Chapter 19
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CHAPTER 19. THE CORPORATION TAX. I’ll probably kick myself for having said this, but when are we going to have the courage to point out that in our tax structure, the corporation tax is very hard to justify? President Ronald W. Reagan. Corporations.

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CHAPTER 19

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Chapter 19

CHAPTER 19

THE CORPORATION TAX


Chapter 19

I’ll probably kick myself for having said this, but when are we going to have the courage to point out that in our tax structure, the corporation tax is very hard to justify?

President Ronald W. Reagan


Corporations

Corporations

  • Corporation – A state-chartered form of business organization, usually with limited liability for shareholders (owners) and an independent legal status

  • Limited liability

  • Corporations are “artificial legal persons”


Why tax corporations

Why Tax Corporations?

  • Only real people can pay a tax

  • Justifications

    • Corporations are distinct entities

    • Corporations receive special privileges from society

    • Protects integrity of personal income tax


Structure

Structure

Revenue

- Expenses incurred earning revenues

Taxable Income

* Tax rate (15% - 35%)

Tax

- Credits

Total Tax

Alternative Minimum Tax

Treatment of Losses


Treatment of dividends versus retained earnings

Treatment of Dividends versus Retained Earnings

  • Double taxation


Effective tax rate on corporate capital

Effective Tax Rate on Corporate Capital

  • Statutory rate versus effective rate

    • Interest deductibility

    • Depreciation allowances

    • Inflation

    • Double taxation

  • Gravelle [2004]

    • Effective corporate rate = 32%; noncorporate rate = 18%

    • Sensitivity of estimate


Incidence and excess burden

Incidence and Excess Burden

  • A tax on corporate capital

    • Incidence in a general equilibrium model

    • Excess burden on a general equilibrium model

  • A tax on economic profits

    • Incidence and excess burden of a tax on economic profits

    • Actual corporate profits versus economic profits

    • Stiglitz [1973] model


Effects on behavior total physical investment

Effects on Behavior – Total Physical Investment

  • Accelerator Model

  • Neoclassical Model

  • Cash Flow Model


Effects on behavior type of asset

Effects on Behavior-Type of Asset

  • Tax system encourages purchase of assets that receive relatively generous depreciation allowances


Effects on behavior corporate finance

Effects on Behavior-Corporate Finance

  • Why do firms pay dividends?

    • Dividends as a signal of firm’s financial strength

    • Clientele effect

  • Effect of taxes on dividend policy

    • Empirical evidence – Chetty and Saez [2004]

  • Effect on savings

  • Debt versus Equity Finance

  • Did the tax system cause the corporate accounting scandals?


State corporation taxes

State Corporation Taxes

  • State taxes have similar incidence and efficiency problems as federal taxes

  • Variation of tax rates across state lines


Taxation of multinational corporations

Taxation of Multinational Corporations

  • Structure

    • U. S. corporations pay tax at standard rate on global taxable income

    • Credit for foreign taxes paid

  • Subsidiary status

    • Deferral of taxes on income from foreign enterprise

    • Repatriation

  • Income allocation

    • Arm’s length system

    • Transfer-pricing problem


Evaluation of tax treatment of multinational firms

Evaluation of Tax Treatment of Multinational Firms

  • Maximization of world income

  • Maximization of national income


Corporation tax reform

Corporation Tax Reform

  • Full Integration (Partnership Method)

  • Issues

    • Nature of the corporation

    • Administrative feasibility

    • Effects on efficiency

    • Effects on saving

    • Effect on distribution of income


Dividend relief

Dividend Relief

  • Allow corporation to deduct dividends

  • Exclude dividends from individual taxation

  • 2003 legislation – 15% maximal tax rate on dividends


Allowable expenses

Allowable Expenses

  • Employee Compensation

    • except compensation in excess of $1,000,000

    • Options do not have to be included

  • Cost of Material Inputs

  • Taxes including employer contributions to Social Security

  • Repairs and advertising

  • Interest but not dividends

  • Depreciation

  • No investment tax credit


Depreciation

Depreciation

  • What is depreciation?

  • Tax life of an asset

    • 3, 5, 7, 10, 15, 20, 27.5, and 39 years

    • Most 5 years


Calculating the value of depreciation allowances straight line depreciation 10 year tax life

Calculating the Value of Depreciation Allowances – Straight-Line Depreciation, 10 year tax life


Calculating the value of depreciation allowances straight line depreciation 5 year tax life

Calculating the Value of Depreciation Allowances – Straight-Line Depreciation, 5 year tax life


Chapter 19

Calculating the Value of Depreciation Allowances – Double Declining Balance Depreciation, 10 year tax life


General analysis of depreciation tax savings

General Analysis of Depreciation Tax Savings

T = tax life

D(n) = proportion of asset that can be written off against taxable income in nth year

θ = corporate tax rate

Present value of tax savings:

ψ = θ * D(1) + θ * D(2) + … + θ * D(T) 1 + r (1 + r)2 (1 + r)T


More on depreciation

More on Depreciation

  • Accelerated depreciation

  • Expensing

  • Intangible Assets


Investment tax credit

Investment Tax Credit

k = investment tax credit

q = acquisition price of asset

(1 – k)q = effective price of asset


Stiglitz model

Stiglitz Model

G = before-tax value of output produced by machine

r = interest rate

Firm buys machine if: G – r > 0

Assume corporate tax

(1) net income taxed at rate θ

(2) net income = G – r

(1 – θ)(G – r) > 0


Neoclassical model

Neoclassical Model

User cost of capital = (r + δ)

After tax rate of return = (1 – θ) * (1 – t)

(1 – θ) * (1 – t) * C = (r + δ)

C = (r + δ) (1 – θ) * (1 – t)

C = (r + δ) * (1 – ψ –k) (1 – θ) * (1 – t)


Effect of user cost on investment

Effect of User Cost on Investment

  • Econometric problems

    • Role of expectations

    • Elasticity of supply curve of capital goods

    • Open economy problems


Cash flow model

Cash Flow Model

  • What is cash flow?

  • Irrelevancy of cash flow in neoclassical model

  • Cost of internal versus external funds

  • Empirical results


Maximization of world income

Maximization of World Income

rf = rUS

(1 – tf)rf = (1 – tUS)rUS

Full credit versus limited credit


Maximization of national income

Maximization of National Income

this one

(1 – tf)rf = rUS

rf = rUS/(1 – tf)

if tf < 1, then rUS < rUS/(1 – tf)

Deduction of foreign tax payments from domestic income:

rf(1 – tf)(1 – tUS) = rUS(1 – tUS)

Note: this equation equivalent to …


Effects on efficiency of full integration

Effects on Efficiency of Full Integration

  • Misallocation of resources between corporate and noncorporate sectors eliminated

  • Tax-induced distortions in savings decisions reduced

  • Remove incentive for “excessive” retained earnings

  • Reduce bias toward debt financing


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