Fix corporate taxes by tying them to American workers
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Lawmakers on both sides of the aisle, along with the Trump administration, decry the current state of the corporate tax system. Yet, none of the current proposals address the major problems facing Americans today — offshoring, mechanization and the resulting rise in unemployment. We offer a plan that addresses these critical issues and could achieve widespread bipartisan support.

The current corporate tax code is counterproductive. Designed in the early 20th Century, corporate taxes initially addressed the gross inequities during the age of the robber barons. It was an afterthought that this new tax would provide substantial revenues, though after World War I, the federal government was hooked.

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It was yet another afterthought that corporate taxation significantly impacts the structure of the economy. Our present system encourages both offshoring and automation by taxing corporate profits irrespective of how and where they are earned. These problems hurt Americans and cost the government hundreds of billions of dollars. 

 

It is time to use the corporate tax to strengthen the American economy and society.

Our proposal ties the tax rate to companies’ employment of American workers. We recommend a 25-percent, top-tier rate (a globally competitive rate) that can decrease to as low as 5 percent, depending on each individual corporate tax payer’s job creation performance. 

Each firm would compute the following ratio — U.S. employment costs (i.e wages and benefits to American employees) divided by revenues (i.e profits from sales at home and abroad).

Here are the details:

For each decile above the median U.S.-employment-costs-to-revenues ratio, the tax rate would decrease by four percentage points. Firms that are between the 40-50 percent decile would pay taxes at a rate of 21 percent. Firms in the top decile would pay just 5 percent.

By the end of December, the IRS would announce the prospective ratios based on previous corporate returns filed by Sep. 15. Any tax saved by the decrease in rate below 25 percent would need to be paid out in dividends (payments to shareholders) within three tax years, if not reinvested in the business.

If these dividends are sent to a tax-exempt entity, they would be subject to the Unrelated Business Taxable Income (UBTI) at a 25 percent rate. Our plan joins the House and Trump plans to close loopholes to allow for lower tax rates without decreasing federal revenues. It mandates that the U.S. use a territorial definition of taxable income.

Three additional specifications to consider:

First, this system should be resistant to loopholes because personal income tax withholding captures employee costs (through records of salaries and benefits separately reported to the IRS). Second, this system accommodates out-sourcing, as vendors would report their own U.S.-employee-cost-to-revenue ratios.

Lastly, this system would provide an incentive against rising U.S. income inequality by computing the U.S.-employment-cost-to-revenue ratio only for salary and bonus costs up to $250,000, indexed for inflation.

Why our proposed system is better: 

Encouraging employment via targeted enterprise zones or specific labor groups is ineffective. Heavily regulated and subject to substantial compliance costs for small and medium-sized businesses, these programs often just shift jobs from place to place. Our corporate tax plan would encourage businesses, large and small, to employ Americans.

So-called border taxes will raise money but might not create jobs. These tax proposals affect the import/export sector, which accounts for only 15 percent of the economy. Our model benefits the entire economy.

Unlike tariffs and other barriers to trade, this is not a “beggar thy neighbor” approach. The entire world income pie can grow, as each country nourishes and benefits from its internal labor market.

Companies, such as Intel and others, might complain that they need embedded tax benefits for equipment to compete with Samsung and Taiwan Semiconductor, which receive long-term subsidized loans from their governments. We are sympathetic. However, if there’s a need for specific subsidies, let it be explicitly debated and legislated for all to see. 

Personal income tax changes largely affect the supply side — job recipients. They bring more or less people into the job market, but only at the margin. In contrast, the corporate tax changes we suggest will increase the demand side, as they influence the behavior of job creators.

In making a decision to offshore or replace workers with machines, a firm will have to consider not only the marginal cost savings, but also factor in potentially raising its tax on all of its U.S. income. 

Presently, current corporate taxation is, at best, neutral when it comes to generating profits by employing people versus machines. Our proposal means high revenue/low employee companies, such as Facebook and Apple, would be taxed at the 25 percent rate. However, U.S. companies that employ many middle-income workers would enjoy much lower rates.

Would this encourage retailers to provide more human service? Would call center providers prefer to operate from Mississippi versus offshore? We certainly hope so. The new tax code would put a finger on the decision scales. 

The positive ripple effects of this new corporate tax system:

Individual income tax revenue should increase dramatically as more people become employed. We also anticipate that net increased revenues will be spent across the economy, stimulating broader GDP growth.

Our new system also encourages new business formation. Successful small and medium-sized enterprises could enjoy productive pro-employment taxation without the non-productive burden of hiring platoons of tax lawyers and accountants. Venture capital funds, which often focus on investments that eliminate jobs, would face different incentives. 

More demand for employment means wage growth and labor participation rates should increase. Further, by encouraging the reinvestment of the tax savings, firms will have an incentive to invest and grow, resulting in a further stimulus to the economy.

By increasing jobs, taxpayers will save money. Essentially, job destroying corporate productivity gains are no longer net-gains for the broader economy. Rather, with less employment, they cost the government billions for healthcare, education, maintenance, housing and general welfare.

After a century of experience we know incentives work and that the current incentives are largely wrong. Let’s make our priority keeping people humming rather than machines. We encourage Congress and the Trump administration to seriously consider our proposal. It’s time for a 21st Century corporate tax. 

 

Michael Davis is managing partner and a co-founder of The Plymouth Group, a New York real estate investment and advisory firm. Scott A. Shay is chairman of the board and co-founder of Signature Bank of New York.


 

The views expressed by contributors are their own and not the views of The Hill.