In our previous blog on the topic of tax reform, the focus was on individual income taxes, while deferring the discussion of corporate taxes for a later date. With the House and Senate announcing the major structures of their respective tax reform bills, today’s blog focuses on the effects of corporate tax reform on the U.S. economy and the accounts receivable management (ARM) industry. Both bills have similar goals for corporate tax reform – eliminate loopholes, reduce corporate taxes, and create jobs. This sounds great in theory, but does theory align with reality?
First, the following is a quick review of the critical components of the House GOP corporate tax reform proposal. While the House proposal differs slightly from the Senate’s, the proposal is more complete and will be the focus of our analysis.
Corporate Tax Reform: House GOP
- Reduces the tax rate on the hard-earned business income of main street job creators to no more than 25% – the lowest tax rate on small business income since World War II. In particular, this is focused on pass-through entities like S-Corps and LLCs.
- Lowers the corporate tax rate from 35% (highest in the industrialized world) to 20%, which would be the largest U.S. corporate tax rate reduction in our nation’s history.
- Establishes strong safeguards to distinguish between individual wage income and pass-through business income so main street tax relief goes to the local job creators it was designed to help most.
- Allows businesses to immediately write-off the full cost of new equipment to improve operations and enhance the skills of their workers – unleashing the growth of jobs, productivity, and paychecks.
- Protects the ability of small businesses to write-off the interest on loans that help these main street entrepreneurs start or expand a business, hire workers, and increase paychecks.
- Retains the low-income housing tax credit that encourages businesses to invest in affordable housing so families, individuals, and seniors can find a safe and comfortable place to call home.
- Preserves the Research & Development Tax Credit – encouraging our businesses and workers to develop cutting-edge “Made in America” products and services.
- Strengthens accountability rules for tax-exempt organizations to ensure the churches, charities, foundations, and other organizations receiving tax-exempt status are focused on helping people and communities in need.
- Modernizes our international tax system so America’s global businesses will no longer be restricted by an outdated “worldwide” tax system that results in double taxation for many of our nation’s job creators.
- Makes it easier and far less costly for American businesses to bring home foreign earnings to invest domestically in creating jobs and increasing paychecks in our local communities.
- Prevents American jobs, headquarters, and research from moving overseas by eliminating incentives that now reward companies for shifting jobs, profits, and manufacturing plants abroad.
Now that we’ve reviewed the above points on corporate tax reform, we must ask whether these proposed changes are logical and have a financial basis. To address this question, we consulted with several tax advisors to determine what they would like to see from corporate tax reform. Here’s a list of the goals they provided:
Corporate Tax Reform: Tax Advisors
- Lower the tax rate without adding additional regulations and limitations.
- Eliminate double taxation of C-Corps, especially on sale of substantially all assets.
- Allow S-Corp and other pass-through entity owners to receive basis from guarantee of corporate debt.
- Make the compensation rules for owners in pass-through entities more pro-business.
- Permit pass-through entities to file their state tax returns as if they were C-Corps.
- Make it easier for business owners to pay medical premiums for its employees.
- Liberalize the rules for deductible contributions to employee benefit plans.
- Reduce the amortization period for goodwill and other intangible assets.
- Require the IRS to provide transcript information on taxpayers within 24 hours in a form that can easily be converted to import into tax software.
- Require uniform state sales tax and nexus rules.
- Reduce the tax on foreign profits to better incentivize repatriation of these profits.
Interestingly enough, the tax advisors list (excluding some of the claimed results) wasn’t too different from the House GOP proposal, which lends some credence to the proposal from a business perspective. However, very little language addresses the elimination of tax avoidance loopholes, and a recent analysis of the House GOP proposal by the Urban-Brookings Tax Policy Center (TPC), a think tank joint venture tasked with assessing tax policy, even suggested that wage earners could be incentivized by the proposal to establish pass-through entities and engage in tax avoidance, especially if enforcement is as lax as it is in the current market.
Considering the GOP tax proposal aligns with the desires of tax advisors, even if it doesn’t necessarily close tax avoidance loopholes, we can say it does have a logical and financial basis. Next, we need to consider whether a reduction in corporate taxes will create jobs and facilitate economic growth as it claims. To do that, we considered the application of agency theory and opinions of industry leaders on the subject of corporate tax reform.
Agency theory, under the context of Dr. Michael Jensen, Harvard Business School, and Dr. William Meckling, William E. Simon, Graduate School of Business at the University of Rochester, suggests that any increase in profitability generated by a corporation will go towards maximizing shareholder benefits, since that is the primary job (or contractual relationship) of management. From a historical perspective, this implies that hostile corporate takeovers during the 1980s – which left many workers abruptly unemployed – and excessive CEO pay, are fine, as long as share prices rise. Given the expansive acceptance of this theory – it’s one of the most widely-cited economic papers of the last 40 years – it stands to reason that any increase in profitability from a reduction in corporate taxes wouldn’t likely go towards creating jobs, unless a corporation believes this will increase shareholder value. In the case of a company with limited growth prospects (i.e., mature companies with stable growth), there would be little benefit to spend the extra retained cash on job creation when it could give this money back to shareholders through a distribution or increase in stock price by simply retaining the earnings.
Some may argue that the agency theory really and truly only holds true for larger, publicly-traded corporations. They may (or may not) be right. Instead of debating its application to smaller, privately-held businesses, let’s consider the opinion of industry leaders on the subject of corporate tax reform. Howard Gleckman, an economist at TPC, when asked his opinion on the House GOP proposal, stated, “This is not what I would call a tax-simplification plan. It raises taxes idiosyncratically on large families in rich states. And it makes life hard for some of the very small businesses it’s trying to help.” Sharing a similar opinion was Michael Linden, economist at the Roosevelt Institute, who said, “This is the tax plan’s original sin. Once you cut the tax rate for large corporations by more than a third, you have to cut tax rates for smaller businesses so that they don’t feel disadvantaged. As a result, tax reform works against wage earners by raising the lowest tax bracket to support corporate tax reductions.” Ultimately, both economists came to the same conclusion – that GOP’s tax reform isn’t focused on wage earners, the individuals that would benefit from the creation of jobs, but the actual corporations. Lastly, Marcus Ryu, co-founder and the chief executive of Guidewire Software, wrote an article for The New York Times in which he pointed out that corporate tax reform, in his view, wasn’t necessary, wouldn’t create jobs, and would increase income inequality in the U.S. since the benefits are targeted towards the wealthy.
As the above exercises reveal, corporate tax reform by the House and Senate would not have a direct and positive effect on job creation in the U.S. – at least in the near future. While long-term effects such as foreign-owned businesses relocating their headquarters to the U.S. is a possibility, it’s only a distant and highly uncertain possibility that should not justify moving forward with corporate tax reform, especially if it moves the U.S. towards a “race for the bottom” on taxation.
From an economic perspective, we’ve demonstrated that corporate tax reform doesn’t hold any distinct benefits for the U.S. economy, and recent reports by the Congressional Budget Office suggest that the House GOP proposal would increase the budget deficit by nearly $1.7 trillion over the next 10 years. This implies that corporate tax reform, as recently proposed, may even negatively impact the U.S. economy.
As for the ARM industry, it’s reasonable to believe that corporate tax reform would have a limited effect, if any, on the consumer market since it probably won’t lead to job or household income growth. However, it would likely reduce the value of federal contracts for debt collection agencies tasked with collecting delinquent taxes. Conversely, many of the ARM companies would stand to benefit from a reduction in their respective taxes. Therefore, the net effect of corporate tax reform would likely be a benefit to owners of ARM companies and detriment to the industry itself since it diminishes the benefit of federal contracts with the Department of Treasury for the collection of delinquent taxes.
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