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The 15% Corporate Rate

The purpose of this note is to expand on my post regarding the potential 15% Corporate tax rate floated by the Trump administration. Before I begin though, three caveats:

1) I am not a tax professional. I also don’t give good advice. Do not take this as tax advice
2) I voted for Clinton. I caucused for Sanders, not that the Washington Caucus has ever affected the outcome of the election.

3) These comments are in reference to the median household income of $51,939 and assumed to apply to Single Filing Individual and Married filing jointly. When discussing ammounts I’ll use the notation

$(Single.Filer/Maried.Jointly)

for dollar amounts.

4) My belief is that strong economies, and therefore strong federal revenues come from a strong middle class. My belief is reinforced by computer science knowledge, not economics, theology, social work, etc… My second belief is that there is truth in all Democrat/Republican/Libertarian/Green policies. As Aaron Sorkin writes for President Bartlett in The West Wing

You don't want to push on one economic lever, you want to push on all of them a little

5) I don’t know what happens if the US defaults on its debt. Probably something between Star Trek and Battlefield Earth

And With That, Here We Go

Where does the Federal Government Get it’s money?

Tariffs and Quotas

The US levies some taxes on the import of goods made in other countries. Protectionism is beyond the scope of this discussion, except to state the obvious

1) Raising the cost of an imported good above the cost of a domestic good will cause citizens to purchase the domestic version, provided the quality of the imported good does not outway the added cost.
2) Fewer domestically made goods can be exported if other countries match those tariffs.

Federal Reserve System

We have a centralized, fiat (at will) currency. The US dollar is (basically) worth whatever the government says it’s worth. That value comes from how much people want to do business with us, but also how strong our ability is to punish if you choose not to do business with us. The consequence of a such a system means that we actually make a pretty penny through controlling interest rates and wire transfers, to the tune of $100.2 billion in 2015

Social Security and Medicare.

Two social services for retired folk in America; the Social Security Pension and Medicare are funded through FICA payroll tax. When considering federal spending, it’s important to separate the FICA revenues from discussion of general spending while at the same time considering the tax burden they place on citizens. Quite the tightrope to walk.

Income Tax

The 16th Amendment allows Congress to levy income taxes directly on the people, rather than demanding revenues from the states/territories. The tax is collected at a graduated rate, with the first $(9,275/18,550) one earns being taxed at 10%, the next $(28,375/56,750) being taxed at 15%, and so on and so forth up to a maximal rate of 39.6%.

The Form

Since you may use tax software or a tax preparer, it can be useful when considering federal revenues the main form we use to pay taxes: the 1040. It is fortuitous that the government is considering taxation changes right after we’ve completed our taxes: it’s still fresh in our minds.

Tax resolution happens in four stages:
1) How much money did you make?
2) What federal adjustments have been allotted to reduce that amount?
3) What credits and “other taxes” did you incur?
4) What payments have you, your employer, and the government made on your behalf?

The TLDR is

  • Section 1 makes your libaility go up
  • Section 2 and 3 generally make your liability go down, but not below 0
  • Section 4 makes you liability go down, and is where the government may end up owing you money.

Income

The important distinction for those non land owning farming small business stock trading W2 employees is that the value that ends up in box seven is the total amount of money you were paid by an employer. This is the amount you put up on Glassdoor and the such. The values in box 12, 13, 17, and 18 are all calculated on other forms and come equipped with various percentages, deductions, and formulas that drive down the amount reported on the main page. In some cases, these values might be analogous to things you do at a W2 job, like the commute to work. Others might not, like the amount of printer ink a deli mart buys.

The fact of the matter is that there will always be expenses incurred by W2 employees that don’t end up getting passed on, and ultimately deducted, by their employers. Whether that is penalizing wage employees or incentivizing making money through one of those other boxes is a matter of perspective. Is the employer’s half of the FICA payment worth not having to fill out those other pages?

Adjustments

For the purpose of discussing the effects of a 15% tax rate on corporate taxes the only important section on this page is box 27. A W2 employee splits the cost of paying into FICA. The idea here is that 7% from your employer ended up going into your pocket first, so adjust your income back to what it would be if you were a W2 employee.

Deductions

Absent the 15% corp rate the government is not prescriptive about how you make your income. Deductions however is where the government incentivizes citizens to get married, have children, give to charity, buy solar panels, etc. Deductions let the government direct behavior without directly levying a tax on people. It’s important to consider the contrast between a deduction, and incentivizing a method of income. This is particularly true for S corps, rental agencies and partnerships, which are definitively more active taxation than a levy on capital gains or estates.

Payments

Finally, payments offer an opportunity for the government to distribute wealth to it’s citizens. These can be in the form of excess witholdings, effectively a 0% interest yearly savings plan, in the form of reconciliation of the ACA tax credit, and in the form of writedowns against accredited higher education.

The most important payment to consider however is the Earned Income Credit, as it is the only mechanism outside of the minimum wage that the US uses to redistribute wealth. Some 5 million people were brought up above the poverty line by the EIC in 2010, and it has broad support among members and constituencies of both parties. As one would imagine, a corporate tax cut does not directly affect the economic outcome of a person receiving the EIC. Conversely a person can never be directly pushed over the median income by the EIC, as it’s a redistributive economic tool

What Choices Should The Federal Government Incentivize Through Tax Policy?

As discussed, there are three ways the government can use taxes to change economic outlook of individuals:

1) Incentivize the way people make money (Capital Gains Tax and the potential 15% tax)
2) Incentivize certain after income through reducing the individual’s tax liability (deductions and credits)
3) Proportion taxes and then redistribute wealth onto lower earners (EIC)

Not everyone benefits from each individual method. People who make over the median can’t benefit from redistributing wealth. People without solar panels or a house to insulate or a car to turn in can’t benefit from deductions. People who don’t have services to offer or stocks to sell can’t benefit from reduced capital gains and corp rates. Ethically there is unanimous approval for government providing, through action or restraint, the opportunity to its citizens to better their lot in life. Morally, some methods are unacceptable to some citizens. The choice of what method or combination of methods to use is therefore left to political debate.

Should I Incorporate? Should Everyone?

First and foremost, people incorporating instead of paying wages will not affect Social Security or Medicare. Self employed persons still pay into those services up to the federal cap. If it is true that decreasing tax liability on the group of people above the median but below the cap caused them to make more money overall (I am not claiming one way or another) then that would mean more money would be available in the those funds. Social Security and Medicare are not about improving economic outlook of the workforce.

Second, the deficit and national debt affect the magnitude of the affordable tax policy changes. They do not affect the methods we use to encourage collective and individual economic growth. Those discussion are moral/political ones.

Third, reports have talked about the 15% rate being levied on Pass Through Taxation corporations and partnerships. There has not been any discussion of Sole Proprietorships. Incorporating everyone’s SPs as S Corps would resolve the inconsistency.

Finally, this plan isn’t out. It has no legislation backing it. There is no non partisan scoring of what it would cost. There’s no non partisan scoring of what economic impact it would have.

When Does The Benefit Kick In?

Assuming:

  • No other changes to the tax system, the bottom end of corperate tax rates would match the current rate
  • W2 employees would be given a flat value of their current salary, benefits, and the employer’s half of the FICA
  • The IRS wouldn’t break if suddenly every W2 employee requested an EIN at the same time

The benefits starts at income over $(37,651/75,300). The advances are more stark for single people rather than married, altough for whatever reason those values converge at the tail end of the 33% bracket (see below)

As for dollar amounts (This is the place I’m most likely to make a mathematical error):

  • The top of the 25% bracket $(91,150/151,900) would see their pre-adjusted liability go from $(18,558.75/29,517.50) to $(13,208.75/21,857.50)

  • The top of the 28% bracket (190,150/231,450) would see their pre-adjusted liability go from $(46,278.75/51,791.50) to $(28,058.75/33,790.0)

  • The top of the 33% bracket $(413,350/413,350) would see their pre-adjusted liability go from $(119,934.75/111,818.50) to $(61,538.75/61,075.0)

A Note On “Gig Economy” workers

Uber reports earning numbers as:

  • San Francisco $732/week
  • Los Angeles $616/week
  • Chicago are making $648/week
  • Boston $732/week

So, at $35,136 the median driver will not benefit from such a tax break. A Single Filing Individually driver in New York, where reportadly drivers make double the national average, the driver would see a benefit from these changes

A Note On Ultra High Earners

As you might except, a 15% tax rate on ultra high earners would be stark. Bob Iger of Disney’s sallary is $44.9mn and he would see his rate fall from $17,726,066.3 to $6,734,075.0, an $11 million dollar tax break. That being said, much of these ultra high owner’s income is coming from captial gains already, so the revenue losses at the very top might not be as extreme as they seem

Conclusions

There are a plurality of individuals and households which could benefit from incorporating to take advantage of a 15% tax rate. The takeover sits precariously on the median income for four year degree holders. Everyone below that median benefits more from expansion of the Earned Income Credit.

Perhaps soon in the future society will have enough surplus to provide food, water, shelter, access to the internet, healthcare, and education for all it’s citizens without the interventionist actions of large bodies like the US government. For now however, we are tasked with electing a government that can provide the most opertunity for the advancement of its people.

When we choose such a plan we should consider the imbalanced recovery from the 2008 recessions, which has seen wage stagnation couple with record success in the finance industry, computer technologies, and advanced engineering. We must draft a plan that is both equitable and provides the correct kind of assistance for the various income brackets. And we must be mindful of the inevitable reckoning that will come regarding our spending deficits

The machinery to run a society of thre hundred million people is vast and daunting. Don’t get overwhelmed, you got this.