The Supreme Court announced that it will hear an appeal in Moore v. United States. The legal case is certainly more complicated than I can imagine but, in my opinion, the economic or political-economy case is quite straightforward. The tax grab at the source of the case is a one-time “mandatory repatriation tax” under the 2017 Tax Cuts and Jobs Act, pushed by President Donald Trump. A Wall Street Journal summarizes the legal case (“Supreme Court to Hear Case That Could Block Democrats’ Plans to Tax the Rich,” Wall Street Journal, June 26, 2023):
The court, in an unsigned order, said it would decide a case that asks whether people and companies have to receive, or realize, income for it to be taxed under the 16th Amendment. …
The case stems from a one-time tax on accumulated foreign profits that Congress created in 2017 in the tax law signed by then-President Donald Trump. That tax applied to 30 years of profits that U.S.-based companies held overseas and hadn’t repatriated. It also applied to individuals who owned at least 10% of foreign companies. …
Charles and Kathleen Moore, a Washington state couple, challenged the tax and sought a $14,729 refund. They argued they hadn’t realized any income on their investment in an India-based company and thus couldn’t be taxed. …
The Moores, backed by conservative organizations and business groups, lost in lower courts.
More interestingly, they were supported by libertarian organizations. The Competitive Enterprise Institute has been representing the Moores (see the Petition for Writ of Certiorari). The Cato Institute has produced an Amicus Curiae brief.
Suppose you own an asset (it could be a physical machine, a financial title, or your human capital) whose present value is $100 and which produces a net return of $5 per year. From the perspective of standard public finance, taxing your (realized) annual income at 20%, that is, $1 a year, is the same as imposing an annual wealth tax of 1% on the asset. In other words, an income tax is equivalent to a wealth tax at some appropriate rate. So what’s the difference?
The financial arithmetic seems unchallengeable, but the economic logic goes further, as Geoffrey Brennan and James Buchanan argued in their book The Power to Tax: Analytical Foundations of a Fiscal Constitution. The problem is the following. If Leviathan—what any government is bound to become if unconstrained—taxes your income in our simple example, the most it can take is $5 per year. (In fact, what Leviathan can grab is less than that if you are free to move your asset away from its grasp, but neglecting this won’t change my argument.) But if Leviathan can tax your asset, that is, your wealth, it can also tax it at any rate up to 100%. A tax on wealth is a tax on the value of all future income from this wealth, that is, a tax on unrealized income. It opens a much larger tax base for Leviathan, and this is why rational individuals in a contractarian setup would never unanimously agree to give this power to a government.
Wealth taxes don’t only threaten the rich. The most extreme case is slavery, where the slave owner appropriates, or taxes away, all future production of his slave, that is, he takes possession of the latter’s human capital.
“The power to tax involves the power to destroy,” said Chief Justice John Marshall, an observation that Brennan and Buchanan used as an epigraph to their book cited above. The approach of public-choice analysis and its offshoot of constitutional political economy is quite different from traditional public-finance theory of the Musgrave sort (see James M. Buchanan and Richard A. Musgrave, Public Finance and Public Choice: Two Contrasting Visions of the State [MIT Press, 1999]).
READER COMMENTS
steve
Jun 28 2023 at 8:58am
So you want income derived from wealth to be treated differently from income derived from labor. What would stop Leviathan from taking all of the income from labor? Why should we afford special protection for income derived from wealth when there are no limits on taxation for labor derived income?
Let’s say instead of having my money sit in a foreign stock fund I invest in woodworking tools. I then sell my finished products to generate income. I will have to pay tax. Why should I get better treatment for just letting money sit somewhere? Wouldn’t it make more sense to have all income taxed similarly rather than have the govt pick winners and losers?
Steve
Jon Murphy
Jun 28 2023 at 9:07am
Yes. All income should be taxed similarly. That’s the point of the post. But you need income to be taxed as income. Unrealized gains (money reinvested in the company and never taken as income) are not income.
Thomas Hutcheson
Jun 28 2023 at 10:54am
It is not clear whether the foreign asset produced no income or produced non-repatriated income. Taxing the profit of a corporation (at home or abroad) by imputing it to the owners makes perfect sense.
vince
Jun 28 2023 at 4:30pm
That’s not true. Income is defined as any accession to wealth, and that’s the starting point for taxable income. There are many examples of unrealized gains that are taxed. One is a PFIC.
Pierre Lemieux
Jun 28 2023 at 10:05pm
Vince: What do you mean by “accession”? I use analytical economic concepts, not arbitrary definitions from government. Please see my last response to Steve, and the reference to a book review where I explain in a bit more detail what is income and what is wealth from an economic viewpoint.
vince
Jun 28 2023 at 10:58pm
It means you gain something of value. Accession to wealth defines gross income according to the Supreme Court. Reductions against gross income are allowed only to the extent Congress has provided.
Pierre Lemieux
Jun 28 2023 at 9:42am
Steve: There are two interesting points in your post. First, taxes on wages are taxes on the return of human capital. This is what distinguishes them from slavery, a tax on human capital directly.
The second point is a bit more complicated and was not evoked in my post. Uniform taxes on different tax bases is not an ideal; only uniform taxes across individuals is. Imagine that Leviathan taxed consumption goods at 10% but did not tax leisure. At least, an individual can avoid part of the tax by substituting leisure for consumption. On the contrary, if Leviathan taxes leisure too (imagine a further $10 tax on every hour not worked), the taxing power of Leviathan has extended to the whole life of the individual. Hence, Leviathan would be able to get more revenue and power, which is not desirable from the viewpoint of all rational individuals at the constitutional stage (in a conceptual contractarian situation). From this point of view, it is less dangerous if Leviathan only taxes either tea or coffee, wine or beer, etc.–because an individual can avoid the tax more easily.
Thomas Hutcheson
Jun 28 2023 at 11:06am
A tax that causes a change in behavior creates a deadweight loss. That is why it is better to tax wine and beer at the same rate. As a matter of fact at non-“confiscatory” rates I think the substation of leisure for income earning work is very small so the deadweight loss along that dimension of an income tax is small. An income rather than a consumption tax does presumably affect saving (future consumption) vs present consumption behavior and so DOES create a deadweight loss there.
Your criteria — the tax that is easiest to avoid — does not make much sense. By that criteria the best tax is none at all but that rather begs the question of what kind of tax/way of taxing is best.
Pierre Lemieux
Jun 28 2023 at 3:00pm
Thomas: “My” criterion is rather a criterion of constitutional political economy. Instead of assuming, like traditional public finance, a benevolent (and omniscient) government whose agents work selflessly to minimize deadweight losses, it assumes a real-world government made of real individuals. It also recognizes that exploitation, tyranny, or slavery create large deadweight losses.
Thomas L Hutcheson
Jun 29 2023 at 12:13pm
Whosever it is, it throws the baby out with the bathwater in that it seems to say minimize revenue collection. If you want to discuss tax policy subject to public choice considerations, do so.
Pierre Lemieux
Jun 29 2023 at 2:44pm
Thomas: You write, with your usual insight:
To try to use these analogies, I would say instead that it throws the majoritarian baby with the bathwater of tyranny. What’s important to understand is that the 50%+1 policy criterion is difficult to justify in itself, and that only unanimous consent (at the constitutional stage) is a clearly acceptable criterion for everybody. (The seminal analysis was Buchanan and Tullock’s The Calculus of Consent. It’s a difficult book, but manageable for an economist.) So the criterion would be, indeed, indeed minimize tax collection given the necessity to enforce the rules that presumably all rational individuals (who don’t want to be exploited) accept. It is admittedly a completely new way to look at public policy, which is difficult to fathom for any economist influenced by Pigou, Samuelson, and Musgrave. (I myself fought for decades with Buchanan’s The Limits of Liberty. The fight is not completely over.)
Craig
Jun 28 2023 at 11:04am
“Let’s say instead of having my money sit in a foreign stock fund I invest in woodworking tools. I then sell my finished products to generate income. I will have to pay tax. ”
Well, think about it this way, you could set up a C-Corp, fund it and have it invest in woodworking tools which produce income. That income will be taxed at the corporate level, right? Now, at that point its up to you whether you disburse that money out to you as a dividend or if you sell the shares of the C-corp to somebody else. But ultimately if you leave the money in the C-Corp, you, individually, won’t owe any tax. Yes, the C-Corp effectively allows you to lawfully avoid individual taxation until you have some kind of recognition/realization event.
In theory you could do a foreign corporation as well though individually you might have practical difficulties bringing that to fruition, but you COULD do it.
steve
Jun 28 2023 at 11:46am
Jon- I can see merit in that argument but unless I am misunderstanding I dont think that is Pierre’s real claim. He wants to call the income that comes from holding foreign investments wealth and not income. It seems to me its income but he wants to give it a special class of income.
Craig- Even in a C corp I would have to pay myself assuming this was how I was making my living. In most small corporations pretty much all “profit” goes out as salary.
Pierre- So if I am paying income tax from my woodworking and someone is paying zero tax on income from their foreign investments how is that uniform across individuals? Once you provide special cases for different tax bases it wont be uniform for individuals. Looks to me like you are picking winners using the power of Leviathan to choose who wins.
Steve
robc
Jun 28 2023 at 1:01pm
They arent paying zero on the income, they just havent yet got any income.
When they get the income, they will have to pay tax on it.
Personally, I have problems with an income tax at all. And this is part of the reason why, it overcomplicates things. The Single Land Tax just makes so much sense.
steve
Jun 28 2023 at 4:57pm
“When they get the income, they will have to pay tax on it.”
I already agreed with Jon on that, but that’s not Pierre’s argument. I think he is also arguing that when they do receive that income they should not have to pay taxes on it. He wants to call it something other than income.
Steve
Pierre Lemieux
Jun 28 2023 at 3:16pm
Steve: In this area like any other, it is important to distinguish capital and income, which is a return from capital. To consider the tax base as capital (wealth) or as income leads to very different capacities for Leviathan, as I tried to explain.
A second distinction: a uniform tax is not one that assumes that all individuals have the same preferences and make the same choice. For example, a tax on tea is not the same as a tax on individuals who drink tea. Granted that if Leviathan wants to discriminate against a set X of individuals and knows that they drink much more tea than its preferred clienteles may decide to impose a special excise tax on tea. But it is still much easier for the X individuals to substitute coffee for tea than it would be if the tax had been applied nominally to all individuals of set X.
vince
Jun 28 2023 at 4:54pm
The repatriation tax is a tax on income that was previously earned but not taxed. The whole point of Subpart F of tax law is to prevent corporations from deferring taxes through foreign subsidiaries. Note, too, that the repatriation tax allows for a ten year payment schedule.
steve
Jun 28 2023 at 5:10pm
Sure, I just thought the explanation was not good. If you want to claim that Leviathan can then go on to take all of your wealth it’s also clear that Leviathan can take all of your income. Besides which I think you are making a slippery slope argument that makes little sense. Calling the money you earn on foreign investments income means that Leviathan is taxing income. No one has ever defined wealth as income.
“A second distinction: a uniform tax is not one that assumes that all individuals have the same preferences and make the same choice. ”
I totally agree with this. However you seem to want Leviathan to decide that we wont tax income generated from foreign investment capital while we continue to tax income from labor. That’s not something written on clay tablets somewhere. That is a decision made by Leviathan that favors one group over another.
Steve
Pierre Lemieux
Jun 28 2023 at 10:00pm
Steve: Let me try to respond to your latest points–although I respectfully submit that if you carefully reread my post and my previous answers, you may find the answers there, assuming, of course, that I don’t write too badly.
You wrote:
No. Leviathan can’t take more than your income of one year if he does not have access to your wealth, which is the (discounted) value all your future incomes. (Don’t forget human capital, of which wages are the return.)
Look at the history of the federal income tax, which started at 4% of income for a very small number of rich taxpayers. Or look at tax rates in Europe. “Slippery slopes” are often another world for the logic of institutions and the incentives they embody.
These are very important economic concepts that one must understand to follow pretty much any economic conversation. Wealth and income are very different analytical concepts. Any return from capital (or wealth) is by definition income; any flow of future returns is, by definition, capital.
No, I don’t want to do that. Incomes from foreign investment (or from any capital) is income. I am not here taking a stance on income taxes, but I am arguing (for reasons of constitutional political economy), that capital should not be taxed.
I hope this is somewhat clearer. You might also find some more information in my discussion of the notion of capital in my Regulation review of a book by Mark Mitchell.
Vivian Darkbloom
Jun 28 2023 at 11:33am
“Let’s say instead of having my money sit in a foreign stock fund…Why should I get better treatment for just letting money sit somewhere?”
Not sure what you mean by “foreign stock fund” but foreign companies are almost always subject to entity-level tax, too. If you mean a fund situated in the US owning foreign stock, they need to report (deemed) dividends and capital gain distributions on those holdings (ever hold a US-based mutual fund?) If you are speaking of an offshore mutual fund holding foreign stocks, I suggest you familiarize yourself with the Passive Foreign Investment Company (PFIC) rules:
https://www.ghjadvisors.com/blog/pfic-rules-a-trap-for-the-unwary
My advice: Never invest in a PFIC. Compliance is a nightmare and fees will easily outweigh any profits, not to mention the lack of deferral.
Vivian Darkbloom
Jun 28 2023 at 9:26am
The US Tax Code has long contained provisions that tax US corporations (and individuals) on income that has not been remitted to them by foreign corporations they control, or even partially own. Subpart F of the Internal Revenue Code was introduced in the 1960’s to prevent deferral of certain types of “passive” income earned by foreign corporations that are controlled by “US persons”. Likewise, rules regarding Passive Foreign Investment Companies (PFIC’s) require current inclusion of income earned by a PFIC by a US shareholder. Those rules were introduced by the Tax Reform Act of 1986. Not to mention the accumulated earnings tax (AET) under Secs. 531-537 and the personal holding company (PHC) tax under Secs. 541-547.
Shall we also then challenge the accrual method of accounting?
The crux of the issue, in my view, is not whether one has to “receive” or “realize” something in order to be taxed. Rather, the issue should be “what does “receive” and/or “realize” mean and therefore, ultimately, what is “income”? Should Congress and the courts apply “form over substance” rules? Do they have the legitimate authority to legislate against unwarranted deferral and avoidance schemes (prior and existing rules attempted to carve out legitimate business exceptions to the current inclusion rules)?
It seems to me that if the Supreme Court wishes to reverse the lower courts in the Moore case, they necessarily would have to vacate decades of long-standing legislative and judicial precedents. I don’t see this happening.
I would advise not drawing too much similarity between this long-standing cases and any future US wealth tax.
As an aside, the 2017 Tax Cuts and Jobs Act wasn’t exactly what I would call a “tax grab”. While that Act accelerated the recognition of retained earnings held by foreign corporations controlled by US persons it taxes those retained earnings at 15 percent with respect to cash and 8 percent with respect to non- liquid assets (the tax can never be assessed on more than accumulated retained earnings). Going forward, the Act turns the US into a partial “territorial system”. This means that foreign earnings are not taxed again when received by a US shareholder, with the exception of “global intangible low-taxed income”. The 2017 Act’s repatriation provisions were estimated by the JCT to raise $190 billion over the first ten years. As you can well imagine given the 10-year budget window and the specific provisions of the Act, that “grab” will likely be rapidly reversed in the years thereafter. As you can see from the attached, the revenue take is already negative in year 10 and the other effect of not taxing foreign dividends going forward (as a result of a dividend received deduction for foreign dividends) results in lower income of $215 billion. The net result a “tax grab”?
https://www.finance.senate.gov/imo/media/doc/JCX5217.pdf
While the power to tax may well entail the power to destroy, it is equally true that “the life of the law has not been (economic) logic: it has been experience”, to quote another famous jurist, Oliver Wendell Holmes. Experience tends to establish what works in practice and what doesn’t, armchair musings of economic theorists notwithstanding.
If the Moore’s win their case, I’ll be one of the first to transfer my bank and securities accounts to an offshore Cayman company.
Craig
Jun 28 2023 at 10:57am
What I particularly found interesting in the link to the federal reserve article regarding this tax was this:
“Cash held abroad is estimated by Board staff based on Bloomberg data for nonfinancial S&P 500 firms and refers to cash and cash equivalents, which include both cash and liquid assets held abroad and excludes overseas profits that are permanently reinvested in the companies’ overseas operations. Estimates suggest that most of the cash held abroad is invested in dollar-denominated fixed-income assets”
Think about a 401k for one second, not uncommon for somebody to contribute a pretax dollar and for that dollar to be invested in whatever mutual fund or bond or whatever. Indeed, when somebody does that, the dollar contributed can now no longer be invested in paying down your mortgage or financing your own personal business, etc. The ability to avoid current taxes shifts one’s investment decision making and if I take that article seriously, it looks like the pre-TJCA scheme was that US parents found it oftentimes more attractive to invest in essentially dollar denominated bonds abroad rather than repatriate the funds, pay the tax and then invest those funds either in their business operations in the US or to even buy the very same assets just under the umbrella of the US corporation. Honestly that sounds like nothing short of a complete debacle.
Vivian Darkbloom
Jun 28 2023 at 11:11am
Craig,
Under the “Subpart F” rules (section 951(a)), if a foreign subsidiary of a US parent invested its earnings in “US property” that would result in a deemed dividend distribution even if that cash were not distributed to the parent itself. Simplified example: US sub buys shares of an unrelated US company results in a deemed dividend to the extent of the purchase price or the retained earnings of the sub. Ditto, lending money to US person, etc.
https://taxexecutive.org/much-ado-but-little-new-a-guide-to-section-951a-after-build-back-better/#:~:text=Section%20951(a)(1)%20requires%20a%20United%20States%20shareholder,US%20tax%20on%20that%20income.
Pierre Lemieux
Jun 28 2023 at 3:28pm
Vivian: By laws that work “in practice,” do you mean those that practically serve to maintain the spontaneous order of the rule of law or those (à la Pashukanis) that are expedient? I am referring to the distinction explained in Hayek’s Law, Legislation, and Liberty, especially Volume 1 and Volume 2. (My links are to my EconLib review of these works, which are of course a poor substitute for reading the real thing.)
Pierre Lemieux
Jun 28 2023 at 3:30pm
Vivian: My “tax grab” was referring only to the “mandatory repatriation tax” provisions.
Vivian Darkbloom
Jun 28 2023 at 4:20pm
I await your suggestion as to how one should have implemented a transition from a US global taxation regime to a (partial) territorial regime (the latter involving far shorter tentacles of “the Leviathan”—which Libertarians should support)!. As indicated, over the medium and long term, this provision doesn’t increase the “tax grab” by “Leviathan”. (Not that I favor Big Government, but I recommend you stop using that pejorative device–it doesn’t strike a positive, much persuasive chord outside the choir and simply marks you as an ideologue, in my humble opinion).
BTW, if libertarians are against a wealth tax, I couldn’t think of a dumber move than initiating and supporting this appeal. My prediction: the Supreme Court will uphold the 9th Circuit on narrow grounds which will only give support to wealth tax proponents who will try to misconstrue and expand that narrow ruling. A triumph of libertarian ideological thought!
Pierre Lemieux
Jun 28 2023 at 11:37pm
Well, Vivian, if you want to study public choice theory or constitutional political economy, I fear I owe you a trigger warning: you’ll have to have to get used to the now-technical term “Leviathan.” For example, you will find it 35 times in Buchanan’s The Limits of Liberty, and 314 times in Brennan and Buchanan’s The Power to Tax. It started its life in political theory with Hobbes’s 1651 book Leviathan.
Vivian Darkbloom
Jun 29 2023 at 3:04am
Pierre,
One does not need to employ the term “Leviathan” to study or teach “Public Choice Theory”. You perhaps are unaware that the name Leviathan comes from the Hebrew Livyatan, which comes from a root that means “to twist, turn, wind, or coil.” Historically, it was used to refer to a sea monster. The fact that others have used it doesn’t mean you have to repeat it, ad nauseam.
In the context in which you use the term, you presuppose, with a not-so-subtle “wink, wink” the very thing you appear to argue: Government = Bad! That, as I said, is a strong ideological marker and doesn’t do anything to advance your case among those who are not fellow travellers. Quite the opposite, in my view, as I’ve indicated above.
I’m reminded of the wise adage for good writers: “Show, don’t tell”.
Viv
vince
Jun 28 2023 at 4:57pm
If you want to talk about a tax grab, consider Washington state. An income tax in that state is unconstitutional. Their courts ruled this year that a capital gains income tax is not an unconstitutional income tax; it’s a constitutional excise tax.
Craig
Jun 28 2023 at 10:47am
“That tax applied to 30 years of profits that U.S.-based companies held overseas and hadn’t repatriated.”
I can say with a straight face owning LLCs and having owned an S-Corp that there is literally no way I would ever even remotely consider owning a C-Corp because of the double taxation regime one must enter into. However, that being said there is ONE benefit of owning a C-Corp and that is that taxation on the individual side of things can be perpetually deferred until some kind of realization event happens, a dividend or if you sell the stock and make some type of capital gain. In fact the public policy behind that is actually to encourage people to reinvest the profits to do exactly that.
Now let us assume that the law is upheld, what incentives will that create? If a multinational corporation based in the US is subjected to taxation in the US based on the profits earned, and which will be taxed by the foreign jurisdiction, and not disbursed back to the parent as a dividend or loan repayment. Well, I would suggest that it won’t be long before that multinational changes the location of the parent. After all nobody is suggesting that Toyota pay tax to the US government for profits earned by Toyota in Saudi Arabia, right? So I would suggest one will see more inversions. If the inversion doesn’t happen the US corporate parents will find themselves less nimble than their foreign counterparts since they will have more difficulty deploying capital effectively.
As the Professor has said ‘dirigisme begets dirigisme’ and the US government’s rationale is here: “Before the Tax Cuts and Jobs Act, foreign profits of U.S. multinational enterprises (MNEs) were subject to U.S. taxes, but only when repatriated. This system incentivized firms to keep profits abroad, and, by the end of 2017, U.S. MNEs had accumulated approximately $1 trillion in cash abroad, held mostly in U.S. fixed-income securities.2 Under the TCJA, the United States shifted to a quasi-territorial tax system in which profits are taxed only where they are earned (subject to minimum taxes); henceforth, U.S. MNEs’ foreign profits will therefore no longer be subject to U.S. taxes when repatriated. As a transition to this new tax system, the TCJA imposed a one-time tax (payable over eight years) on the existing stock of offshore holdings regardless of whether the funds are repatriated, thus eliminating the tax incentive to keep cash abroad.” — https://www.federalreserve.gov/econres/notes/feds-notes/us-corporations-repatriation-of-offshore-profits-20190806.html
This admits that the government created a taxation system which actually incentivized corporations to have their foreign subsidiaries retain earnings rather than disburse it back to the parent. Well, the government is going to fix that, aren’t they?
Here’s a better solution, eliminate all corporate taxes and sure enough US parent corporations will likely find it more advantageous to repatriate profits to invest in the US itself while foreign corporations with US subsidiaries will be more likely to retain and reinvest their US earnings right here in the US.
Thomas L Hutcheson
Jun 28 2023 at 11:16am
Yes. Eliminate all corporate taxes but impute all the income to owners.
Craig
Jun 28 2023 at 2:38pm
With respect to publicly traded companies the cast of owners is changing by the second. How would it be practical to impute earnings to the various owners and former owners who may have held the stock for as little as a part of a day? Let’s say I sell a stock today just before the end of the 2Q and the company reports a loss for the first half of the year, but then does better the 2nd half of the year and then reports at the end of the year income for the entire year.
robc
Jun 28 2023 at 2:59pm
Treat dividends as regular income and REQUIRE dividends of at least x% of earnings. Also, you could require a % of retained earnings in those years where earnings are negative.
So something like, minimum dividend in year X will be the greater of 20% of taxable (the tax rate is just 0%) earnings in year X-1 or 5% of retained earnings at end of year X-1.
Where year is fiscal year, of course.
That would still allow C corps to delay taxation, and encourages reinvesting capital, but not forever.
Craig
Jun 28 2023 at 4:05pm
“Treat dividends as regular income”
With respect to this, if corporate taxation is eliminate I support the concept that LTCG and dividends be treated as ordinary income.
“and REQUIRE dividends of at least x% of earnings. ”
Why? Let the shareholders determine if they prefer to reinvest their earnings in the corporation or if they prefer a return of their capital. The whole purpose of a corporation is to allow large numbers of otherwise unassociated individuals to pool capital, why compel divestiture?
robc
Jun 28 2023 at 4:31pm
To avoid the “problem” this article discusses and to avoid Thomas’s suggestion of imputing all earnings to owners.
As I said elsewhere, I oppose the income tax in general. But if it exists, I would prefer to get rid of the corporate income tax and tax dividends (and cap gains) as ordinary income. The rule I proposed would be a “compromise” because the obvious complaint would be that they would never pay out and taxes would be delayed basically forever.
Right now the corporate income tax is 21%. A 20% minimum dividend still requires* them to pay out less than the income tax would, so they could keep at least a little more capital than under current taxation.
*ignoring tax credits from previous losses
vince
Jun 28 2023 at 4:41pm
That’s right, Craig. One solution is to tax the corporation but allow a dividends deduction. A similar alternative is to tax the corporation but allow a refundable credit to the corporation when dividends are paid.
Thomas L Hutcheson
Jun 29 2023 at 12:16pm
End of year. Intra-year transitions will be reflected in sales/purchase prices.
Vivian Darkbloom
Jun 28 2023 at 11:18am
Craig,
Yes, with certain exceptions under Subpart F, etc (no deferral of “passive income”) companies were allowed to defer US tax but at the same time discouraged from repatriating funds back to the US where that dividend would be subject to tax, less any offsetting foreign tax credit on the direct and underlying foreign taxes already paid on the earnings the dividends represented.
The 2017 Act was an attempt to (partially) reverse these disincentives, but necessarily “going forward”. A drastic change in international tax law, as this was, involves difficult issues of transition. Hence the rather modest “repatriation tax” on deemed repatriation of earnings that had accumulated over the decades.
Rather than a “tax grab”, I think the change represented a policy choice in the right direction.
vince
Jun 28 2023 at 4:37pm
It wasn’t so bad when corporate rates were 21%. The dividend rate was 15%, for a total tax of 36%. The top individual rate was 37%.
Jim Glass
Jun 28 2023 at 12:31pm
As an interesting related aside, the US Supreme Court in the early days of the income tax repeatedly ruled (on the advice of the leading economists of the day) that capital gains are not income. On just this reasoning, that since a capital gain reflects discounted future income, it is not additional income. E.g.:
“Enrichment through increase in value of capital investment is not income in any proper meaning of the term,” Eisner v. Macomber, 252 U.S. 189, 1920.
Note that capital gains are not included in income in the national accounts. But in tax law Congress can define what it wants as it wants to tax as it wants, pretty much. It explicitly changed the law here to what we all know today. (Congress can pretty much define a dog as being a fish and apply a fish tax to it. I was recently looking at an environmental law case where fish literally were defined as land animals so a land-based environmental law would apply to them … but I guess I digress.)
Vivian Darkbloom
Jun 28 2023 at 1:40pm
“It explicitly changed the law here to what we all know today.”
As far as the specific facts of Eisner v. Macomber, the law has not changed at all. That case involved a pro rata stock dividend (or essentially a “stock split”). Today, non-elective, pro-rata stock dividends are still not taxed as income. See, IRC Section 305.
The case did not at all address the issue of whether “capital gains” are subject to tax. The court essentially held that each case should be considered on its own merits, according to the substance rather than form: “What is or is not “income” within the meaning of the Amendment must be determined in each case according to truth and substance, without regard to form. P. 252 U. S. 206.”
But, yes, it’s true: the law changes according to experience and the needs of the times.
Pierre Lemieux
Jun 28 2023 at 4:18pm
Jim: You don’t really digress!
David Seltzer
Jun 28 2023 at 3:25pm
If one of the pillars of economics is the concept of incentives, I suspect the very nature of taxation engenders strategies and tactics designed to legally avoid or defer payment. In 2013 Apple increased stockholders dividends and stock buy-backs. Apple’s cash position was $144 billion but most of the cash was offshore. Investors wanted access to the cash. Apple didn’t want to pay corporate tax rates that were as much as 35% if they repatriated profits. Apple borrowed about $30 billion. Borrowing in the US lowered Apple’s cost of capital due to low interest rates, about 3.5% ,and could deduct that interest from the tax payments it does make. The street called this move a tax arb. I suspect Apple executives believed they were more efficient users of investor’s cash and capital than the Leviathan.
Pierre Lemieux
Jun 28 2023 at 3:51pm
Note: My critique of the tax grab of the “mandatory repatriation tax” was not meant as a study of the sedimentation of unreadable tax laws resulting from more than one century of galloping legislation and regulation, but as a critique of the result in light of public-choice theory and constitutional political economy. An introduction to constitutional political economy can be found in Geoffrey Brennan and James Buchanan, The Reason of Rules: Constitutional political economy, where you can find a link to the actual book.
Of course, we can still benefit from the knowledge and comments of our readers who are legal experts. As Craig so cleverly said, dirigisme begets dirigisme!
Mark Brady
Jun 28 2023 at 4:39pm
Two thoughts.
A. Pierre, do your strictures against a wealth tax also apply to property taxes that homeowners and landlords pay in respect of the houses and apartments that they own?
B. When discussing which taxes are economically more efficient and/or more compatible with widely accepted principles of a limited state, we should not forget to discuss tax rates. Whatever the arguments against a wealth tax, many wealthy taxpayers would prefer to pay, say, a 5% annual tax on their wealth than a 50% annual tax on their income.
Pierre Lemieux
Jun 28 2023 at 9:19pm
Mark: I fear I don’t understand your second point. Given appropriate ceteris paribus conditions, a taxpayer would only prefer an annual 5% tax on his wealth (0.05*W) to a 50% tax on his income (0.5*Y) if two conditions are realized:
(1) The return on his capital is more than 10%. Proof: 0.05*W<50%*Y) –> (Y/W)>0.1.
(2) He believes that Leviathan will never tax his wealth at a rate higher than Y/W.
Your first point is very good. My short answer is yes, for the reasons of constitutional political economy I have (summarily) explained. Some exceptions may be justifiable. A major one would be for unimproved land, on which a Georgist tax, probably the most efficient tax, could be applied. Fred Foldvary tried to persuade me of that a few years ago, and I fear I have an old post where I badly argued against his and George’s arguments. (I hope to come back to this topic to disavow my post!) So I would have to reformulate my arguments above by adding “unearned wealth whose total supply is fixed.”
Mark Brady
Jun 28 2023 at 10:32pm
A. Indeed, property taxes are in part levied on the site value of land as distinct from the improvements to that site, and economists have long recognized that such a tax has little deadweight loss compared with a tax on the improvements. That’s why (from an economist’s perspective) most property taxes in the U.S. do not compare well with a tax on the site value of land alone.
B. My point was an example of a more general argument that a great deal of discussion about replacing one tax by another both here and elsewhere ignores the question of the rates of taxation. I think part of the reason is that exponents of limited government fear for good reason that a new tax would not replace an existing tax but would be levied in addition to the taxes that are already in place.
Matthias
Jul 2 2023 at 10:10pm
Why do you just assert that an income tax has to stop at 100%?
(In practice, it’s hard to charge anything close to that, but governments can make laws all they want.)
Btw, thanks to inflation capital gains taxes can also exceed 100% of real gains fairly easily.
Pierre Lemieux
Jul 3 2023 at 11:41am
Mathias: I think you will find your answer in my parenthetical sentence:
But you are right that unanticipated inflation can raise the tax take over 100%, but not for long. An asset taxed at more than 100% will quickly cease to return any profit (or will disappear). Imagine if you own a factory whose profits are taxed at more than 100%.
vince
Jul 3 2023 at 4:41pm
Just as it can and frequently does with interest income.
Jose Pablo
Jul 8 2023 at 7:57am
There is not a big difference between taxing “realized annual income from capital” and taxing your “capital” (assets), over the “marketing” effect of taking more from you using a lower “headline rate”
But there is a stronger case against taxes on “realized annual income from capital” or “capital”: your “capital” has already been taxed as labor income. Capital is, after all, labor income that has not been spent, and, as such, has been already taxed.
In a world with no taxes, if my labor income is 100, I can spend 50 and save 50. So, my “capital” would be 50.
Now, the government introduces, let’s say, a 40% tax on my labor income. Now I earn 100, send 40 to the government, spend the same 50 and save 10. My capital is now 10
So, a 40% tax on labor income is equivalent to an 80% tax on “capital” … and, obviously, to an 80% tax on any realized annual income from this “taxed away” capital.
Pierre Lemieux
Jul 10 2023 at 12:16pm
José: I don’t think this theory works.
A tax on income is not a tax on the things one does with one’s income, it is a tax on all income, and THEN one decides what he wants to do with one’s net (reduced) income (although the tax on income may reduce the increase of his capital). His consumption of chewing gum or his savings may, depending on his preferences, decrease or increase relative to his consumption of beer or to his savings. He may buy more potatoes, for example (if he is Irish). Similarly, a tax on capital is a tax on the capital one uses to earn his income, either human capital or physical capital (including land) or titles on the latter, not a tax on income (although it will reduce future income, ceteris paribus).
In this perspective, a tax on labor income is a tax on labor income, not a tax on human capital. The former is not arithmetically translatable into a latter, nor vice-versa, for the public-choice reason that I tried to explain (following Brennan and Buchanan), and which is related to the logic of the institution called government (the danger of Leviathan). A 40% tax on the return from your human capital (i.e. on your labor income) is not a tax on your savings more than it is a tax on chewing gum, on marriage, or on skydiving. (It is not an excise tax.) If, after the income tax, you decide to forego chewing gum and buy more potatoes, it is still an income tax, not a 100% tax on chewing gum.
In your illustration, the proportion 50-to-10 depends on your own choices to minimize the impact of the income tax on your utility. Moreover, this reduction of your savings from 50 to 10, is a reduction of your INVESTMENT, which is of the possible increase of your CAPITAL. None of your existing capital (before you earned this year’s taxed income) has been taxed: indeed, that is the essence of the difference between a tax on income and a tax on capital.
Jose Pablo
Jul 11 2023 at 8:36am
Thank you, Pierre, for your answer.
I agree that the math on my example is questionable since the tax introduced by the government resulting in less disposable income, could alter your preferences compare with the no-taxes scenario, but the main point was not the equivalent rate (that was just an intent to illustrate the point).
Building on your “savings as a form of consumption equivalent to gum or potatoes” reasoning, my point is that a tax on “capital income” is equivalent to a tax on potatoes when you consume your potatoes.
Why you should pay an additional tax on your savings when you “consume” your savings (“capital income” is the equivalent to “consume” your potatoes) and not when you consume your potatoes.
You can consume less potatoes because of the labor income tax, the same way that you can have less savings because of the labor income tax. Why you should pay additional taxes when “consuming” your savings in future years but not when consuming your potatoes in future years (assuming you can safely storage them for years).
“Capital” is equivalent (as in it is the same thing) to the discounted future stream of cash-flows this same capital produces. Same way that potatoes bought for future consumption are equivalent to the future stream of potatoes consumption they can produce.
Why this “future streams” should be taxed (again) in one case but not in the other?
I still don’t see the “rational” for that and it clearly provides a biased incentive towards consumption today which is not double taxed by income taxes) vs consumption tomorrow, meaning “capital” which is double taxed by income taxes.
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