Untaxing-III (Laffer Curve) ch 11:     Why Penalize Market Values?

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Misguided tax policy that penalizes the profit engine of 19,893 US public companies (arguably the most powerful engine on the globe) with a high 35% direct tax on corporate profit and a 35% delayed short-long term capital gains (for 2012) is a 70% tax swing. Without new capitalist facts that optimize tax revenue, this giant slice tax policy is unwise.

According to The Tax Policy Center the US treasury collected $2.5 trillion in taxes in 2008 where 12% was collected as corporate taxes.

Without separating the corporations into public and non-public companies, let’s assume that all corporations are subjected to their market values being suppressed by the 35% tax on their profits. Our assumption means $300 billion was collected in corporate taxes from corporate profits of $857.14 billion.

With a dividend yield of 3%, $300 billion in federal taxes paid by US corporations suppressed $10 trillion in market values ($300 billion divided 3% dividend rate) when we assume that this $300 billion is returned to the shareholders as annual dividends.

Reducing the corporate tax rate from 35% to 12%

Although no presidential candidate receives an endorsement, it is worth noting that Speaker Newt Gingrich has said that one of the pillars of his 2012 Presidential Election campaign is a 12% corporate tax. What the Speaker is saying from a Laffer curve perspective is that the profits of US corporations should be taxed at 12% rather than the current rate of 35%. US companies would pay $102.86 billion instead of $300 billion.

The US Treasury would collect $102.86 billion in annual corporate taxes plus 35% of the remaining $197.14 billion in short term capital gains taxes. The total collected would be $171.85 billion (the sum of $102.68 billion and $68.99 billion). Gingrich’s plan would cause the US Treasury to lose $1.2 trillion in tax revenue, an improvement over the current loss of $3.5 trillion but not the optimum case.

Why deny the US treasury tax revenue?

It is not the point of this paper to grant or deny revenue to the US Treasury but to give policy makers various versions of the math-facts they need to write a tax policy that’s more efficient and actually produces more tax revenue. So let’s use the math correctly here and further analyze the Speaker’s 12% tax initiative.

This logical analogy of $102.86 billion (12%) subtracted from $300 billion does not recognize how much tax potential is left on the table. What is left on the table is the difference between $300 billion and $102.86 billion leaving $197.14 billion to be declared as dividends. When these dividends are divided by a current 3% dividend yield, the market values for US public companies are increased by $6.57 trillion.

This $6.57 trillion tax base omission is astonishing — an omission not just by the Speaker who is not an economist, but by all contributors to economic and financial thought to date. Since most of the policy makers are not students of finance they fail to realize that as long as this $197.14 billion is paid as dividends when the dividend yield is 3%, the $6.57 trillion equity value is stable and is immediately subjected to predictable short-long term capital gains tax.

This $6.57 trillion is subjected to a current 35% short term capital gains tax, potentially giving the US Treasury up to $2.3 trillion in a continuous stream of capital gains taxes over a few months and years from this change in tax policy to a 12% corporate tax. Look at the Tax Loss Table  (Table 5) above, compare and observe carefully what is being said here.

A 12% (Gingrich) tax rate for the US public companies would give the US treasury $102.85 billion in taxes now and $2.3 trillion (= $197.15 billion ÷ 0.03 * 0.35) in 35% capital gains over time.

The US government and shareholders are the two substantial beneficiaries of this 12% tax.

This 667% increase in tax revenue ($300 billion to $2.3 trillion) comes from a simple 12% tax rate on corporate profits. This 12% tax on corporate profits potentially gives corporate shareholders $6.57 trillion more in market value when the dividend yield is 3%.

The conclusion thus far is that the current ill-conceived US tax policy suppresses the US GDP by $6.57 trillion with a naive “get-it-now” $300 billion tax policy on profits of corporate and public companies.

Go to (part III) chapter 12: How Much Market Value is Suppressed by Corporate Taxes?