President Reagan and Congress moved corporate taxes among different types of corporations and personal earners. And not so amazingly, almost everyone reorganized their businesses so that their income fell into the lower tax rates.
What was recorded as a huge spike in income was really just a simple tax reorganization.
Major Changes Are Coming to Corporate Income Taxes
There are some really great parts of the “Better Way Plan,” Congress’s tax proposal that we have been discussing. The good news is that this plan is bold. The bad news (at least from my standpoint) is that it is not bold enough.
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Bluntly, getting the “Border Adjustment Tax” approved by this Congress is going to be hard. If you’re going to try to change things, then REALLY change things.
Changes to corporate income taxes include:
- Reduced top rate from 35% to 20%
- Elimination of the corporate Alternative Minimum Tax (AMT)
- Immediate, full deduction for capital investment expenditures
- Indefinite carryforward of net operating losses
- Interest on future loans nondeductible
- Elimination of most deductions except the research and development credit
- Exemption of foreign-subsidiary dividends from US tax
- US companies can repatriate currently deferred foreign cash holdings at an 8.75% tax rate
Let me say that some of these features are very appealing. Getting rid of the AMT—both corporate and private—for example, is a very good thing. Many of the other changes really will make it much easier and simpler to pay taxes. And increasing the earned income tax credit and streamlining education tax benefits are both good things.
The Devil Is in the Details
The Better Way Plan’s other aspects will also bring about major changes in the way American businesses operate. I’m not sure anyone has truly thought these through yet.
Good-bye, depreciation and amortization. Businesses will be able to immediately “expense” (deduct from income) capital expenses that once had to be split over many years.
Build a factory this year, and the full construction costs will be deductible this year. Land costs will still have to be amortized. This simplifies bookkeeping, which is nice, but it will also have an impact on balance sheets.
This also means that the actual effective corporate tax rate is going to be a LOT lower than 20% for most business. Especially tech firms and manufacturers, biotech companies with large R & D outlays, and other firms with large capital costs.
Interest not deductible: Inability to deduct interest expenses will discourage borrowing. That’s probably a good thing overall, but in some industries, it could be catastrophic.
Here again the benefits don’t get evenly spread. Think about how the change will affect REITs, which generally uses a lot of leverage and other structures that presently spin off cash flow paired with tax and interest deductions.
Also, think of all the hedge funds and other investment tools that use leverage and deduct the cost.
We Need to Consider How the Policy Will Affect Foreign Operations
What the proposed tax policy does is encourage businesses to produce goods in the US and export them overseas.
We are nearing the end of a long state of taxation equilibrium. To expect other global players not to react as we disrupt that equilibrium is naïve.
That doesn’t mean that we don’t need to change the way our corporations are taxed. Or that we shouldn’t give our corporations the same competitive advantages every other country gives their companies.
But we have to think the proposed changes through in a way that understands multiplayer game theory. This exercise is especially important if you are an investor and your investments and/or your income are closely tied to how well the economy does.
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