Untaxing-II (Modigliani-Miller) ch 8: The Same Equity vs. Debt Clarity Applies to Lost Tax Revenue
The US Treasury loses $3.5 trillion this year because the wrong entities are being taxed. There will be up to $14.7 trillion more in similar losses in the coming months and years. This is simply too much money not to be clear on the purpose and power of capitalism once and for all. The nuclear analogy of true capitalism’s power cannot be taken lightly. This understanding is crucial for academics, policy-makers and public company executives.
Loss of tax revenue.
Now, let’s clarify the figure of $3.5 trillion in lost taxes. By taxing the profits of public companies the US Treasury earned $300 billion. If the same profits were not taxed, $300 billion could have been declared as dividends and released to shareholders and the total market value of US public companies would increase by $10 trillion. This $10 trillion production of equity is calculated by applying a 3% dividend yield to the declared dividends of $300 billion. $300 billion divided by 3% equals $10 trillion. Then apply a 35% tax rate on this capital gains of $10 trillion. Thirty-five percent of ten trillion dollars is $3.5 trillion.
Should the US Treasury continue to collect $300 billion in corporate taxes or should it change tax policy to collect $3.5 trillion in capital gains taxes?
For background reading on the origin of debt, the reader is asked to look at another white paper entitled The Capitalistic Renaissance: Where we went wrong with creating debt and what the solution is. This paper suggests that mixing debt with capitalism is dangerous because debt actually suppresses the equity-producing power of the public company.
For now, however, we must be clear that the suppressive nature of credit-debt-interest and that taxation of public company profits are not part of the pure concept of capitalism. In the next part (Part III: Examining Tax Policy Based On The Laffer Curve) we will examine taxable equity value. But it’s important not to sour this examination by inserting the lemons of debt. In no form does the debt instrument define the concept of capitalism.
Yes, we understand that there are operational costs to get the goods and services to the consumers. Yes, we understand that some forms of taxes are necessary for the common good. When CFOs do not understand the vehicle they are driving, they recklessly opt to use debt. Yes, we understand that such decisions by CFOs are, at times, based on unsubstantiated assumptions.
These assumptions are now replaced by capitalistic public company tax facts. Each new discussion about capitalism should include in its definitions section that Risk and Equity are understood as the foundations of capitalism for academic integrity.
With the Modigliani–Miller theorem modified with a correct definition of capitalism, i.e. Risk and Equity, students of the subject of economics and capitalism won’t have the misunderstanding that debt is just as good as equity for financing the public company as per the Modigliani–Miller’s Capital Structure Irrelevance Principle.