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The communist revolutions in the 20th century sought to nationalize
the wealth generated by privately held industries back to the
"exploited" workers on whose backs the profits were supposedly derived.America has made the rejection of this idea and
its support of free market principles the centerpiece of its economic
narrative. However, as a result of our current and proposed tax policies
towards corporate shareholders, our government collects a portion of
industrial output that would inspire envy in even the most rabid Bolshevik.
The purpose of a corporation is to generate profits for owners (all
other functions are secondary to this goal). Public corporations distribute
these profits through dividends. But as a result of America's system of
double taxation, where income is taxed on the corporate level and then again
on the personal level, government receives a much bigger share of corporate
income than the owners themselves. I also address this topic in my latest video blog .
Suppose a publicly held U.S. corporation made one million dollars in
income over the course of a year. Currently its profits would be taxed at a
35% level (for the purpose of this example I will not factor in the lower
rate that is applied to its first $100K of profits), meaning that the company
would have to pay $350,000 directly to the government (assuming it earned its
income without special tax breaks). Of the $650,000 that remained, the
typical dividend-paying corporation might distribute 40 percent to
shareholders (this is known as the "payout ratio" and the actual
average is slightly below 40%). So in this instance the company would pay
$260,000 (40% of $650,000) to shareholders. The remaining $390,000 would typically
be held as "retained earnings," and would be used to maintain and
replace depreciating equipment, make capital investments, fund research and
development, and expand operations. If the company did not make such
investments it would be impossible for it to survive and its ability to
perpetuate profit distributions would be limited.
These retained earnings still represent assets to shareholders, but
their primary purpose is to generate future profits and higher dividends.
However, shareholders do not directly benefit from those retained earnings
until future distributions are paid. Sure they can sell their shares at a
gain, paying a capital gains tax in the process, but this merely transfers
those deferred benefits to the new buyer.
When received by shareholders, the $260,000 in dividends are taxed again at a rate of 15 percent (according to
current law). As a result, shareholders receive just $221,000 of the million
dollar profit. The $39,000 in dividend taxes are added to the $350,000
"off the top" corporate tax to bring the government's total take of
the company's profits to just a shade under $390,000. In other words the
government gets about 75% more cash flow from the company than the actual
owners. Looked at in a slightly different way, the government gets about 65%
of the non-retained earnings while shareholders, who put up the money and
take all the risk, get 35%. Does this seem fair?
This level of taxation puts American corporations at a noticeable
disadvantage vis-a-vis
companies in the countries against which we are most keenly competing. In
China, the slicing of the pie is much more favorable to owners. There,
corporations are taxed at a rate of 25% and dividends at 10%. Using these
numbers (and the same payout ratio used for the U.S. corporation), the
Chinese government gets 51% of distributed corporate profits and shareholders
get 49%. In Hong Kong (which is part of Communist China), the situation is
even better. There, the corporate tax rate is 16% and the personal dividend
rate is zero. If you do the math there, the government gets 33% and the
shareholders get 67%.
This comparison raises an interesting point. If shareholders in
communist China are allowed to keep more of their earnings than shareholders
in capitalist America, which nation is more
communist and which more capitalist?
Late last month the Obama Administration and Mitt Romney offered
competing proposals on corporate tax reform that both politicians say would
make U.S. corporations more competitive. Romney's plan lowers the corporate
tax rate to 25% while maintaining the dividend tax at 15%. This makes things
slightly better, sending 54% of distributed earnings to the government and
46% to shareholders (not quite as generous as Communist China). Not
surprisingly however the Obama plan will make things much more difficult.
Although the President proposes lowering the corporate tax rate to 28%
he also wants to scrap the dividend tax and instead tax the distributions as
ordinary income. In practice, the vast majority of individual recipients of
dividends fall into the higher end of the income spectrum. Which means a very
large chunk of these dividends will be taxed at the highest personal rate of
39%. But Obama also wants to subject these high earners to a surtax to pay
for his health care initiative, which means that many of the recipients will
be taxed at a rate of 44% (this also accounts for the phase out of personal
deductions for higher earners!) So for these high-income earners, using our
current example, the new distribution split with the government under Obama's
proposals will be about 70/30 in favor of the government. This is actually
worse than the status quo.
But it's actually much worse than that. The corporate income tax is
just one of the veins that corporations open for government. Think about all
the other taxes that corporations pay, such as the payroll taxes and sales
taxes. Sure they pass those taxes on to their employees and customers, but
the revenue flows 100% to the government with shareholders getting nothing but
a bill for the cost of collection.
Then there are all of the taxes paid directly by the employees
themselves on their wages and salaries. Sure, this money belongs to employees
and not shareholders, but if not for the profit-making activities of
corporations, those wages and salaries, and resulting taxes, could not have
been paid. And while employees derive benefits from those after tax
distributions too, shareholders get nothing.When
all of these channels are factored in, think about how much more the government
derives in taxes from corporate activity than its owners receive in
dividends. Who knows how high this figure is, but I'm sure the government's
take is many multiples of what shareholders receive.
Back in the 19th Century, America really was a capitalist country. We
had no corporate tax and no personal income tax. Shareholders got 100% of
distributed corporate income. As a result of this structure, U.S.
corporations grew rapidly and helped spark the fastest economic expansion the
world had ever seen. But that was then, this is now.
Given the current numbers, even if our leaders were dyed-in-the-wool
Marxists, what would be their motivation to nationalize Fortune 500
companies? If they already receive the lion's share of profit distributions,
what would be the point? Such a move risks upsetting the management
structures and destroying the remaining profit motive. It would risk killing
the goose that lays the golden egg. If government nationalized a company, it
would also have to manage it. Does anyone think bureaucrats would make better
decisions than private owners? What's worse, if those decisions produced
losses rather than profits, the government would have to absorb them. Under
the current systems, the government gets the lion's share of the profits, but
private shareholders are stuck with 100% of the losses.
There is actually a name for our present system: fascism. While
fascism and communism are both forms of socialism, at least the fascists are
smart enough to know that if the means of production are nationalized,
employees and owners won't work as hard, and the government will lose
revenue.
It's a shame that the country that was once the beacon of freedom and
economic liberty no longer has the ability to recognize what capitalism
actually looks like. Unless corporate owners are appropriately rewarded for
their risks, U.S. corporations will not regain their lost dominance,
Americans will not regain their lost liberty, and our standard of living will
continue to fall. As it stands now, the United States has become a people of
the government, by the government and, most importantly, for the government.
Peter Schiff is CEO
of Euro Pacific Precious Metals, a gold and silver dealer selling reputable,
well-known bullion coins and bars at competitive prices. To learn more,
please visit www.europacmetals.com or call (888) GOLD-160.
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