Tax reform requires politicians prepared to think about their country first, not reelection, or their parties’ ideologies. Tax reform must protect the vulnerable in society while encouraging sustained economic expansion and job creation.
A critical aspect of tax reform must be to free the economy’s growth engine, business, to do what it does best—-expand. Thus, governments must not tax retained profits (undistributed profits), they must eliminate corporate taxes. Then, firms will use retained profits to reinvest, create jobs, help grow the economy, and pay dividends. In turn, governments will tax additional salaries, wages, and dividend payments. Allowing businesses to keep retained earnings tax-free will help companies compete more evenly against overseas competitors. This idea is not rocket science; business is the only productive job creators in the economy.
Governments might shy away from this proposal because they fear firms will waste retained earnings. However, it is the owners’ role to ensure business leaders invest retained earnings wisely for modernization and growth as appropriate. Governments should tax business’ profits when they eventually leave the company as dividends. Meanwhile, they should continue to tax wages and salaries. Ultimately, other uses of retained profits will create economic expansion.
Tax Reform Must Encourage Job Creation
The core of my simple job creation formula could apply to Canada and the USA:
- Abolish capital gains and corporate income taxes.
- Tax only funds leaving the business to employees and owners––employees’ compensation and dividends paid to owners.
- Abolish special tax incentives.
- Introduce a two-tiered tax regime for individuals, eliminate special deductions and credits, and simplify the tax code.
Removing corporate income taxes sounds like a huge deal. Certainly, many students and left-leaning politicians will oppose it, although several studies show many USA and foreign firms doing business in the United States pay no federal income taxes. Under my proposal, imagine the number of accountants and lawyers who would be able to focus on productive work instead of working to avoid taxes legally.
For individuals, there would be two rates after establishing a threshold below which nobody pays taxes. The first rate above the threshold should not exceed 15% and the second rate of not more than 20%, applied to the top 10-15% of taxpayers.
Principles inherent in this personal taxation proposal in the above table are more important than the numbers. To implement these suggestions will require a politician who cares about his or her country and not his or her agenda—a rare breed.
Tax Reform Needs Courage
In 1991, then Canadian Prime Minister, Brian Mulroney, introduced needed tax reform, among other things, abolishing the penal manufacturing sales tax and introducing a consumption-based tax, Goods and Services Tax (GST). The electorate punished him and his party for this profound decision that almost wiped out his conservative party.
The hugely unpopular GST provided a significant boost to the Canadian economy, vindicating Brian Mulroney. Eliminating corporate taxes, scrapping capital gains taxes, and introducing a simple, two-tiered income tax system, might produce the same results.
Governments need to choose a realistic timetable to implement this tax reform. It won’t be popular so any time will be right. In contrast, so-called government stimulus and corporate welfare programs, by any name, merely adds to debt and deficits and detracts from economic growth.
Getting rid of corporate taxes could mean fewer funds to government in the medium term, and a significantly reduced tax collection bureaucracy. Hopefully, that would spur government to cut waste. Then it might do what good business leaders do; it might review its departments, eliminate unneeded functions, and shrink. Unfortunately, that’s wishful thinking; governments and waste are inseparable.
Politicians will dislike this proposal because it is simple. Besides, it will create negative emotions with the public, who, like some politicians, enjoy bashing businesses. Who will tell people they need companies to sustain lifestyles to which they aspire? Politicians won’t because that’s not a popular position. Besides, they might prefer a more convoluted tax scheme they can hide behind to deflect criticism.
As long as people run businesses, greed and fraud will exist, and some business owners will exploit workers. We must always work to preempt these bad practices, and where they exist resolve them promptly within current laws. We don’t need new government rules.
Businesses Are Sole Productive Job Creators
A skeptic might say: What happens if a company sits on retained profits? That’s not an issue because owners will push business to pay dividends or invest—two acceptable actions for consumers to help grow the economy, but with a downside. Some greedy CEOs will use excess cash to buyback the company’s shares even when the stock price is high—a waste of company funds.
Shares’ buyback makes sense for undervalued companies’ stock prices, not at high prices. That’s why CEOs need real oversight. We need better corporate governance to rein in CEO’s pay and to embed and enforce proper values in the organization. Developing more effective corporate governance models is a separate matter that businesses must address responsibly.
Tax Reform Benefits
In my tax reform scenario, the economy benefits in three ways:
- Businesses focus on reinvesting profits to expand, modernize, and create jobs, instead of hiring accountants and lawyers to find legal means to minimize business taxes.
- Governments won’t tax society’s wealth-producing vehicle, instead, they tax only paid out profits (dividends), salaries, and wages, resulting in a simple taxation system.
- People have more disposable income to buy more goods and services from businesses to fuel economic activity.
Tax Reform’s Four Principles
The USA seems headed in the right direction; their proposal isn’t perfect, but none will be perfect. Sadly, we are discussing tax reform in a political context. So, the left takes one position and the right another. Tax reform needs to transcend politics and include four fundamental principles:
- Government must look after the most vulnerable in society in such a matter that doesn’t encourage dependency on government.
- Society must acknowledge that we need robust businesses to create productive jobs.
- Wealth redistribution by taxing businesses doesn’t work, and is counterproductive because businesses create jobs.
- Governments are inherenetly wasteful and should get taxes needed to fulfill needed services only.
Canada continues to bash businesses and will lose job creators when the USA does the right thing and relieve businesses from the present oppressive tax burden.
(c) 2017 Michel A Bell
(Exercpted from Michel’s latest book, Business Simplified)
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