business & professional » e co n o my Corporate Taxes C orporate taxes have been in the news recently due to inversions — deals that allow American compa- nies to relocate their headquarters to lower their tax bills. Since 2012, 20 companies have reincorporated in low-tax countries. The most recent is Pfiser, who has agreed to combine with Allegran, based in Ireland. A related issue is earnings stripping. After a company completes an inversion deal and moves its headquarters for tax purposes outside the United States, the now-foreign company still has operations in the United States. The company arranges for the United States part of its operation to borrow large amounts from the now-foreign parent. The indebted American subsidy will pay interest on the debt to the parent and, under United States tax code, the interest payment can be used to offset the American earnings. The issue of corporate inversion is one of tax arbitrage, an investment strategy that attempts to profit by exploiting the price dif- ferences between tax rates or systems. The U.S. has the highest marginal corpo- rate tax rate at 35 percent, and state taxes bring the rate to 40 percent. In contrast, the rate in Ireland is 12.5 percent, and ties based on tax rates. The average the E.U. average is 22 percent. Tax tax rates vary widely by sector, due to arbitrage also exists in the personal the ability of industries to take advan- income tax code when different tage of preferences embedded in the forms of income are taxed at dif- tax code by Congress. ferent rates, e.g. capital gains and Enormous disparity in effective earned income. The larger the gap marginal tax rates across industries between the two rates, the greater creates economic distortions and Jonathan the incentive to reclassify earned inefficiency — reducing economic Silberman income as a capital gain, e.g. car- growth. Tax reform that removes ried interest. loopholes will improve economic The corporate tax is the most inefficient efficiency. and least defensible of all taxes. The central The corporate tax code harms the econo- problem with the corporate income tax is my in a number of other ways, including: that, ultimately, only people can pay taxes. • Decreasing the incentive for businesses The burden of the corporate income tax, over to invest because it taxes income from capi- time, shifts to workers. W ith a smaller capital tal. stock to employ, workers are less productive • Increasing the incentive for businesses to and earn lower real wages. Corporate capi- organize as sole proprietorships or partner- tal investment has been lagging during the ships, which are not taxed. economic recovery and is one reason why • Increasing the incentive for businesses productivity and wage growth are low. to raise capital by borrowing (debt) versus Corporate taxation, with its large number selling shares, since interest on the debt is tax of deductions and complexity, distorts the U.S. deductible. economy because resources are misallocated. • Biasing some types of capital investments This causes inefficiency as economic activity over others because of depreciation rules that shifts away from its most valuable opportuni- allow companies to spread tax deductions for capital assets over its life span. • Finally, the complexity of the tax code requires businesses to spend large sums of money on tax compliance and planning. Corporate tax reform is likely when the new Congress and president take office in 2017. The outlines of corporate tax reform may include: • Reducing the general corporate rate to 20-28 percent. • Eliminating most of the tax expenditures (special preferences) for businesses. • Adopting a territorial tax system (taxes domestic income but not foreign income). • Diminishing the tax code’s bias toward debt financing. • Moderating tax arbitrage by using the principle that firms engaged in similar activi- ties should be taxed at similar rates. These measures will improve economic efficiency and economic growth. * Jonathan Silberman is a professor of economics at Oakland University. He writes a monthly column on the economy for the JN. You can contact him at sil- berma@oakland.edu. STM Wealth Management Group Pursuing life’s goals starts with a plan Paul J. Monacelli Senior Vice President–Wealth Management 248-637-0278 paul.monacelli@ubs.com Paul A. Toby Senior Vice President–Wealth Management 248-637-0274 paul.toby@ubs.com STM Wealth Management Group UBS Financial Services Inc. 2301 West Big Beaver Road, Suite 800 Troy, MI 48084 248-637-0274 855-821-4312 fax ubs.com/team/stmwmgroup As a firm providing wealth management services to clients, we offer both investment advisory and brokerage services. These services are separate and distinct, differ in material ways and are governed by different laws and separate contracts. For more information on the distinctions between our brokerage and investment advisory services, please speak with your Financial Advisor or visit our website at ubs.com/workingwithus. ©UBS 2016. All rights reserved. UBS Financial Services Inc. is a subsidiary of UBS AG. Member FINRA/SIPC. 31.00_Ad_9.75x6.333_DE0302_TobP 2053380 68 April 14 • 2016