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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-à-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 US 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 US 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, US 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, US
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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