Archives For taxes

Uncorporate Kodak!

Larry Ribstein —  11 August 2011

There are reports in the press that corporations are sitting on a huge cash pile — $1.2 trillion.  Apple has over 70 billion.  Today’s WSJ discusses Kodak (remember film?) which is burning through money it’s collected in patent litigation in a so far futile effort to compete in selling computer printers.

Since the government can’t throw around much more cash, maybe part of the solution to our economic woes is to encourage firms like Apple and Kodak to become uncorporations — i.e., limited partnerships or LLCs — whose dividends are not subject to the corporate “double” tax.  They can’t do this now because they aren’t in the small category of firms (e.g., pipelines) that can be publicly held and taxed like partnerships.  A simple change in the tax laws would solve this.  For more on all this, see my Rise of the Uncorporation.

If these firms were uncorporations they would be subject to agreements that require cash distributions and liquidation at some point.  The owners would not tolerate being taxed on earnings that’s not either working for them or being distributed to them. When the firms’ rate of return on retained earnings fell enough (consider the negative interest rate being paid on corporate cash sitting around in bank accounts) they would have to distribute it.

Consider what would happen if mature firms like Kodak (and, yes, maybe even Apple) could uncorporate.  Retained earnings would go back to the shareholders who would either invest it in or spend it on young and adolescent growth companies — the Apples and Kodaks of the future.  The government might lose some tax revenues, but there also would be a way to construct this system so that it’s revenue neutral.  In any event, the decisions would be made by the owners of the cash, not by politicians and bureaucrats who haven’t been doing such a good job lately.

Think about it.

A few days ago Paul Caron summarized moves toward corporate taxation of pass-through entities with more than $50 million gross receipts, adding links to prior posts on this subject.

Today’s WSJ echoes this story, quoting Sen. Max Baucus, Senate Finance Chair: “We’re talking about business income here. Why not have the large pass-throughs … pay a corporate rate?”

Well, here’s “why not”:  Changing the tax on pass-throughs could significantly reduce governance efficiency and may not produce that much more revenue.

As detailed in my Rise of the Uncorporation, an important uncorporate feature is their emphasis on owner “exit,” in the form of distributions and buyouts, over corporate-type monitoring such as boards of directors, shareholder voting and fiduciary duties.  Recent financial crises have shown the problems with corporate-type management, even after decades of reform.  This should encourage openness to alternatives, including uncorporate management. But corporate taxation, by taxing income both when earned by the corporation and when distributed to owners, effectively penalizes the distributions and buyouts that are so important to uncorporate governance. 

Instead of increasing the application of the corporate tax we should be asking how expanding the domain of tax pass-throughs could increase efficient uncorporate governance.   As discussed in Rise of the Uncorporation (243-44, footnotes omitted):

Taxing distributions burdens an important aspect of the uncorporate approach to governance. Yet the only way large firms can be publicly held is to fit into a small exception from the rule treating publicly traded firms as corporations. Large firms that want the discipline provided by owner access to the cash need to end-run the tax on distributions by using tax-deductible debt, thereby increasing the risk of costly bankruptcy. This encourages firms to continue to use the corporate form even as the costs of this form increase. * * *

The factors discussed above in this chapter pointing to more use of the uncorporation for publicly held firms eventually might encourage a change in tax policy. As discussed above, the current exception from the corporate tax on publicly traded firms is limited essentially to passive rent collectors such as natural resource and real estate firms. This is probably narrower than the class of firms that could benefit from flow-through partnership taxation and that would seek this taxation under a more flexible rule. For example, mature, slowgrowth firms that get fairly predictable earnings from established brands might derive comparable benefits from a tax rule that encouraged regular distributions to owners.

Congress might accommodate this need for flexibility by drawing the corporate-partnership tax border with a view to encouraging governance structures that mitigate agency costs. Firms arguably should be able to balance the costs and benefits of the tax as they do with other governance devices. In other words, firms’ governance choices should determine the application of the tax rather than vice versa. At the same time, as long as the corporate tax remains, Congress has to restrict firms’ ability to opt out of it. Lawmakers could let firms choose to be taxed as partnerships on the condition that they have substantially adopted partnership-type governance, including committing to making distributions. This would be analogous to the tax code’s approach to REITs in which the application of partnership-type tax turns to some extent on the firms’ distribution of earnings. It also would be consistent with the goal of making statutory standard forms coherent because it would enable firms to mesh tax consequences with their choice of business association.

A full analysis of proposals to tax pass-throughs should look closely at claims about potential revenue gains given likely increased reliance on debt, as well as the efficiency costs of undermining the uncorporate form and increasing bankruptcy costs.

Illinois politicians, many of whom had already been voted out of office, as their last act in the old session yesterday raised the state’s individual and corporate taxes 67% and 45% to try to bail Illinois out of the results of their fiscal profligacy. Remember that the voters who elected this gang were the same ones who elected Rod Blagojevich.  Twice. 

But as summarized in today’s WSJ, there is, more than ever, an “exit” response to political “voice.”  First in the capital markets:

Investors have closely monitored Illinois’s financial woes. The spread on the state’s municipal bonds, a measure of the perceived risk of its bonds above a broad market benchmark, is the widest in the country. Investors have been concerned about the state’s willingness to right its finances. Ratings firms said they would review the state’s creditworthiness in light of the legislature’s actions.

The state is particularly worried about these markets because it has to use them to pay its bills. As the WSJ noted:

the failure in the legislature of a proposed $8.75 billion restructuring bond means the state won’t immediately be able to start paying off its backlog of about $6 billion in unpaid bills. That leaves hundreds of state vendors, including hospitals, schools and the maker of bullets for the state prison system, facing continued uncertainty

But raising taxes is not necessarily the logical solution.  That’s because of jurisdictional competition– there are many other places the would-be taxpayers can go:

The new corporate tax rate would bring the total percentage Illinois corporations pay on income, including a separate personal property replacement tax, to 9.5%, one of the highest in the nation. That would make the corporate income-tax rate in Illinois the third-highest in the country when combined with an assumed 35% federal corporate income tax, following Pennsylvania and Minnesota, said Scott Hodge, president of the Tax Foundation, a conservative-leaning Washington research outfit. Illinois currently ranks 21. As other states cut taxes and Illinois raises them, the state “will be even more of an eyesore by comparison,” Mr. Hodge said.

A spokesman for Caterpillar Inc., one of the largest manufacturers in Illinois with 23,000 employees in the state, said in a statement that “such a tax increase will make it more difficult for Caterpillar to compete in today’s global economy from our operations in Illinois.”

On Wednesday morning, newly inaugurated Wisconsin Gov. Scott Walker sought to capitalize on the tax increase: He said he would renew a long-ago campaign to lure tourists to Wisconsin called “Escape to Wisconsin”—but target it at Illinois companies. His state’s corporate tax rate is 7.9%.

Illinois’s Governor responded that

Chicago is the capital of the Midwest, and “if we want to talk about the capital of the Midwest, the state that is the strongest is Illinois.”

Yes, and remember when Detroit was Motor City?  Detroit would seem to be a good example to keep in mind when thinking about Peoria without Caterpillar.  Remember that any company considering moving to or staying in Illinois not only has to pay corporate-level taxes, but has to pay its executives about $4,000/year more just to make up for Illinois income taxes in order to provide the same compensation as it did last year.

Obese states should remember that the best way to lose weight is to stop eating.  This will lead to reduced services, which will anger voters.  But the tax “solution” will drive out the most mobile residents and investors.  It’s not pretty, but unfortunately for profligate governments, push has come to shove.

And, by the way, the U.S. also has to worry about residents and capital markets.

Mankiw on taxing the rich

Larry Ribstein —  10 October 2010

I suppose that the Obama tax plan is something this blog should stay away from.  But I can’t resist a note on Mankiw’s NYT column

Mankiw makes all the “correct” disclaimers:  he’s being “narcissistic,” yes he can “afford to pay more in taxes,” “I don’t have trouble making ends meet,” “I am almost completely sated.”  In other words, you can’t blame him for being whiny rich.  

Alas, for the supporters of Obamatax, there’s a sticky issue that still remains:  the tax will affect Mankiw’s incentives, because like a lot of rich people he can choose how much to do and how much to make.  Read the article to see how, and why. 

In other words, it’s not Mankiw that has a problem — it’s the people outside of his family who depend on him.  He notes that even if you don’t care how much an economist does, what about surgeons, orthodondists, singers, novelists? 

He concludes:  “Don’t let anyone fool you into thinking that when the government taxes the rich, only the rich bear the burden.” 

I would add: but don’t expect people to stop trying.

Earlier this week, the WSJ reported on a nuance in the New York state tax code that has come take a bite out of at least one bagel company’s profits, and it illustrates how the complexities of arbitrary taxation schemes can rear their ugly heads and create incentives–and challenges–for consumers and sellers alike that would seem silly were it not for their very real economic impacts. The article reads:

State tax officials, under orders from cash-strapped Albany to ramp up their audit and compliance efforts, have begun to enforce one of the more obscure distinctions within the state’s sales tax law.

In New York, the sale of whole bagels isn’t subject to sales tax. But the tax does apply to “sliced or prepared bagels (with cream cheese or other toppings),” according to the state Department of Taxation and Finance. And if the bagel is eaten in the store, even if it’s never been touched by a knife, it’s also taxed.

To make matters even more confusing, this distinction is apparently not clearly stated in the tax code–and it applies to bagels, but not bread.  So you can have your bread and slice it too, but not your bagel. Unless, that is, you are going to eat the bagel on-premises, in which case you may as well slice since the marginal tax is zero.

A public welfare argument for such an arbitrary distinction is difficult to imagine. Even Catherine Rampell at the NYT recognizes the difference between a Pigouvian tax and a completely arbitrary one. (Please refrain from the obvious point that those are not mutually exclusive sets, since the ‘welfare measures’ used for most any Pigouvian tax can be rather arbitrary themselves.) I’m guessing Ms. Rampell is a bagel eater!

Besides the incentives for people to simply cut their own bagels (no word on whether the provision of free plastic knives is somehow taxed), one should wonder about the further implications of this tax scheme. If customers are charged a tax for eating on premises, how is the store owner supposed to enforce the transaction? Chase customers out of the store before they can pull the bagel out of their to-go bag and take a bite? Have a “tax staff” that goes around collecting the additional 7 or 8 cents from any customer who (wittingly or no) defies the carry out rule?  A tax of 7-8 cents may seem not worth the effort, at least not on a per customer basis. Perhaps the bagel shop owner should just increase the menu price to include taxes…meaning the shop owner would be price discriminating against whole-bagel-eaters on the go. Or a tax-included menu might allow for some cross-subsidization from those on the go to the slice-or-stay crowd.  Of course, the tax-included menu might result in greater consumer upset (or confusion) since the prices of all products would have to be shown higher.

Will a consumer choose to eat on the go simply to save a few cents? Maybe not. But apparently the new tax is causing some displeasure with consumers, suggesting such a change might not be unrealistic. And what then? Are customers who linger in the shop more likely to buy more items before they leave, pay for coffee refills, etc.? Will the shop lose additional revenue because of the change in dining behavior? Will the state end up losing revenue in its attempt to find more?

My guess is no one in Albany has thought that one through.

What I’m Watching Now

Josh Wright —  14 July 2010

The Future of Individual Tax Rates: Effects on Economic Growth and Distribution,” United States Senate Committee on Finance Hearing (HT: Taxprof Blog).  Scheduled witnesses include:

  • Carol Markman (CPA, Feldman, Meinberg & Co.)
  • David Marzahl (President, Center for Economic Progress)
  • Donald Marron (Director, Tax Policy Center)
  • Douglas Holtz-Eakin (President, American Action Forum)
  • Leonard Burman (Professor, Maxwell School, Syracuse University)

Its not quite the World Cup, but also…no vuvuzelas.