Untaxing-III (Laffer Curve) ch 10:     Why Not To Tax Corporate Profits

Loss of equity value.

Let’s take the 2011 US corporate tax rate of 35% and apply this rate to a public company paying \$30,000 in federal taxes. If the \$30,000 is declared as dividends for shareholders with a 3% dividend yield (see Barron’s for the 2011 public company’s dividend yield), the company’s market value increases by \$1,000,000 (= \$30,000 ÷ 3%).

Since the current tax policy claims the \$30,000 in direct taxes, the company’s market value is suppressed by \$1 million. Look at this calculation again so as not to miss the suppression of equity value that would have been produced if the \$30K were released as dividends.

What does this mean? For each \$1 paid in federal taxes today instead of as dividends, \$33.33 in equity value is suppressed today and \$11.67 cannot be collected as capital gains tax tomorrow. \$33 of equity value and a potential \$11 in tax revenue is lost just to collect a \$1 tax!

Loss of jobs.

Without the debate on the reason for the concentration of public company value into the hands of a few institutions, let’s look at market value and jobs. The ratio of company market value to number of jobs helps us understand the impact of a flawed tax policy on jobs.

Now we are dealing with statistics here. So please let’s be careful about the point that is being made. A \$30,000 tax on corporate profits suppresses \$1 million in market value. If US per capita income is \$47,200, then 21 US jobs are potentially lost for each \$30,000 of corporate taxes. This number of potentially lost jobs is calculated by dividing the lost market value by per capita income (\$1 million divided by \$47,200).
NOTE: Per capita income is calculated by dividing the US GDP by the US population size.

Do these numbers make sense?

Let’s assume that 20% of the \$47,200 (per capita income) goes to pay federal taxes on salaries and wages. 20% of \$47,200 is \$9,440. Since 21 labor units are impacted by the \$1 million loss in market value (because of \$30,000 of corporate taxes), we multiply \$9,440 of individual taxes by 21 to calculate the amount of individual taxes that will not go to the US Treasury. \$198,240 in individual taxes from 21 US workers is lost to the US Treasury just to collect \$30,000 in corporate taxes from the public companies.

Is a \$30,000 gain in tax revenue from a direct tax on corporate profits worth \$198,240 in lost taxes from 21 jobs? The net loss in tax revenue is \$168,240, exceeding initial gains by 461%. The existence of such net losses just doesn’t make sense.

Cumulative Negative Effects of taxing corporate profits.

It gets worse. The current tax policy (of taxing public company profits) prevents the US Treasury from collecting more taxes from jobs created and from a short term 35% capital gains tax.

The worst negative impact comes from denying the US Treasury up to \$350,000 in tax revenue from a 35% capital gains tax applied to \$1 million in market value that would have been produced if the public company’s profits were not taxed by \$30,000 but declared as dividends for company shareholders. A \$350,000 loss for a \$30,000 gain is a negative impact of 1,067%.

The net loss in tax revenue is \$198,240 from 21 jobs and a \$350,000 loss (\$30,000 tax divided by 3% dividend rate multiplied by a 35% capital gains) in short-long term capital gains for a combined loss of \$548,240!

If a \$30,000 tax suppresses \$1 million in market value when this \$30,000 is paid as 3% dividends, then \$300 billion in corporate taxes suppresses \$10 trillion in market value (\$300 billion divided by \$30,000 times \$1 million).

This \$10 trillion in market value is subjected to the 35% capital gains tax. Up to \$3.5 trillion in federal taxes is lost because the market value is suppressed.

The cumulative effect is more sinister when the impact on jobs is examined. For each \$30,000 collected in corporate taxes, there is a potential loss of 21 jobs in the economy and \$198,240 of lost tax revenue to the US Treasury.

Now be watchful here because the numbers do not lie for the student of economics and the student of banking, both of whom are familiar with the economic multiplier effect and fractional reserve banking which have the effect of producing more economic value and more money.

It should be clear that \$30,000 in taxes reduces the amount that a public company can declare as dividends. We see that \$30,000 suppresses \$1,000,000 in market value when the dividend yield is 3% and the tax rate is 35%, potentially decreasing 21 jobs that can be produced.

OK, now let’s look at \$300 billion divided by \$30,000 times 21 jobs.

\$300 billion ÷ \$30,000 * 21 equals 210 million. Do you see this number of 210 million potential jobs being impacted because of a \$300 billion tax on corporate profits?

What this 210 million potential jobs means is that the multiplier effect of a \$300 billion tax on public company profits can cause \$9.912 trillion in wages and salaries not produced when the US per capita income is \$47,200.

Take the 25 million US unemployed workers. Multiplying 25 million by \$47,200 per capita income results in \$1.18 trillion that could have been producing \$236 billion in individual taxes when the individual tax rate is 20%.

Clearly, the \$300 billion tax on corporate profits is partly to blame for 25 million unemployed US workers.

What is potentially being said?

We cannot say for certain what investors will do with their \$10 trillion of new-found market value. But we do know that this new market value is subject to a 35% capital gains tax when cashed in.

We also know at this point that 19,983 US public companies are worth \$17.14 trillion and the US GDP is \$14.72 trillion. It is an economic fact that 16% of the 155 million labor units are unemployed.

It doesn’t matter how the number of unemployed is calculated.

Multiply the government figures of 8% by the US population or calculate 16% of the number of people available for work (155 million labor units). Either calculation gives us about 25 million.

Now when \$10 trillion (\$300 billion tax on corporate profits divided by 3%) is added to the total market value of 19,983 US public companies, this \$10 trillion is also added to the US GDP. Instead of \$14.72 trillion, US GDP would be \$24.72 trillion.

When the US public companies are worth \$17.14 trillion and the US GDP is \$14.72 trillion, then 130.2 million Americans are employed (155 million labor units minus 16% unemployed workers).

When US GDP is \$24.72 trillion, then 218.65 million Americans are required to produce this GDP.

Simply dividing the projected GDP (\$24.72 trillion) by the current GDP (\$14.72 trillion) and multiplying by the currently employed American workforce (130.2 million) gives us 218.65 million Americans.

This is a labor shortage of 63.65 million (218.65 million minus 155 million). In other words, a 68% increase in employed workers (from 130.2 to 218.65 million) overruns the 16% unemployment rate.

Go to (part III) chapter 11: Why Penalize Market Values?