Transcript Corporate Income Tax

CHAPTER
15
Taxes On Business Income
and Wealth
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
Corporate Income Tax
Tax rate is about 35% for most
corporations
 Dividends paid out of after tax income
 Dividends taxed multiple times

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
15-2
Federal Corporate Income Tax
Rates, 2003
Table 15.1 Federal Corporate Income Tax Rates, 2003
Marginal Tax Rate
Income Range
15%
$0-$50,000
25%
$50,000-$75,000
34%
$75,000-$100,000
39%
$100,000-$335,000
34%
$335,000-$10,000,000
35%
$10,000,000-$15,000,000
38%
$15,000,000-$18,333,333
35%
Over $18,333,333
Source: http://www.irs.gov/pub/irs-psf/i1120_a.pdf.
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Interaction Between Corporate
and Personal Income Taxes
Trade-off between corporate payment of
dividends or reinvestment of funds
 Dividends face higher tax cost than
interest payments when corporate and
income taxes are counted
 Trend toward lower corporate dividends
in last half of 20th century

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Fringe Benefits
Can be legally deducted by corporation as
a business expense for tax purposes
 Employee not required to declare value
of benefit as income

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Depreciation

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Accounting depreciation - decline in value over
time of capital equipment
Economic depreciation – reduction in value of
assets
Accounting and economic depreciation may
differ in practice
Cost of capital equipment cannot be deducted
when expenditure is made
Fraction of cost of equipment taken each year
as depreciation expense
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Straight-line and Accelerated
Depreciation
Straight-line depreciation – life of asset
determined and equal fraction of cost of
asset allowed as depreciation expense
each year
 Accelerated depreciation – larger amount
of depreciation allowed in early years,
offset by smaller amount in later years

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Straight-line and Accelerated
Depreciation
Firms prefer accelerated depreciation
 Firms prefer the most accelerated
depreciation schedule allowed
 Firms prefer to depreciate over fewer
years rather than more
 Inflation affects the real amount of
depreciation expenditures

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
15-8
Burden of the Corporate
Income Tax
Corporations do not pay income tax
 Corporate income tax ultimately borne by
individuals
 Principles of tax shifting suggest
corporation may be able to shift tax
burden
 Relative elasticities of supply and
demand determine who bears the tax
burden

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Competitive Markets

Elastic market demand
 Tax
burden shifted toward suppliers
 Causes inward shift of supply curve

Inelastic market demand
 Tax
burden shifted toward demanders
 Causes outward shift of supply curve

Relative shares of tax burdens are equal
in each market in long run
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Competitive Markets
The Effect of a Corporate Income Tax in Different
Markets
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Monopoly
Income tax on firm making monopoly
profits may have no real effects in short
run
 If tax is constant fraction of corporation’s
profits, monopolist’s profit-maximizing
level of output will not change

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Monopoly
Monopoly Response to a
Proportional Tax on Net
Income
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Income Tax and Return to
Bearing Risk
Saving/Investing behavior entails risk
 Income tax lowers return to risk bearing
 Government shares in gains of bearing
risk, does not share in losses
 Incentive against risk taking built into tax
system

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Taxation of Capital Gains
Capital gain – increase in wealth caused
by an appreciation of value of an asset an
individual or corporation owns
 Capital gains income treated similarly to
ordinary income in corporate and
personal income tax system

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Unrealized Capital Gains
Occurs when value of individual’s
property increases but has not been sold
 Current U.S. tax system does not levy
taxes on unrealized capital gains
 Liable for taxes when property is sold
 Capital gains tax discourages selling of
assets with unrealized capital gain

 Creates
an inefficiency
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Capital Gains Taxation as a
Double Tax

Capital gains tax represents a double tax
 Assets
bought with after-tax income and
capital gain on appreciation of asset also
taxed

Capital gains taxed at higher rate than
ordinary income if asset bought with
after-tax income
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Inflation and Capital Gains
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If taxes are placed on nominal value of asset,
an individual may be liable for capital gains tax
although the real value has declined
Phantom capital gain – a capital gain in nominal
terms that is not a real capital gain
Capital gains not indexed for inflation
Inflation increases tax bills for taxpayers
realizing capital gains
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Wealth and Property Taxation
Wealth is another possible tax base
 Property tax is most common tax on
wealth
 Close relationship between income
taxation and wealth taxation

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
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Incentives in Income Taxes
and Wealth Taxes
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Flow of income – return on individual’s stock of
human capital along with work effort
Can tax individual’s income earning potential as
wealth

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Incentive to accumulate less human capital and work
harder
Can tax individual’s actual income as a flow

Incentive to under utilize human wealth
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Unrealized Capital Gains and
Wealth Taxation
Renter and homeowner treated equally
under wealth tax
 Some sources of wealth more easily taxed
if flow of income from wealth is taxed

 Example:

human capital
Some sources of wealth more easily taxed
directly
 Example:
real estate
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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The Property Tax
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Major source of revenue for local governments
Primarily a local government tax
Real estate major source of property tax
revenue
Taxed components of real estate:
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Land
Improvements made to taxed site
Provides disincentive for improving value of
property
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Locational Decisions and the
Property Tax
Differences in property taxes among
locations influence locational decisions of
businesses
 Businesses view taxes as price paid for
government goods/services
 Examine mix of public sector output and
level of taxation
 Excess burden of property taxation

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Property Tax Limitations

California’s Proposition 13
 Limits
level of property taxation
 Restricts future increases in property tax
rates
 Effect of charging different property owners
with identically valued property different tax
rates
 Creates disincentive to sell property
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Differing Property Tax Rates
Different tax rates depending on use of
property
 Can be used to price government services
for different types of consumers

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Site Value Taxation
Tax placed only on value of site
 Ownership of property implies ownership
of asset and stream of future tax
liabilities
 Tax has effect of being lump sum tax on
wealth of property owner at time it is
levied
 Entire site tax borne by owner of land

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Site Value Taxation Versus
Property Taxation
Present owner bears entire tax burden on
existing property in both cases
 Property tax on improvements discourage
improvement

 Lowers
market value of land by present value
of tax

Site value taxation provides no
disincentive
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Site Value Taxation and Value
of Land
Placement of tax on site value only
provides incentive to develop property
 Market value of land lower under site
value taxation when a national policy
 Market value of land rises in a locality
under site value taxation if surrounding
area uses a property tax

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Inheritance Tax
Provides incentive to live longer to
postpone payment of tax
 Relatively insignificant source of tax
revenue
 Federal estate tax being phased out

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Avoiding the Tax
Trust funds to shield estate from taxation
 Pass wealth on through gifts while living
 Spend wealth before death

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Justifications for an
Inheritance Tax
Not fair to benefit from wealth earned by
someone else
 Fosters goal of creating a more equal
distribution of income
 Closes a loophole in current income tax
structure

PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
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Severance Taxes
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Charged on extraction of natural resources
Comprise less than 1% of total state
government revenues
Similar to a property tax - owner of resource
owns value of resource less tax liability to be
paid if resource extracted
Owners of resource have ability to shift some of
tax burden to demanders of resource by slowing
rate at which resource extracted
PUBLIC SECTOR ECONOMICS: The Role of Government in the American Economy
Randall Holcombe
15-32