Put corporate taxes to work for America (without building legal fences)

  • Article by: JOHN MURRAY
  • Updated: July 28, 2014 - 6:34 PM

How? Make dividends a deductible expense for companies. There’d be broad benefits.

Laws to keep major corporations from moving out of the country will not work, but incentives to keep them here can.

How do we keep companies from moving overseas? Dividends should be made a deductible expense for domestic corporations. This would make major changes in the way corporations operate, encouraging bigger payouts and the distribution of profits. This sounds like a giveaway to large corporations, but likely it would benefit the economy as a whole, for numerous reasons.

 

To understand this, just a bit a background is necessary. Major corporations finance their operations with loans, or stock issues. Bonds pay interest that is taxable income to the recipient and a tax deduction for the corporation. The sale of stock by a corporation comes with the promise of a share of future profits and potentially the payment of dividends. Those dividends are taxed twice, both at the corporate level and again to the individual owner who receives it, if a taxpaying entity. As a form of financing, debt holds the advantage as the cheaper method.

Allowing a tax deduction for dividends would result in the repatriation of profits. Publicly traded U.S. companies hold an estimated $2 trillion of profits outside the United States. As long as these profits are not repatriated, they are not taxed. This is a huge incentive to not bring them back to the U.S.

If dividends were deductible, those profits could be repatriated at little or no cost to the company. The money would be paid out as dividends, where it would be taxed and recycled as investment into the economy, putting it to work creating jobs.

About two-thirds of all publicly traded stock is held by institutions — insurance companies, pension funds, endowments, mutual funds and others. Much of the rest of publicly traded stock is held by wealthy individuals. Dividends paid to individuals would be taxed at fairly high rates that could actually be higher than the corporate rate.

Many companies are operating with a great deal of debt and very little equity. Allowing corporations to raise money by selling stock would be much easier if dividends were allowed as a deduction. Current tax law favors debt over equity. As long as the economy is going smoothly, that’s fine. But if a company should hit an economic speed bump, the risk of bankruptcy is higher with high debt levels. Bankruptcies cause job losses.

Corporate CEOs administering large amounts of cash in their companies have the very human tendency to play with the money. To keep the company growing, if they don’t have an internal investment, they frequently buy something — like another company. Large corporate mergers in which the parent company is buying market share have a poor track record. Many of these mergers end in layoffs, terminations and downsizing of the target company. To make the economics of big mergers work, the purchasing company has to get rid of employees. This is very bad for the job market. Let shareholders invest the money, not the CEOs.

Smaller businesses are often organized as either S corporations, LLCs or partnerships. These are pass-through entities — profits pass through to the owners and are taxed at only one level. Allowing large corporations to deduct dividends would help put small and large businesses on an equal footing.

So what is wrong with this idea? Why has it not happened already? Corporate managers don’t like it — managements and boards of directors prefer to have money to play with. The proposal also sounds bad politically.

But the actual effect of making dividends tax-deductible should save and create more jobs, redistribute money to be invested more effectively, and simplify the tax code. It will bring money back from overseas, make the use of various credits less desirable, and make the buying of another company to use it for its tax loss, the moving of headquarters overseas and other financial games less useful.

This is an idea whose time should come.

 

John Murray, of New Brighton, is a certified public accountant.

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