Reforming the U.S. Corporate Tax System to Increase Tax Competitiveness - Essay Example

? Taxation System (Full Table of Contents I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 II. Purpose of the study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 III. Discussion Corporate Tax System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Double Taxation of Corporate Profits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Progressive System of Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 – 6 Provisions on Tax Expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 – 7 IV. Tax Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 – 9 V. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 VI. Bibliography (Last Name) 1 Taxation System I. Introduction Taxation is the means by which the sovereign body raises income through collection from natural or juridical persons to defray the expenses of the government so that the latter could perform its functions. Without taxes, the government cannot exist as it will not be able to deliver the services expected from them by the constituents. Although one of the fundamental powers of the State, the exercise of the power of taxation however should not be abused. Certain principles must guide its application so as to make it as equitable and efficient to all stakeholders as it must be. Since taxation generally depends on income, taxes should be proportionate thereto and should not go beyond the net income; otherwise, the same would constitute as part of the expense already that could deprive the income-earner of the fruits of his labor. However, certain rules and practices in the taxation system of the United States appear to violate the principle of equity. This results to resentment, loss of bigger revenues, lesser capital investments in the country, and ultimately, deprivation of better economic life for the citizenry. II. Purpose of the study This study aims to present the current system of taxation, particularly with respect to income taxation of both individuals and corporate entities, analyze the effects thereof, and recommend areas for improvement. III. Discussion Worldwide Tax System There are two (2) kinds of international tax systems: (i) worldwide; and (ii) territorial. The United States system of taxation is classified as worldwide as it imposes taxes on all (Last Name) 2 incomes derived by the United States domestic companies within and outside its territorial jurisdiction. However, the United States allows tax credits of tax payments made by these companies in country where the income or profit was produced. This was made in order to avoid the apparent double taxation of the same income. This tax credit is allowed only up to the extent of the tax rate imposed in the United States. Thus, if the tax paid in a foreign country based on the income derived by a United States domestic company therein is much higher than the tax supposed to be collected by the United States, the difference thereof is not chargeable against the other tax liabilities of said domestic company. This however, is generally fair and the United States has no fault on this aspect. The problem however lies with respect to businesses made by domestic corporations in another country which practices territorial system of taxation. Territorial system of taxation is a form of taxation wherein domestic corporations are taxed only for income derived within the country’s territorial jurisdiction. Hence, income derived by the domestic corporations from outside the country is tax-exempt. Here, the problem lies with the global competitiveness of companies incorporated in the United States which, as mentioned before, practices worldwide system of taxation. For instance, Company A was incorporated in X country while Company B was incorporated in the United States. Both companies engage in manufacturing and selling of products within X country. Since Company A’s tax liability is limited to the taxes imposed for income derived from its business within X country, Company A’s prices on products is most likely lower than that of Company B which has to pay taxes for both X country and the United States. The main problem will however arise only if the tax rate in X country is lower than that of the United States because if it is the same or higher, Company B may always credit the tax payments made to X country so as to avoid paying twice for the same income. In this case, Company B has two (2) options: first, its (Last Name) 3 prices may be higher than that of Company A which could result to eventual loss since consumers will surely choose Company A rather than Company B; second, Company B may set its prices equal to that of Company A but its income will definitely suffer as the excess taxes will constitute as an additional expense.1 Undoubtedly, the worldwide system of taxation or the practice of taxing a domestically-incorporated company for all incomes derived within and outside the territory of the United States does not in any way help these kinds of entities. Because of this, domestic companies will have lesser money to re-invest and eventually diminish the earning potential of both the company and the United States. Double Taxation of Corporate Profits The current system of taxation is based on receipt of income rather than on consumption. Income-based taxation means that for every release and/or receipt of income by a person, there is a corresponding tax. If that income is passed on to another, the same income will subject the later recipient of another tax. A classic example of this is the corporate profit. Company A earned profits for say $1.0 million. This $1.0 million will be subject to corporate income tax of an estimated 35% or $350,000.00, thus, a net profit of $650,000.00. If the latter amount will be distributed as dividend to its stockholders, the latter shall be liable for individual income tax for his proportionate share in the dividends up to a maximum rate of fifteen percent (15%). Thus, additional $97,500.00 will go to the coffers of the government, leaving the stockholders with only $552,500.00 net profit, or almost half of the gross profit of the corporation.2 (Last Name) 4 Progressive System of Taxation A progressive system of taxation is a system in which the tax rate increases at the same rate as the tax base. This is allegedly based on the principle of ability to pay. In short, those who earn more will have to pay more taxes. However, there is a continuing opposition to this system of taxation based on a number of grounds. One, the otherwise progressive system of taxation ultimately ends up as regressive due to some loopholes embodied in the system such as the allowance of certain exemptions and deductions which may be susceptible to abuse. For individuals, the following are some of the permissible personal deductions from their gross incomes: (i) medical expenses; (ii) state and local taxes on income and property; (iii) interest expense on identified home loans; (iv) gifts to qualified charitable institutions; (v) contribution to retirement or similar plans; and (vi) educational expenses. For business entities, the following are some of the allowable deductions: (i) salaries for personnel; (ii) travelling expenses in pursuit of business; (iii) rental fees; and (iv) depreciation of assets. Of course, these are subject to certain qualifications and limitations. Practically however, the ability of a taxpayer or his or its accountant to maximize the use of these deductions determines the fate of the taxpayer. In the end, those who earn more may benefit more from the government through availment of allowable tax deductions such as the deduction on interest expense to buy homes and exemption of contribution to retirement plans. Obviously, those who earn less cannot afford to buy their own homes and retirement plans. Hence, they have no items for deduction. On the other hand, those who earn more may have the capacity to avail of these items for deduction and may end up benefiting from the system. An example is that of a middle-class household with $50,000.00 annual income receives benefits equivalent to $500.00 via tax breaks for mortgages and property taxes. Meanwhile, a taxpayer with more than $1.0 (Last Name) 5 million receives benefits equivalent to around $95,820.00 a year through property tax deductions, breaks for mortgages, or investment tax breaks3. Two, the bigger the percentage of income taken by the government in the form of taxes, the lesser the amount of money that goes to capitalization in business. For example, Company A has a gross profit of $1.0 million. Assuming that the maximum tax rate for business entities is 35%, Company A will be left with only $650,000.00 for possible re-investment or additional capital which could have had produced more income and definitely more taxes for the government. Meanwhile, the $350,000.00 that goes to the government will be spent to direct compensation or benefit to the constituents which may or may not boost the economy of the country. Considering that those who pay bigger taxes are the big business entities which have the potential to expand or increase their businesses, the government appears to be taking this possibility of expansion by taking away bigger percentage from their incomes. On the other hand, those who pay less because they belong to the lower income bracket tend to save more. However, since they are smaller income-earners, the possibility for them to invest in other businesses or expand whatever they have is minimal as compared to the bigger income-earners. The overall impact then of progressive system of taxation becomes regressive. Three, progressive system of taxation encourages resentment among the constituents of the government. Glaringly, the projects of the government appear to have been shouldered by only a few big income-earners whose benefit from the government are limited since they are presumed to have the capability to provide not just for their basic needs but also for their luxuries.4 (Last Name) 6 Four, individual employees or workers whose earnings are high tend to go abroad in order to avoid the alleged unfair system of taxation in order for them to save more considering that the higher their incomes are, the bigger percentage of which are lost and goes instead to the coffers of the government. Five, the psychological effect of avoiding or preventing the constituents to earn more is quite apparent. Those who have to work overtime are discouraged by the thought that whatever additional income they would get as overtime pay will just go to the government since additional income means additional taxes for them. Foregoing considered, a system of flat income taxation is being proposed in lieu of the progressive system. According to some arguments, a flat system of taxation will eliminate the disparity in the burden of contribution to the government. The source of income of the government will no longer be concentrated on few taxpayers but will be equitably distributed so much so that everyone has his own share of assistance to the government. Also, the process of computing taxes will be simplified since the science or art of maximizing the available tax deductions and exemptions will be eliminated. Further, individual employees or workers whose earning potentials are high will no longer go overseas to look for employment in a place where tax burdens are less. Provisions on Tax Expenditures Taxes are generally raised in order for the government to perform its functions such as building of infrastructures and providing for the basic needs of the underprivileged. However, certain provisions on tax expenditures appear to benefit those who have more rather than those who have less. These happen because of the direct spending programs of the government. Instead of taking the initiative to put up income-generating institutions that will help create employment and eventually enable the constituents to provide for themselves such as education, healthcare, (Last Name) 7 and retirement, the government tends to directly release the hard-to-earn monies called taxes to individuals for temporary solution of their problems. For example, the United States government is known for its generosity in providing basic food necessities such as milk, bread, cheese, and fruits to the so-called underprivileged like unwed mothers and unemployed. For the latter, the government even provides for allowances for as long as one (1) year. Retirees are given free healthcare benefits in government hospitals. Although highly appreciated, these strategies of the government are prone to abuse and provide short-term solutions only. First, it is quite difficult to check whether the recipients thereof are really entitled thereto. Second, it creates a psychological effect on the residents to slow down instead of striving hard to get an employment. Three, direct assistance in form cash is totally un-called for since it prevents economic stimulation. Employment of those who can still work is the solution to any financial problem of each family, not a temporary donation of allowance. IV. Tax Reforms There are three (3) general principles of taxation, to wit: (i) fiscal adequacy; (ii) administrative feasibility; and (iii) theoretical justice. Fiscal adequacy means that the amount of taxes that must be generated or collected by the government must be sufficient to defray the expenses involved in the delivery of basic services expected from the government. The amount must not be too low so as to destabilize the government for its failure to perform its functions towards its constituents. It must not be too high however so as to effectively deprive the income-earners of their fruits of labor. In short, taxes must be in such amount as to sustain the needs of the government. Administrative feasibility on the other hand refers to the simplicity of the process of its collection. The manner by which taxes are computed must not be too complicated so as to (Last Name) 8 unduly burden the taxpayers with the computations and documentation process for their timely compliance. Finally, theoretical justice relates to the principle of equity or the proportionate sharing of tax liabilities vis-a-vis the income earned by the taxpayer. Here, the amount of taxes must have direct relation to the amount of income earned. Taxes should not depend on classifications which are totally unrelated to the source or amount of income being taxed (except for cases wherein taxes are imposed not only to raise revenues for the government but to control some areas of business or transactions such as those termed as sin taxes, e.g. tobacco, alcohol). The abovementioned principles should govern all systems of taxation. Any deviation from which will surely result to instability of the economy as well as of the government. Hence, the following reforms in the United States’ system of taxation are respectfully suggested: A. Shift to territorial system of taxation Under this system, profits earned by domestic companies outside the territorial jurisdiction of the United States should be exempt from taxation. In short, collect only taxes from profits made within the country. Through this, domestic companies will be more competitive in performing business in other countries as it can lower its prices due to lessened tax burden. In exchange for the lost income, the United States government may impose higher taxes to foreign companies doing business in the United States, the nature of which is exactly the same as those of domestic companies. This will directly support truly American companies within the boundaries of their territorial jurisdiction as against foreign companies. By doing so, domestic companies shall have an edge against foreign investors and will be encouraged to invest within the United States that will help create employment and ultimately boost the country’s economy. (Last Name) 9 B. Shift to consumption-based tax system Every income should be taxed only once. The number of times it is passed should not be the number of times it should taxed. Thus, corporate income tax should be dissolved if the government is to encourage more investments within the country. This will surely create long-term economic benefits. C. Shift to flat-rate taxation Through flat-rate system of taxation, several problems that are being encountered in progressive system of taxation will be eliminated. One, computation of taxes will be simplified. Only the gross income will be used as the tax base and simple mathematical computation will do. Genius and artistic accountants will no longer be necessary. Two, since the tax base will be the gross profit or income, there will be no more tax deductions or exemptions. However, it does not mean that necessary expenses incurred in order to arrive at income will not be considered. These items of expenditures will be deducted in a form of debit-credit formula with complete supporting documents such as Official Receipts. Thus, the tax base will be the net profit of an individual or business entity. For those earning purely compensation income, their total compensation less government-imposed deductions prior to tax shall be the tax base. Three, high-earning individuals will opt to stay in the United States rather than go overseas just to avoid higher taxes. Their talents and skills will be used within the country. Four, employees will be encouraged to work and earn more without fear of paying higher taxes. They will strive harder knowing fully-well that their contribution to the government shall be in proportion to their income and as equitable as those of other income-earners. (Last Name) 10 D. Re-direction of tax expenditures This may be indirectly related to taxation but the manner taxes are spent will surely affect the eagerness and willingness of the taxpayers to comply with their obligations. If the government will spend taxes wisely, directed towards income-generating programs, those who will need its direct social benefits will be lessened and eventually, the government will no longer feel the necessity to impose more taxes. V. Conclusion The above findings and recommendations are made in an effort to continually develop and improve the tax system of the United States. Perhaps the present system was appropriate during the time of its enactment. However, due to recent changes in the global economy, the government must consider innovations such as those discussed in this paper. Bibliography Congress of the United States Congressional Budget Office. “Corporate Income Tax Rates: International Comparisons.” cbo.gov. n.d. Web. 28 September 2011. http://www.cbo.gov/ftpdocs/69xx/doc6902/11-28-CorporateTax.pdf. Saxton, Jim. “Reforming the U.S. Corporate Tax System to Increase Tax Competitiveness.” house.gov. n.d. Web. 28 September 2011. http://www.house.gov/jec/CorporateTaxReform.pdf. The Washington Post Company. “The current U.S. tax system is tilted toward the haves.” Washingtonpost.com. n.d. Web. 28 September 2011. http://www.washingtonpost.com/wp-dyn/content/article/2010/10/10/AR2010101003254.html. “17% Income Tax vs. Progressive Income Tax.” One-Simple-Idea.com. n.d. Web. 28 September 2011. http://one-simple-idea.com/TaxComparison.htm Read More