As inevitable and inescapable as death, taxes are an integral part of what we earn vs what we bring home, what we net earn on investments, and what we pay for what we buy. Since 1913, with the ratification of the 16th Amendment to the US Constitution, personal Income Taxes have been a constant as a funding mechanism for Federal government. A few Federal programs (FICA and Medicare) are funded by separate payroll taxes. In addition, business income taxes on net profits, as well as short- and long-term capital gains taxes on the sale of investments, are Federal funding vehicles. Sales and property taxes, along with State Income Taxes, are generally methods to pay for local, county, and State government. This discussion will be limited to Federal income taxes, both personal and corporate. There is no question that the Federal government needs funding. The LEVEL of funding is a large discussion point! And TONS of questions remain on how to SPEND that money, and what priorities should be, and that is the topic of a separate writing. This article is about the income side (from government’s point of view), and how best to fund whatever programs are deemed necessary.
Personal Income Taxes
This section will focus on Federal personal income taxes. A point to consider: it is an Economic axiom that if you want less of something, tax it; if you want more of something, subsidize it. As taxes increase the cost to the buyer, and subsidies decrease the cost to the buyer, that axiom makes total sense. So, a fun question: does taxing wages and interest income discourage those activities? Back in the 1960s, when the marginal high-end tax rates were in the 70%+ range, dodging taxes via ‘write-offs’ was a common practice—almost no one paid that high marginal rate. Even in the current, relatively lower marginal rates environment, some folks will forgo work to retain income-ceiling-based benefits. Why earn additional wages, if it means losing a housing allowance?
Back in its inception, Federal Income Taxes were levied in any real size only on the very wealthy. The TOP END tax rate was 7%, and that only applied to incomes over $500,000! The overwhelming majority of income earners paid between 1-3%. These rates remained unchanged from 1913 to 1915. The first changes were implemented in 1916, and we have never looked back. Our system is considered ‘Progressive’, in that the marginal tax rates increase for higher incomes. In our current state, for many folks, Federal Income Taxes are their largest expense yearly—more than housing (#2), transportation (#3), insurance (#4), or food and clothing.
Another point: the personal tax code now is a behavior modifier, not just a governmental income generator. Some folks buy houses, rather than rent, specifically due to tax treatment of mortgage interest. Why it should be a tax difference for married vs single, zero children vs several, charity spending vs non, green energy usage vs traditional, etc. is beyond me. Taxing savings interest as regular income certainly discourages saving. Tax fairness may be the ultimate oxymoron. That the top 1% of incomes pay roughly 65% of all personal income taxes collected, while the bottom 47% of income earners have zero net tax liability lays waste to that whole ‘fairness’ thing.
Best-selling books have been written regarding replacing Federal Income Tax with a National Sales Tax. Google ‘Fair Tax’. There are obvious benefits to such a sales tax: the tax collection mechanism is already in place; personal income would no longer be tracked at all (I dig the privacy of that); personal yearly tax filing would disappear; the IRS could focus on sales tax collection only; illicit income currently untaxed or hidden would be taxed upon usage; and so on. Want to decrease taxes paid? Buy less stuff (see the above Economic axiom). Maybe exclude food and medicine from sales tax? That would certainly be worth a look. It’d be nice to turn April 15th of every year into just another Spring day, rather than a pressure-packed filing deadline.
Corporate Income Taxes
This section deals with taxes on business entities. That definition stretches to cover many small businesses.
Corporate Federal Income Taxes are corporate income, less legal deductions, times the prevailing Federal Corporate Income Tax Rate, for each individual company. Many, if not most, small businesses, LLCs, and Subchapter S corporations report their incomes (or losses) as line items on their personal IRS 1040 forms, so the corporate tax rate does not apply to them. While many of the principles in this writing apply to them, I will exclude them from this discussion. This also does not include payroll taxes, which are dependent upon income level of employees, number of employees, etc. Note that payroll taxes (called 941 taxes) are due to the government at least quarterly, and are due to the government even if the company loses money for that period.
I’ll start off with an axiom many do not understand: NO corporations pay income tax outright. NONE. Why? Because income taxes for a business are just a cost of doing business, pure and simple. While most pay a dollar amount at the end of their fiscal year, taxes are just a reduction of profit, like any other expense (although this expense can be massaged a bit, as I’ll cover in a bit). That cost is either passed on to the consumer in higher prices, passed on to the employees in fewer hires, smaller wages, or smaller raises, or passed on to the shareholders as a decrease in share value. It’s easier to understand as an example of a sole proprietorship:
Let’s say Phil wants to start a business, making widgets (what else?). He factors in all of his costs of production, and determines that he can make a profit of $1/widget, with sales of $10/w, and costs of $9/w. But Phil knows, at the end of the year, he will owe the government $.25/w, at the existing corporate tax rate. At $.75 projected net income after taxes per widget, Phil has a big decision to make: is that enough net to start the company at all? Or would he be better served taking his time, effort, and personal investment, and putting those resources into something less risky? $.75/w may be a good number, maybe not, but it is NOT guaranteed—business risk is always a factor. What if sales do not meet projections? What if unforeseen expenses pop up? Such is the life of the business owner. But for this example, let’s assume the projections are solid. Phil can pay that $.25/w a few ways: hire less people (provided he can maintain successful output levels), he can raise the price to $10.25/w (provided his sales don’t suffer due to the higher price), or he can take the hit in his own income. If Phil has investors, he can reduce their payout at year end (provided those investors don’t decide to invest elsewhere for a better return). Note that the LEAST likely of these happening is Phil decreasing his own income.
Massaging expenses. How can Amazon, for example, have $Bs of profit, but owe $0 in corporate income taxes for a given tax year? Current tax law allows for investment spending in certain company assets to be written off over time (depreciation), some even entirely in the current tax year. And the current tax year may take into account portions of several years worth of such spending. If Amazon’s depreciation expense for assets purchased over the last several years is large enough, it can negate profit for the current tax year. In addition, Congress, via the IRS, has encouraged some behaviors of companies with specific deductions, for example: Green energy initiatives. GE used this method to write off the value of an entire year’s profits to zero by tailoring their spending in renewable energy projects. Those deductions are not perpetual, unless the spending is maintained. Note that these deductions are LEGAL, and available to any company that chooses to spend their resources in this fashion. Spend enough, decrease or eliminate their tax bill.
One of the biggest changes to the US economy in the last few years is the change in Federal Corporate Income Tax Rate, from 35 percent to 21 percent. Some say that really shouldn’t make that big of an impact. I completely disagree.
Above, I discussed corporate income taxes, and how they are paid. But that is a scratch on the surface of such things, as corporations are generally owned by…nearly anyone. Stock funds are in nearly every mutual fund, IRA, or 401K account in the US. So, if your retirement or investment account has seen great returns over the last few years, thank the tax changes, in nearly all cases. Fourteen percent of a company’s profits are no longer paid in taxes—they can be reinvested in the company, buy plant assets to increase production, paid out to employees in various forms (bonuses, raises, increase in 401K matches, increased hiring, higher minimum wages, etc.), buybacks of company stock (bringing more of the shares inhouse), or just bump up the share prices of that company due to increased net earnings, encouraging other investors to buy. Remember, buying stocks is just as competitive as pro sports: there is always competition for the investment dollar, both by fund managers and individuals. What to buy for the best, largest, safest, return on investment? At last count, over 500 companies announced they are doing one or many of the options above, for their employees or their companies. The net result: increased spending power or retirement accumulation for those employees, and increased wealth for shareholders. The ripple effect of such improvements cannot be overstated. Maybe a formerly out-of-reach car purchase is now made, enriching both the buyer and the car dealer—who now has more sales commission to pay his folks. Maybe a long-overdue vacation is taken, to the betterment of everyone in those transactions (transportation, resort areas, and the quality of life of the vacationers). And on it goes.
But a difficult to track benefit of reducing the US corporate tax rate: more investors. The truly wealthy can invest ANYWHERE—US, EU, Canada, Australia, etc.—wherever they can get the best returns. Lowering the tax rates increases the returns of US companies, so funds that may have been targeted for investment elsewhere may now be kept in the US. Funds that were in tax havens (Cayman Islands, Switzerland, etc.) may now return back for usage in the US. Production companies that may have been earmarked for countries abroad may now be built in the US, which increases employment here. And so on.
It will be interesting to see if the change in rates encourages more business start-ups. Most new companies do not see a real profit in the first few years of operations. Lowering the bite of taxes just might shorten the time period to profitability for new businesses. And if more businesses get started (yet MORE employment), the net result to the IRS is actually MORE taxes collected than at the higher, former rate.
Note that the above analysis purposely excludes the effects of COVID-19, and the government’s responses to avoid spreading it. The dynamic above is valid pandemic or no. That the economic lockdowns enforced by many State and local governments hurts or closes impacted businesses is a given. And any taxes paid by profits or sales are directly reduced or eliminated entirely by business’s inability to fully operate, if not close entirely. When or if this pandemic reaction is over, it will be interesting to see how it all shakes out: will currently closed firms reopen with the same ownership and staff? Will the assets liquidated by closed establishments be utilized by new (or at least different) users and companies? One thing is certain: whether government collects taxes from the same or different taxpayers, they WILL require taxes to spend. Government spending appetites are nearly as constantly growing as tax collections themselves. That spending never DECREASES.
Tax Breaks
This is last section isn’t about ‘taxes’, as much as it is about ‘breaks’ and ‘envy’.
I’ve seen folks post on the Internet repeatedly complaining about ‘this company got HUGE tax breaks!’, or ‘the tax changes only benefitted the RICH!’. Both of these statements reveal either ignorance or envy on the part of the poster. The first: unless a company lobbied for, and got, a carve-out of tax law that only applies to them or their industry (which I am COMPLETELY against), the company arranged its expenses, spending, and behavior in such a way as to minimize its tax burden–exactly as it should. There is no requirement to pay more than the absolute minimum in taxes, either as an individual or as a company. Government is a notoriously inefficient and poor spender of tax dollars, while the individual or company (who EARNED the funds) is MUCH better suited to spend the funds as they see fit. No exceptions. Folks will complain when Amazon has zero corporate tax bill at year-end, but do not realize the YEARS of infrastructure spending it took for Amazon to be profitable. Those write-offs are available to literally ANYONE choosing to risk their ass(ets) for such a venture! True test: open your own biz, compete with Amazon—that market is not regulated, other than the pure amount of resources needed to succeed. You’ll immediately see the spending required to establish the network of buyers and suppliers, along with shipping, site management, advertising, etc. needed to make that company work. But, when the story comes out that Amazon had zero taxes due on $Bs profit, folks decried the system as a whole as being ‘unfair’!
Next is the impact of the tax rates reduction. Virtually everyone earning wages got a reduction in taxes due. Everyone. The rates were lowered across the board, with the biggest rate reductions at the BOTTOM of the scale! Now, for some in State Tax Hell, they saw little or even negative impact to their returns, as the changes also included removing or capping the amount of State Income Tax paid as a deduction on Federal returns. But the REAL gripe: anyone making more than the complainer got a big tax break! Two things: 1. It required paying taxes to get a reduction. Those who had no wages got no break. 2. The tax rate reductions simply allowed those that EARNED the money to keep more of it. The envy crowd is still in full force, bitching because there are still those making more, sometimes dramatically more, than they do, so the percentage change, applied to a bigger dollar amount, results in a bigger break. My thinking is that the real complaint is on the discrepancy of income, not the taxes paid—notice how they didn’t complain about the size of break of the folks making LESS than them?
A final point about tax reductions: because of our ‘progressive’ tax system, those that earn more get taxed at a higher percentage. And those paying more are the job creators in our system—those that take risks, start companies, or invest in other companies, as well as direct hiring of labor (lawn care, baby sitters, gardeners, whatever). Think of the number of folks whose lives are positively impacted when a wealthy person buys a luxury item, like a yacht: boat designers, builders, sub-contractors, upholsterers, wood workers, dock workers, fuel distributors, and so on. None of the effort to get that item created happened for free—many people got paid to make that work. The same is true for all items, but more so on the luxury side. Yeah, I envy those that make more than I do—but I don’t hate them, or disparage their ability to earn more, I want to BE them! Except now, as an older dude, I just don’t see me putting out the effort necessary to do so 😊.
