sectors of manufacturing and industry, have greatly declined. For example, in 1965 manufacturing as a percentage of US GDP was about 36%, and by 2011 it was only 12.2% (3). Moreover, none of the data presented here captures how much foreign labor outsourcing and foreign importing into the US has been made much, much easier since 1967 due to the world’s explosion in revolutionary telecommunications technologies!
I have focused on the industrial and manufacturing sectors of foreign trade because they are generally much more affected by foreign competition than are the service and government sectors. In 2008, manufacturing alone as 57% of US exports (9). Manufacturing and industry are also the most “value added” of all economic sectors. That is, they generally pay their employees more and purchase more products from the rest of the economy than do most other sectors. Also, and very importantly, the larger foreign trade is as a percentage of a nation’s GDP, and the lower that manufacturing and industry are as a percentage of that nation’s GDP, the greater generally will be that nation’s “effective” foreign competition rate, that is, the more it is effected by global economic competition. Furthermore, as you can see with the above and below data, US manufacturing and industry rate as having some of the highest levels of competitive pressure on earth!
Over this same period, manufacturing as a percentage of GDP has decreased for nearly the entire world, even often in the developing nations. Between 1970 and 2008, manufacturing went from 35% to 20% of GDP in Japan, 32% to 20% in Germany, and 27% to 16% for the world as a whole. Between 1980 and 2008 manufacturing went from 24% to 12% of GDP in the UK, 20% to 11% in France, and 34% to 33% in China, and between 1885 and 2008 it went from 31% to 15% of GDP in Brazil and 24% to 25% in Korea. (5)
These competitive pressures have motivated the US and most other nations of the world to cut taxes on their emerging businesses and Corporations in order to keep and attract business capital and remain competitive.
Below are the top personal income tax rates of various developed nations in 1981 versus 2010 (10):
The US 70%, 35%
Canada 43%, 29%
France 60%, 40%
Germany 56%, 45%
Japan 75%, 40%
The UK 60%, 50%
Spain 65.9%, 27.13%
Italy 72%, 43%
Australia 60%, 45%
New Zealand 60%, 35.5%
The top corporate income tax rates were also cut by these nation’s central or federal governments between 1981 and 2010 (10):
The US 46%, 35%
Canada 37.6%, 16.5%
France 50%, 34.4%
Germany 56%, 16.5%
Japan 42%, 30%
The UK 52%, 26%
Spain 33%, 30%
Italy 40%, 27.5%
Australia 46%, 30%
New Zealand 45%, 28%
In 1981 the US’s top capital gains tax rate was 28% and its top tax rate on dividends was 70%. Until very recently both of these rates were 15% (11, 12). Further, the OECD Centre for Tax and Policy Administration creates a complex amalgamation of effective top capital gains tax rates with effective top dividends tax rates, and these rates have also greatly decreased between 1981 and 2011 (10):
The US 42.9%, 17.8%
Canada 62.8%, 46.4%
France 61%, 52%
Germany 56%, 26.4%
The UK 75%, 42.5%
Spain 65.1%, 19%
Italy 72%, 12.4%
New Zealand 42.9%, 17.8%
Japan did not have a capital gains or dividends tax until 2000, at which point their top amalgamated effective OCED tax rate was 50%. By 2011 this rate had been dropped to 10%.
Our Employer Tax Carve Out Tax Plan
Now that it has been demonstrated that the US economy, as well as virtually all the economies of the rest of the world, have been drastically altered over the past 45 years due to increased levels of foreign economic competition, how in the case of the US this has meant an effective 8 to 12 fold increase in this competition, and how all of this competition has lead to lower tax rates throughout the globe for businesses and the wealthy, we can see some of the reasons why ETCOs and US Employee Tax Credits are in this relatively new environment needed to protect America’s fastest growing and most promising employers, who are also likely in the relatively soon future to be some of America’s largest exporters and highest paying employers. These reasons related to what type of employers ETCOs are protecting and incentivizing, and just how concentrated these employers are, these reasons are also very important.
Let’s examine just the top 2% of all US income earners for now. Only 18% of all the income that is made by all of the top 2% of US income earners is the profits of any businesses that is taxed as personal income that has one or more employees in the US (13, 14, 15). Yet this 18% of income is extremely important. It comprises the immediately available capital for what are generally America’s fastest growing and most dynamic businesses, that are also generally of the greatest importance to America’s economic future. Businesses that are taxed as personal income are responsible for generally 60% to 90% of all new private sector jobs, and closer to 90% when coming out of a recession. Such US employers that are in the top 2% of incomes are the most successful and fastest growing of these US employers, so they are responsible for as much as, and often near to, 55% of the total of new private sector jobs (16). Such businesses in the top 5% of incomes are responsible for generally 55% to 85% of the new private sector jobs (16). Data for these incomes above the top 2% of US income earners is less certain on this question from my data vantage point, but they do appear to keep the same mathematical pattern established with the data points above, relative to measures of active employer, personal income (16).
One common misconception about growing businesses is that they are not adversely affected by high income tax rates and quarterly income taxes because they can write off as a tax deduction the profits they quickly plow into their expansions. But very few businesses ever expand this way. Most often they need to save for a few years before they can then make their next big expansion. This expansion savings pool would be reduced without ETCOs. Therefore, we should not be reducing their immediately available capital in their most important stage of development when the availability of this capital is so very important to all of us, even if it is intended for needed government revenues.
Also, very importantly, these same businesses often become America’s most stable and highest paying employers and America’s most prolific exporters in the following business cycles a decade latter and well beyond. Two great political-economists in American, George Modelski and William R Thompson, wrote, “Leading Sectors and World Powers: The Coevolution of Global Economics and Politics,” in 1996. This is a great overview for this subject of just how important these leading employers are, and particularly in manufacturing. This book will lead you to more current and earlier works that are even more detailed and specific regarding the importance and concentration of these employers.
Due to the reasons stated above, and due to the universality of ETCOs, it could be said that ETCOs make personal income taxes four to five times more efficient when compared to a tax plan scenario with identical income tax brackets and rates, yet without an ETCO (17)!
ETCOs work the following way:
Personal income ETCOs are built on the economic reality that even within the highest income stratum in the US and elsewhere, and even more so entering lower income levels, a relatively small percentage of total income is the profits of any for profit business that in not a C Corporation that has one or more employees employed domestically. For example, this number peaks at about 21% at about the income level of the top 1% of US income earners, which is now at about $400,000 of adjusted gross income (18,19,20). Within all the income that is earned by the top 2% of income earners in the US, or those earning above about $250,000 a year, only about 19% of all that income is the profits of any for profit business that is not a C Corporation that has one or more employees in the US (18, 19, 20). For the top 5% of US income earners, those earning above about $200,000, this number is about 18%, and for the top 10% of incomes, employers earn above 12% of that total (18, 19, 20). Moreover, when an “active” definition of ownership is enacted in order to qualify for the ETCO, the actual cost of the ETCO when statically scored drops down much lower. For example, the extremely beneficial, bipartisan co-sponsored, Collins-McCaskill ETCO that is in S 1960 for businesses with less than 500 employees and with incomes above $1,000,000, which is an income level very close to where employer income peeks as a percentage of total income, would only cost about 14% of what would be raised when statically scored without the ETCO. Yet this ETCO would help generate back via much increase economic growth far more revenues to the federal government than this 14%!
ETCOs are created by using Employee Tax Credits. US Employee Tax Credits are calculated by adding $.07 for every dollar spent in employee net earnings for the first $113,700 in one tax year of W2 1040 based wages and/or salaries that are paid for work done in the US. By only rewarding tax credits for wages and/or salaries paid below $113,700, where social security payroll taxes are paid, the calculating of the tax credits for businesses and the IRS, and the policing of the policy by the IRS, will be made much earlier. Few if any data points in our entire economy and tax system are document more often and by more people than are W2 1040 based FICA taxes paid. Also, the $113,700 cap, which will increase as the social security tax cap increases, will insure that not much of the tax credits will be rewarded for the payment of very high salaries. Further, and very importantly, our US Employee Tax Credits would create an incentive for businesses to claim their employee expenses on their books and not pay employees under the table. Given that FICA taxes have been raised recently due to the Affordable Healthcare Act, and may need to be raised in the future given increasing healthcare and social security costs, the underground economy in labor is going to become an increasing problem.
Regarding the potential problem of businesses claiming ETC’s for people who currently work for them as independent contractors: Remember, ETC’s are worth 7 cents for every dollar of qualifying wages or salary spent. No business would ever spend 7.65 cents of every wage or salary dollar expense for their employer side of FICA taxes only to then receive only 7 cents of tax credit. Also, an independent contractor would no longer be able to employ anyone to work for him or her and thereby be able to use these qualifying employee expenses for ETC’s against their income.
Also, of course, in the final yearly IRS tax bill calculation of an employer, all state and local government tax incentives to employ, along with other such federal tax incentives that Congress designates, that are exercised by employers will be included in an employer’s final tax bill calculation as you will read a bit further below. However, it may be that it is decided by law makers that some tax credits or deductions for employment, like for example employment of disabled veterans or the recently discharged, have such social benefit that they not be included in employer’s final compilation of tax credits and deductions for domestic employment, thus creating a bottom line financial government subsidy for employment for these purposes.
7% for the value of the ETC was chosen because by being below the 7.65% employer side of FICA taxes the ETC would not be a tax shelter or in other words a bottom line financial government subsidy. However, the lower the value of the ETC, the less universal the ETCO will be and the more it will be that extremely small employers, with generally five or less employees, will not be able to take full advantage of the ETCO. So the ETCO’s contribution to the question of how high or low employer FICA tax rates will be a question for economists to answer in the future. However, and very importantly, with cuts to employer FICA tax rates being proposed in the past few years, it is true that it would be best for the value of the ETC to go down along with any such cut. It is also true that the value of ETCs should go up along with any increase in the total employer FICA tax rate, something that may have to occur under Obamacare, and this would increase the ETCO’s universality.
Given the tax plan in this paper, with US ETCs for employers of less than 500 worth 7%, the universality of our ETCO would be quite extensive. Under the exact same features and numbers of this tax plan, if a personal income tax increase were enacted on the non-employing wealthy along with an equal degreed ETCO tax cut for US employer, only about 2.5% of employees who work for a business with less than 500 employees that is taxed as personal income would have their employer’s effective tax rate go up, about 2.5% would stay about the same, while 95% would receive a tax cut. The 2.5% that would go up would be very high income employers with very few US employees, the vast majority of them with less than five US employees.
Below are more of the rules to qualify for Employee Tax Credits and therefore ETCOs:
Employee wages and salaries that qualify for the ETC may not go to any “business owner” nor any dependent of any business owner, be it a C Corporation or otherwise. Nor can they go to any immediate family member, including by marriage, who reside in any home owned by that business owner. Also, ETC qualifying compensation should go to any of the portion above 33% of any single employee’s wages and/or salary who works more than 33% of the year outside of the US. Nor can they go to any “employee” who works less than 18 hours a week on average who simultaneously receives income from more than two other employers who use that employee’s wages or salary for the ETC. If a dispute arises regarding which three employers can use their paid compensation for the ETC for any one particular employee, the three employers who pay the three highest total compensation amounts over the calendar year will be the qualifiers.
A “business owner” is anyone who owns 10% or more of a business, C Corporation or otherwise, who also qualifies as “active” owners under current IRS rules. Also, as part of an active definition of ownership, no one business can have more than five business owners who qualify for the ETC at any one time. There also may have to be enacted what is called the Captivation Rule. The Captivation Rule simply states that a current employee of a business cannot suddenly become their own private business or independent contractor who then lowers their effective tax rate through ETCs when their former employer makes up more than 60% of the total client revenues of the new private business. This rule should have a time limit of no more than 10 years.
Tax credits are never perfectly simple. But overall the ETC is much simpler than most tax credits because they are calculated using W2 1040 based employee expenses which are one of the most documented expenses and figures in all economic data. Moreover, with a few simple rule differences ETCOs can be made with 1099 compensation payments. Meanwhile, ETCOs and ETCs accomplish so much more than any other tax credits or tax strategy.
A private or pass through employer’s tax bill would be arrived at by first going through all existing steps in the tax code. Then, if an employing “business owner,” it would be calculated by using new tax tables at the end of each applicable business schedule. These tables would give two numbers in each income grid square, the first number as though the bracket tax rates, in the case of this papers plan were, 39.6%, 35%, 33%, 28%, 25%, 15% and 10%, and the second number as though the rates were 30%, 25%, 23%, 18%, 15%, 5%, and 0%, respectfully. The business could then deduct $.07 for every dollar of qualifying US ETC employee wages and/or salaries spent, plus all local, state, and perhaps other federal incentives to employ, from the dollar amount of the first number in the grid square, to no lower than the second dollar amount number in the grid square.
In order to alter ETCs and phase out the ETCO at 500 employees, as the fantastic, bipartisan co-sponsored, Collins-McCaskill ETCO does, the following should occur. As a business adds their 501st and 502nd employee and so on, what would normally be the qualifying employee expenses for the ETCs for the 501st and 502nd employee and so on without the employee cap, would be subtracted in an exact dollar amount from the existing total dollar amount of qualifying employee expenses for the ETCs of the business’s first 500 employees. At this point the same above tax table calculation would be made.
Remember, ETCOs, due to their extremely simple, transparent, and nearly universal design, accomplish four primary goals. ETCOs protect America’s most prolific job creators from burdensome income tax bills that can leave them uncompetitive with current or future global competitors. Also, the deeper the carve out with ETCOs, that is, the greater the difference in effective tax rate between the non-employing wealthy and domestic employers, the greater will be the tax incentive for wealthy non-employers, and especially talented people who find ways to become wealthy regardless, to employ domestically. Further, because such a small percentage of the wealth’s income comes from the direct and active profits of any employer that is taxed as personal income, and also due to the universality of ETCOs, ETCOs allow governments to have the option to raise personal income tax rates on the wealthy to rates much higher than governments otherwise would be able to do in our relatively new, highly competitive global economy without adverse effect on American employers and our economy. Lastly, ETCOs allow for the elimination of many, much more complex, much more open to fraud, but much less used tax credits that now go to the businesses community.
Moreover, enacting ETCOs into our tax code creates a code that rest on a more just and moral foundation than does our existing tax code. Most everyone who has done, or who has attempted to do both, will tell you that, generally speaking, it takes more work to make the same income through employing others than it does by being employed by another. Furthermore, all other things being equal, the person who is employing others here in the US is more beneficial and important to other Americas than is a person earning an equal amount who does not employ; one has found a way to make a living for themselves and all those who they employ, the other, only themselves. Lastly, virtually the only issue that all economists throughout the spectrum of economists agree on is that monetary incentive work, and that the simpler and greater that monetary incentive, the more influential the incentive will be. Remember, the deeper the ETCO, that is, the greater the difference in effective tax rates between the non-employing wealthy and employers, the greater will be this monetary incentive, and the more private sector jobs and government revenues will be generated!
Before explaining specifically this submission paper’s tax plan for personal income, a somewhat cleaner tax slate needs to be cleared regarding personal income tax deductions. Obviously, for three or more years now tax policy makers in Washington DC have been focused on “pro-growth” tax reform. On the C Corporation side of tax reform, most of the rationale behind this pro-growth tax reform is the idea that large, not as quickly growing, less in need, and more politically connected C Corps get most of the tax deductions that then bring their effective tax rates very low, meanwhile, America’s fastest growing, most in need of capital to expand, and least politically connected C Corps are stuck with much higher tax rates that are close to the statutory maximum of 35%. Reducing the amount of tax deductions and then lowering C Corp tax rates for all would be a positive adjustment to our tax code. Although as you will see, our ETCO and ETC tax policy for C Corps and for employers of over 500 would be much more direct, efficient, and beneficial to our nation. On the personal income tax side the rationale behind this pro-growth tax reform is that wealthy non-employers are more likely then are wealthy employers, who often desperately need capital to expand, to spend money in ways that are not related to employment but in ways that can be used for a tax deduction. By reducing the tax deductions that are more proportionally used by wealthy non-employers, tax rates could be cut a bit for all incomes, employer or non-employer, and employers would then get a tax cut because they are less likely to be exercising these tax deductions to begin with. Obviously, on the personal income tax side enacting ETCOs would be much more efficient and pro-growth than would be the above tax strategy. Moreover, unlike on the C Corp side, on the personal income side there really are not a whole lot of tax deductions that can be reduced without adverse effect, even for America’s wealthy.
The most costly to the federal government itemized deduction for the wealthy is the charitable deduction. It would not make political, economic, social, or moral sense to limit charitable deductions in any way. Even when it comes to non-cash donations, the low hanging fruit of these tax deduction reductions has already been picked, and new and much better ways of generating more government revenues by only reforming our tax code await us. Also, given the new tax laws in the Affordable Care Act, these “new and much better ways” are better than reducing any existing healthcare tax deductions, even for the wealthy. Further, regarding savings tax deductions, they could definitely be consolidated and simplified, but regarding federal revenues to be raised, the new and much better ways are definitely much better in this area.
Really, only the home mortgage interest deduction for second homes could be cut to some degree, and the simplest way to reduce it would be to cut the total amount of mortgage debt that could be deducted from the current $1.1 million cap. But before anyone gets too carried away with a reduction here, please realize that with our new economy, where much work can now be done via cyberspace, and given how, especially in many of our rural areas, seasonal work especially due to tourism that we hope will become an ever larger portion of our economy, but also due to other economic forces, it would be very beneficial to have at tax code that allows for both labor and management to move seasonally, i.e. have two homes. Given this reality, and the cost of housing throughout our nation, it would not be beneficial to take this cap below $800,000. However, lowering the cap to that point would raise federal revenues, and likely not inspire as many “magamansions”, which have greatly expanded over the past two decades and that evidence shows has helped to some degree to lead to higher home prices during this period. The total homes mortgage interest deduction is said to cost the federal government about $100 billion a year. Under this paper’s calculations, the above cut to the mortgage interest deduction cap would save the federal government about $10 billion a year.
Very fortunately, $10 billion goes very, very far when it comes to ETCOs. Not only could this $10 billion “pay” for an ETCO for the employers who are hit with January 1, 2013’s personal income tax increase on joint filers earning over $450,000 and singles over $400,000, but about $13 billion a year, when statically score, could pay for the below personal income tax and ETCO tax plan. Furthermore, $13 billion is when statically scored. Remember, that when the assumptions of a fairly respected Heritage Foundation study were used when analyzing a personal income tax plan with an ETCO that is much similar to the plan below, versus the exact same tax plan without the ETCO, it showed that over a 10 year period the ETCO plan raised as much as four to five times the government revenues, this again, because employment was incentive and allowed to grow (17)! In other words, due to more efficient tax incentives and more economic growth domestically, the tax plan in this paper, over at least the medium and long runs, will certainly raise far more government revenues, without ever raising any tax rates at all, only lowering certain tax rates! Below are the current 2013 personal income tax brackets and rates with the corresponding flour cap tax rates for our ETCO tax plan.
Non-employer Rate for Single Filers, and Married Joint Filers, Employer tax rate with ETCO
10%, $0 to $8,925, $0 to $17,850, O%
15%, $8,925 to $36,250, $17,850 to $72,500, 5%
25%, $36,250 to $87,850, $72,500 to $146,400, 15%
28%, $87,850 to $183,250, $146,400 to $223,050, 18%
33%, $183,250 to $398,350, $223,050 to $398,350, 23%
35%, $398,350 to $400,000, $398,350 to $450,000, 25%
39.6%, $400,000 and up, $450,000 and up, 30%
Remember, our plan’s reduction of the mortgage interest deduction debt cap gave us about $10 billion a year to work with. The above ETCO plan would cost only about $3 billion a year above that, but this is when statically scored. The C Corporation tax side is far more riddled with inefficient tax deductions and tax loopholes, so if Congress insists that an ETCO plan like this be statically scored, then some revenues from tax deduction reductions on the C Corp side should be brought over to the personal income tax side for an even deeper ETCO. Better yet, some revenues from the C Corp side should be used for tax incentives to employ in America in higher compensating ways for businesses that are taxed as personal income that have over 500 employees. How this is done will be explained with the discussion of our C Corporation tax plan, that will now begin.
Our C Corporation and Employers of Over 500 Tax Plan
Now that we have examined ETCOs, let us further examine US Employee Tax Credits and how they can go a long way to modernizing our entire tax code for the competitive global economy of the 21st century. More specifically to start with, this submission will suggest a revolutionarily clean tax slate by suggesting a very important and new tax distinction to be made between businesses with less than 500 US employees and business with over 500 US employees, be they C Corporation or taxed as personal income. In fact, with ETCOs, ETCs, and the personal income tax code, different tax schedules at the least will have to exist for non-employers, employers with less than 500 US employees, and employers with over 500 US employees. While for C Corporations an important distinction in the tax code will need to be made between those with less than 500 US employees and those with over 500 US employees. Further, employers with less than 500 US employees, both C Corporation and otherwise, would share much of the same tax laws, as would employers with over 500 US employees, both C Corporation and otherwise.
It is best to start understanding this area of this modern tax code by first examining what happens to US Employee Tax Credits as businesses begin to have more than 500 US employees, and we will essentially start on the C Corporation side.
As businesses begin to employ more and more over 500 US employees, Employee Tax Credits begin to work less as Employer Tax Carve Outs and more as incentives for businesses to employ more often in the US and in higher compensating ways. In this area of our tax code concerning C Corps and businesses with over 500 US employees, our tax plan has three primary tax incentives. One is intended to incentivize employment in the US, and it is referred to as the Employment Tax Incentive. The second is intended to incentivize higher employee compensation levels in the US, and it is referred to as the Compensation Tax Incentive. The third tax incentive is retained within our world-wide tax system and it achieves both an employment incentive and a compensation incentive simultaneously.
To start on the C Corporation side, C Corps with less than 500 US employees should have an ETCO and Employee Tax Credits that are in every way, but tax rate, identical to ETCOs and ETCs for businesses with less than 500 US employees that are taxed as personal income. This policy exists in an effort to create as much parity between the C Corp code and the personal income code within the realities of the extra costs to governments of governing C Corps. This effort to keep relative parity between C Corps and private businesses will become more evident as the tax rates for this overall tax plan are explained. Moreover, there are many C Corps in the US that do not employ at all. Many of these are dormant C Corps that are essentially out of business but still involved in the tax system. Yet many are also high income earners, who either for good future planning reasons, or for legal or illegal tax avoidance reasons, have chosen to file as C Corps. If Congress and the President were to enact C Corp tax reform that reduces tax deductions and thereby lowers tax rates, these non-employing C Corps should not benefit with a tax rate reduction when the same monies could go towards incentivizing similar income level C Corps to compensate in greater ways their existing US employees! Furthermore, for all the other positive features of ETCOs, the above policy should also be enacted.
Let us examine the first tax incentive for employers of over 500 that is intended to increase employment in the US, the Employment Tax Incentive.
As C Corps begin to employ over 500 US employees, the 7 cent on the dollar US ETC that creates the ETCO that is explained in the ETCO portion of this paper above, is reduced to a 4 cent on the dollar ETC. It becomes a 4% ETC because of what this number is attempting to achieve. A more accurate number for what this number is attempting to achieve is about 3.4% (Which please always remember has nothing to do with the coincidence that 3.4% is almost half of 7%). What this number is attempting to approximate is the rate at which the ETC will need to be to compensate the businesses in America that have the top 50% of US employment costs to US profits ratio. That is, the point at which, as an equal dollar amount of C Corp tax deductions are reduced from our tax code, assuming that they are equally and proportionately reduced among businesses, half of all US businesses with over 500 US employees would have their effective tax rate go down, and the other half would go up. The 4% is a more generous number, but these ETCs will have a simple cap on how low, and how high, they can be exercised. So this slightly more generous than need be tax incentive will have an expenditure limit on what it costs the government or a business. With the tax plan in this paper, the floor cap for the tax rate will be 300 basis points lower and the ceiling cap will be 300 basis points higher for a total tax incentive of 600 basis points of tax rate.
The tax plan that is being proposed in this submission paper does not intend on its own to do much slate clearing in the area of tax deduction reductions on the C Corp side. Although in the past Third Way Progressives has always very much supported extensive R&D tax credits and early depreciation of capital expenses. On the C Corp side, this submission’s tax plan will assume the 12 tax deductions reductions or loophole eliminations that President Obama proposed on July 30, 2013. This is enough, the President’s plan says, to reduce the top C Corp tax rate to 28% and the top rate for manufactures to 25%. This paper’s plan will assume the exact same level of tax deduction reductions and lowering of C Corp tax rates as does President Obama’s plan, but of course the C Corp tax rate reductions in our plan will be much more strategically designed for the realities of our highly competitive global economy. However, it would be great if Congress and the President could come up with more tax deduction reductions on the C Corp side, outside of R&D tax credits and early depreciation. In this way this entire plan’s ETCs and ETCOs could be made even deeper, even on the personal income tax side.
Under our plan, the top C Corp tax rate for non-employers should remain at 35%. Yet with the less than 500 employees US ETC of 7% even for C Corps and therefore the ETCO that is created there, the top C Corp tax rate for virtually all employers will very quickly be 30%. From this point our Employment Tax Incentive for employing more often in the US would take C Corp employers to top tax rates to between 33% and 27%. The Employment Tax Incentive and ETC credits must be taken, or the tax rate for the business will default to the ceiling cap of 33%.
From this point would begin our second of three tax incentives in this area, this one designed for the purpose of incentivizing businesses in the US to compensate their domestic employees at higher rates. The Compensation Tax Incentive sounds more complex than the last one, but it is more efficient per federal expensed dollar. The fairest, simplest, and probably for the reason of being simple, the most efficient and hard to game method for achieving this tax incentive is to start by making a large sample probability distribution of the mean of the median and the mean level of total US employment compensation for businesses in America with over 500 US employees. This distribution should be made by first eliminating from any of the calculations any employee incomes that are over the dollar amount that demarcates the top 1% of US income earners.
From here it is quite simple. The distribution is divided into 100 percentiles. With the 1st percentile exactly two standard deviations, while employing the 68-95-99.7 Rule, below the mean of the distribution, and the 100th percentile exactly two standard deviations above the mean. When an employer of over 500 has a mean of the median and the mean of their total employment compensation that moves into the 51st percentile, than it will begin to be able to deduct basis points off of their tax rate. This incentive will gradually and incrementally reduce an employer’s tax rate until the 100th percentile. How far the tax rate can be reduced is up to how much policy makers chose, although some tax rate should be left over, even for the most generous employers, for environmental tax incentives.
But again, for the C Corporation tax plan in this submission we are using the amount of tax deduction reductions that has been proposed by President Obama on July 30, 2013. This plan brought the top tax rate for all C Corps, including non-employers, to 28% and manufactures to 25%. Given that manufactures make up about 30% of all of the profits of C Corps, and given the fact that the President’s plan does reward non-employers, and just to make the math for us a little easier here although the number is not far off, let’s say that the President’s plan and our plan here will both reduce the equivalent of 850 basis points off of the top tax rate for C Corps in America. The President’s plan does this by lowering the top rate for C Corps from 35% to 28% and for manufactures to 25%. Our plan has already dropped the top tax rate for C Corp employers down to 30%, then in a somewhat below revenue neutral way because the ETC is worth 4% and not 3.4%, we created a tax incentive that could raise or lower a C Corps tax rate by as much as 3 percentage points. This leaves our plan with about 3.5 percentage points to work with, but these 350 basis points can go a long way when it comes to ETCs! For one, it can become a reward of up to 700 bases points off of a business’s top tax rate for how well they compensate their employees relative to the rest of America’s employers. You remember, that mean of the median and the mean thing. 14 basis points are than deducted off of a C Corp’s top tax rate as they move each percentile from the 51st percentile of the distribution up to the 100th percentile and 700 basis points.
Moreover, with just a little more work at reducing tax deductions on C Corps, the Compensation Tax Incentive could be greatly enhanced. Further, while this tax incentive is not perfect, it is certainly better than what exist today or the option of lowering C Corp tax rates equally whether a C Corp employs at all or in terrible ways relative to others. Moreover, this mean of the median and the mean of total US compensation could also be measured on a state by state basses or by regions. This would complicate the process a bit but add much more accuracy to this tax incentive. Also, further elaborations of our overall tax plan allow for this same tax incentive to be used by businesses with less than 500 employees, both C Corp and otherwise. In order to do this for employers of under 500 in a way that avoids gaming and fraud, and for much larger and more important reasons that you will relatively soon learn about, Employee Tax Credits have to be calculated and used as one moves up or down the 51st to 100th percentile, with the value of the ETCs being worth more as an employer moves closer to the 100th percentile. This is a simple calculation that the IRS can provided on one simple graph.
Nonetheless, with our tax plan in this submission paper, a C Corp with over 500 US employees that has accumulated many US Employee Tax Credits and is compensating their US employees in exceptional ways could lower their top tax rate to 20%!
Our third and last tax incentive for larger employers works though our world-wide tax plan that will be described in just a bit. This last tax incentive is one of the reasons that we keep calculating an employer’s US Employee Tax Credit throughout the entire tax process, and this tax incentive is designed to measure both US employment and levels of US compensation.
Yet first, let us clarify what we have learned so far regarding the specific tax plan in this submission paper and what could easily be four new Chapters to Subtitle A of Title 26. Our personal income tax rates for employer and non-employers were shown in the personal income tax portion of this paper above. Below is this paper’s C Corporation tax rates:
Non-employer C Corp rate, C Corp Employer Rate
Up to $50,000- 15%, 10%
$50,001 – $75,000- 25%, 15%
$75,001 – $100,000- 34%, 15%
$100,001 – $335,000- 39%, 26%
$335,001 – $10 million- 34%, 30%
Over $10 million – $15 million- 35%, 30%
Over $15 million – $18,333,333- 38%, 30%
Over $18,333,333- 35%, 30%
From this point a common misconception could often be made. The C Corp employer tax rates above are derived at by first an employing C Corp being able to exercise 7% US Employee Tax Credits that are exercised up until 500 US employees where they are then phased into a 4 cents on the dollar ETC. With our plan, at the point of reaching 500 US employees, American C Corps should all have a possible top tax rate of 30%. From this point, as the Employment Tax Incentive is exercised, a little fewer than half of these C Corps will then have their possible top tax rate go up, and to as high as 33%. Meanwhile, a little more than half of these C Corps will have their possible top tax rate go down, and to as low as 27%. But at this point, the Compensation Tax Incentive is not exercised. At this point, any other tax deductions and tax loopholes that exist should be exercised, and the Compensation Tax Incentive of up to 700 basis points is not exercised until after. Therefore, given that today the average effective tax rate for C Corps in America is about 17% when the top statutory tax rate is 35%. Hence, given that this paper’s C Corp tax plan, as well as President Obama’s plan, only reduces tax deductions and loopholes for C Corps by the equivalent of 8.5%, when 18% of tax deductions and loopholes still exist to be had, a possible lowest top tax rate will be far lower than 20%, perhaps as low as 2% or more. That being derived at via the lowest rate of 27% after exercising the Employment Tax Incentive, then deducting whatever C Corp tax deductions still exist, then minus the 700 basis points for excellent US employee compensation.
One of the great things that we could do with more revenue pulled out of our current C Corp tax deductions and loopholes, would be to allow employers of over 500 that are tax as personal income to also be able to partake in the Employment Tax Incentive and the Compensation Tax Incentive. Remember, these employers of over 500 that are tax as personal income are having their ETCO erased as they employ over 500 employees and their top tax rate is going back up to 39.6%. So a reward for employing in American in the highest compensating ways that could reduce 700 basis points off of their top tax rate, or hopefully even lower, this could go a long way to improving the lives of the American people. At a cost to the federal government of only about $3 to $4 billion a year, this would certainly be worth a try, and certainly be better than our existing tax policy.
If Congress really wanted to get ambitious this year they could enact a Compensation Tax Incentive for employers of less than 500, both C Corp and personal income. This cannot be enacted for businesses with less than 20 employees, and a slightly different distribution of the mean of the median and the mean of employment compensation is needed. But while costing only about $2 to $3 billion a year to the federal government, this would be a very inexpensive but effective tax incentive.
Also, all employers of over 500, C Corp and personal income, could engage in our third tax incentive in this area that rewords employment and compensation through our world-wide tax plan. Yet employers of less than 500, C Corp and personal income, should be treated differently regarding their world-wide income.
All of the tax rates generated both above and below could also be calculated once for a five or even 10 year period as opposed to annually.
Our World-Wide Tax System
The optimum policy for the US and for most other nations of the world would be to use a world-wide tax system, with the caveat that the US tax for foreign profits would be set at a much lower rate than the C Corp or personal income rates. Most of us already acknowledge this need, but let us suppose that the US’s top C Corporation statutory tax rate is brought down to 30% after reducing tax deductions on the C Corp side. Let us suppose further that a US C Corp must pay US taxes on profits made in Ireland. Ireland has a top statutory tax rate of 12.5%. If income tax deferrals were ended, this US C Corp would have to pay a 12.5% tax to Ireland, and then it could credit that tax bill paid to Ireland against income that is then taxed at a top rate of 30% for an effective US tax bill payment of about 17.5%. The problem with this extra 17.5% payment is that it might be so large as to cause this US C Corp to move completely out of the US and to Ireland, or to some other much more tax friendly nation. Therefore, the US tax rate for foreign earnings for a US employer of over 500 should be set at no more than 9%. Moreover, very similar tax incentives as the Employment Tax Incentive and the Compensation Tax Incentive should allow a US employer to be able to lower their foreign income tax rate quite substantially depending upon how well they are treating their employees in the US relative to that multinationals total global business expenses.
How specifically this incentive is operationalized within our tax code is started much the same way as with the Compensation Tax Incentive, however the sample distribution is different and the percentiles are organized differently. The sample distribution is different in that it is a distribution of total business expenses outside of the US to total US Employee Tax Credits accumulated. The higher the number, the closer an employer will be to the 100th percentile and a tax rate of 2%. Remember, to this point a US multinational with over 500 US employees has had their US ETCs increased by both their larger US employment costs and by how much greater over the norm they compensate their US employees. We can therefore structure our world-wide overseas tax rate to reward those multinationals that do employ the most and in the best ways in the US, and in relation to how much of their workforce they keep in the US. Moreover, this is a ratio of total business expenses, of ever kind outside of the US, to total US ETCs, so no conflicts will arise with foreign governments, especially those who enact ETCO and ETC tax policies, and in this way the policing of our tax policy will only be made much easier. The percentiles also work differently when compared to the Compensation Tax Incentive in that they begin to reduce a tax rate by 7 basis points beginning with the 2nd percentile and a tax rate of 9% to the 100th percentile and a tax rate of only 2%. This tax incentive can be known as the World-wide US Employee Tax Incentive.
Perhaps Congress and the President will chose to enact this tax incentive but with slightly different extreme tax rates than 9% and 2%. Keep in mind, the above tax policy, done in almost any way, would be far better than what exist today in our code or any other known proposed plan of today regarding overseas taxes, but Congress should certainly not deviate to far from either extreme tax rate. This policy also has the advantage in that a world-wide tax system makes most other forms of international tax avoidance, like transfer pricing, much easier to detect for the IRS, so even more federal revenues would be raised. You will also find that an ETCO and ETC tax policy makes many areas of IRS tax policing much easier. It does this by actually reducing the numbers of receipts and other financial numbers that an employer must keep track of. Remember, the ETCOs and ETCs can replace many existing employer tax credits in ways that make everyone happier. But with ETCOs and ETCs, the fewer receipts and financial numbers that employers do have to collect for the IRS, are calculated in different ways that are much more beneficial to the employer, the government, and especially our citizens!
Also, because the tax plan in this paper is committing to a world-wide tax system, some of the past writings by Third Way Progressives concerning having to average in foreign multinationals in a “delicate” manor regarding our system of taxing US employers foreign earnings are no longer needed or relevant, which is a strong addition to simplifying and strengthening our tax code.
In past Third Way Progressives policy discussion papers a FICA tax plan for new employers has been discusses. This FICA tax plan was created for a more advanced ETCO and ETC tax policy, perhaps in ETCO and ETC tax reform 2.0 or 3.0. Certainly it could not be enacted until Potential Employer Banks are created. Here again, this is simply an ETCO and ETC tax concept that was always believed to more likely be part of ETCO and ETC tax reform 2.0 or 3.0. Yet PEBs are great ideas that would make are economy much more efficient and make employing in the US much easier. Potential Employer Banks would allow potential US employers to save for a few or more years monies that would otherwise be taxes paid, that could then become business expenses with a number of ETCs spent in the US. But again, with ETCOs and ETCs let’s get the fundamental and big stuff enacted first, but if Congress wants to get fully ambitious, then we are right there with them. Third Way Progressives older FICA tax plan needs PEBs and a little more, and it was advertized a few years ago when FICA tax cuts for employees and employers was becoming a popular concept in Washington DC, and it was also due to TWP using in a “Hey, you like that, you certainly will like all these other ETCO and ETC policies” marketing strategy. That said, this paper must address a very important aspect of FICA tax policy.
For IRS efficiency reasons, and for reasons to make employing much more seamless and less bureaucratic for employers in ways that do not distort and disrupt the employment and employer growth dynamics in economically stunting ways, it appears from this vantage point that it would probably be best to attach Affordable Care Act payments by employers and their employees to the FICA tax system. Very importantly in this regard keep in mind, the top value of the US ETC is dictated by the rate of the employer payment to FICA. If FICA tax rates on the employer and employee side were increased to pay for Obamacare, then the value of all US ETCs could also be increased. In this way ETCOs could be made much more universal, that is, even US employers of a few people would be able to see a much more dramatic, yet still not open to gaming, tax reward for employing in the US. Also very fortunately, any FICA tax rate increase can be phased in gradually and without any harm to the ability for employers to hire in the US by phasing in the FICA tax rate increase with a phase in increase to the value of US ETCs. With this policy, very small employers could also be given the option to either choose a higher FICA tax rate and have a higher value US ETCs, or have the old and lower employer FICA tax rate and the old and lower US ETC value. In this way, we will be making it as easy as possible for employers to grow, which from now on should always be one of the primary features of all tax law!
Our Capital Gains and Investment Income Tax Plan
Our capital gains tax plan works under the same principle as does our Employer Tax Carve Out and Employee Tax Credit tax systems, in fact, once again, US ETCs will serve an important function. Our capital gains and dividends tax plan is essentially an Employer Tax Carve Out regarding investment income.
Our capital gains tax plan carves out from taxes and greatly incentivizes long term gains derived from four investment types. These four investment types are the primary investment methods for businesses in America to acquire needed capital to expand. These four investment types are: One, all venture capital funds and projects. Two, all stocks bought at IPO or secondary offering. Three, all bonds bought at first issue. Four, the direct underwriting of any of the above three investments, and also in ways that would be taxed under today’s Carried Interest rule. Moreover, all investments that would qualify for the lower carve out tax rate with these four investment types are also subject to US ETC requirements that will be explained in a bit.
Very importantly, these four investment types represent anywhere from 3% to 20% of all capital gains in the financial markets, but most of the time they are only 3% to 12% of all financial market gains (21, 22). Therefore, the tax level on the 97% to 88% of capital gains that are more speculative, and what could be considered more “paper trades”, can stay at the same rate or go up, and capital gains from the four investment types with our ETC requirement can be taxed at a lower tax rate.
This policy would increase government revenues, while steering capital to US job creators, while also curtailing destructive speculative investment bubbles. Plus, it would reword those financial investments that require the most research and risk for the investor, and it rewords those investments that generate the most return to society. The cost of capital in the financial markets would be greatly reduced for growing businesses in the US due to this tax incentive that would drive more investment monies into these four investment types. The risk of destructive speculative investment bubbles would be reduced because, due to the tax incentive, monies would be moved away from investments where price volatility is greater and economic overexpansion is much more likely, into investments that are adding jobs in the US and therefore are monies that are more likely to become consumer spending, and therefore are much less volatile and susceptible of creating economic overexpansions.
The above four investments cannot qualify for a lowered capital gains tax rate if the business floating the stock or bond does not have at least 5% of its US expenses, or the venture capital project does not have at least 5% of that investment, being employee costs that would qualify for our US Employee Tax Credits as explained in the personal income tax section of our plan. Moreover, a year and three years after the initial stock, bond, or V.C. investment the company invested in would have to have a higher US payroll than it had at the time of the initial investment. In this way, our plan would insure increased job growth in the US, and not just an increase in the underwriting of financial instruments.
In order to achieve access by ordinary investors to the purchasing of IPO’s and bonds at first issue, stocks should still be considered to be bought at IPO and bonds at first issue until the moment either is sold for the third time by an institutional trader or five open financial market days after the first purchase, or until the moment either is sold for the first time by a non-institutional trader. Moreover, it would be beneficial to ordinary investors, institutional investors and their industry, and the economy as a whole, for the federal government to enforce the existence of a minimum level of IPO and first issue purchases for the non-wealthy investing public.
Under this papers tax plan, all tax brackets and rates for ordinary dividends and qualified dividends would remain the same. But other methods of scoring this plan could bring such top tax rates down to as low as 10%, and other environmental tax incentives could take these rates even lower.
Our Environmental Tax Incentives
The final component of our tax plan is much like the investment income portion of our tax plan in that, due to the fact that there is presently little talk in Washington DC regarding reform in these two tax areas, our tax reform plans in these two areas will probably only be addressed during tax reform 2.0, and we hope not, but maybe even tax reform 3.0. Regardless, just like with our investment income tax plan, the below environmental tax incentives would go a far way to increasing the proliferation and power of more green technologies while greatly helping to create a much more environmentally sustainable economy, and not just for the US, but for the rest of the world!
Under our first environmental tax incentive plan, all private and public businesses, both foreign and domestic, would be allowed to lower their top tax rate on personal and corporate income by as much as 35 percentage points but to no lower than 0. Congress would be empowered to dictate to the EPA which manufacturing sectors and goods, and what types of production techniques that the EPA can then proclaim to be using “best practices” and/or “standard practices” in. Congress could dictate what is pollution regarding what is generated during the production of a product, and/or while a product is in use, and/or when a product is discarded.
It would be up to the EPA to propose “best practices” and “standard practices”. Yet it would be up to Congress and the President to make law regarding what products and techniques these best and standard practices can lower a tax rate through the use of and by how much these tax rates can be lowered. Our philosophy regarding environmental taxes is that they are most efficiently and effectively structured when they use primarily a reward approach as opposed to a reward and punishment approach or just a punishment approach.
There is a second environmental feature of our tax plan, which also can be assisted by the US ETC. This is what we call an Environmental Fair Tax. One of the tax proposals that have gained much popularity in conservative political circles is the Fair Tax. This tax is essentially a national sales tax that claims to allow for the elimination of the income and payroll taxes. Third Way Progressives oppose this tax because it is regressive, and because of its regressivity that would therefore slow the economy by reducing consumer demand, the plan’s numbers would not add up. Even more importantly, the sales tax rate that the Fair Tax advocates propose is a rate of 23%, although that rate would probably have to be much higher. However, past experiences throughout the world have shown that, when a sales tax goes above about 12%, the underground economy to avoid the sales tax seriously begins to organize, and that therefore, government revenues anticipated are never collected.
That said, a revenue neutral, national sales tax with an environmental objective that had a rate below 12% would be a very positive policy. That is, the federal government could piggyback on the state and local sales tax systems, and enact an increased sales tax on those products that are deemed environmentally inferior. This sales tax revenue would be used to reimburse states and localities that have lowered their sales taxes on products that have been deemed environmentally superior by the federal government.
Our US ETC comes into play in that, many will complain that increased sales taxes on products like trucks or certain other heavy equipment used by businesses will be an increased burden on American job creators. However, by allowing the US ETC to count against some of such a sales tax, the burden on American job creators would be reduced and a greater tax incentive to employ in the US would be created.
It should now be obvious to readers what the four suggested new Chapters for Subtitle A of Title 26 should be: One, personal income taxes for employers with less than 500 US employees. Two, personal income taxes for employers with over 500 US employees. Three, C Corporation taxes for employers with less than 500 US employees. Four, C Corporation taxes for employers with over 500 US employees. The possible amendments to Subtitle C concern the possible FICA tax changes in this paper related to the Affordable Care Act. Hopefully the rest of this paper is just as obvious, if not, please feel free to contact Tom Pallow during EST business hours at 202-903-1133 and he will personally answer any questions you might have regarding any ideas in this paper or any of the ideas that can be found at ThirdWayProgressives.org.
(1) “Wresting and Bouncing Crude Keynesianism Out of Washington DC for Good” ThirdWayProgressives.org.
(2) US Census Bureau, Foreign Trade, Historical Series, US International Trade in Goods and Services: 1960 – present.
(3) Globalization and International Trade by National and Region, “Globalization and International Trade”- World Bank Group
(4) World Trade Developments – .wto.org/english/res_e/statis_e/its2009…/its09_highlights1_e.pdf
(5) US Historical Tariff Collections by Federal Government: Historical Statistics of the US 1789-1945 and Office of Management and Budget US Whitehouse; Table 1-1
(6) World Bank Trade: World Trade Indicators, TAAG Tables
(7) 2011 Index of Economic Freedom: Trade Freedom, The Heritage Foundation
(8) World Bank, Trends in Average Applied Tariff Rates, GoeCommons
(9) US Bureau of the Census, 2008.
10 OECD – Centre for Tax Policy and Administration, OECD Tax Database.
11 Tax Policy Center, Brookings Institute, Tax Facts, Capital Gains and Taxes paid on Capital Gains 1954 – 2008.
12 Tax Foundation – Tax Data – Federal Individual Income Tax: Exemptions and Treatment of Dividends, 1913-2006.
13 Emmanual Saez and Thomas Piketty, “The Evolution of the Top Incomes: A Historical and International Perspective,” National Bureau of Economic Research, working paper no. 11955, January 2006.
14 The World Top Incomes Database, Facudo Alvaredo, Tony Atkinson, Thomas Piketty, January 2011.
15 US Census Bureau, Statistics of US Businesses: 2008 : All industries US.
16 Bureau of Labor Statistics
17 The four to five times more efficient is derived by using the same economic assumptions as the below study, yet using the ETCO personal income tax plan that is in the Summary of Our Overall Tax Reform Plan that can be found in the Weekly Blog section of the website ThirdWayProgressives.org: Obama Tax Hikes: The Economic and Fiscal Effects, Published on September 20, 2010 by William Beach , Rea Hederman, Jr. , John Ligon, Guinevere Nelland Karen Campbell, Ph.D. Center for Data Analysis Report #10-07.
18 Emmanual Saez and Thomas Piketty, “The Evolution of the Top Incomes: A Historical and International Perspective,” National Bureau of Economic Research, working paper no. 11955, January 2006.
19 The World Top Incomes Database, Facudo Alvaredo, Tony Atkinson, Thomas Piketty, January 2011.
20 US Census Bureau, Statistics of US Businesses: 2008 : All industries US.
21 “Recent Changes in US Family Finances” Federal Reserve Bulletin.
22 Jay R Ritter, University of Florida, “Initial Public Offerings.”
August 5, 2013 – 11:36 PM
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