Many of the difficulties of the tax code arise from distinctions which may be confusing and possibly counterproductive. For instance, why is it necessary to have one income item taxed as a capital gain and then another as ordinary income? Why is it necessary to have different tax rates apply to essentially similar entities or transactions?

The purpose of this post is to suggest ways of simplifying taxes and tax collection, to make the system somewhat more understandable and fair, and possibly to increase the US government's tax revenue.

Tax suggestions

Equality in tax rates at a reasonable level is desirable.

Every entity, person, corporation, LLC, subchapter S. etc., should have the same tax rate (except that lower graduated tax rates could apply to the lowest of incomes of each entity).

  • The top primary US tax rate should be the same for all business entities and persons.
  • It should be competitive with like rates in other first world countries.

An estimated top rate for all business and persons might be approximately the 28 percent alternative minimum tax rate that prevails in the US at present.

  • This rate possibly would be high enough to provide significant greater income to the US government while at the same time making it sufficiently low so that corporations in the US which now pay 35 percent would have an incentive to stay in the US rather than moving or merging overseas.
  • My assumption is that the total average tax rate paid by U.S. corporations currently is in the 28 percent range. However, if it is in fact higher and would result in a theoretical loss of Federal tax revenue as currently computed, increased velocity of exchange arising from a paper reduction of the tax rate would more than make up for any cash discrepancy.

The distinction between long-term capital gain and short term capital gain is counterproductive.

The long-term capital gain concept, which unnecessarily subsidizes holding of assets which otherwise might be sold, means that assets are taken out of the economic flow for secondary purposes and not their highest and best to use. Moreover, this inefficiency is currently subsidized by the U.S. treasury with an irrationally low tax rate.

  • If assets are held for an inordinate period, when the economic conditions otherwise would justify their sale, the United States Treasury is undesirably deprived of tax proceeds it currently could use constructively in the economy one way or the other.
  • Moreover, it is respectfully suggested that holding passively invested assets for periods longer than economically justifiable stultifies economic trade in other ways without countervailing economic benefit.

To put it another way, keeping assets out of active economic flow for the sole purpose of giving someone a tax subsidy does not help the economy and probably reduces the economic utility of the assets being unreasonably held.

The gift of an asset or its passage by an estate should not be taxed.

  • It would not be a sales transaction.
  • However, the cost basis of the transferred assets should be carried over (as it currently is with lifetime gifts) so that when the asset is ultimately sold by the giftee or estate recipient, income tax would be paid by the selling recipient owner based up on the total gain over the original owners tax basis. (Not “stepped up” as it is now in the case of estates.)
  • The estate tax probably should be eliminated, as it inhibits many current expedient uses of assets which causes people to engage in complex and confusing transfer forms. In the long run, the tax does not produce sufficient revenue to justify current IRS efforts, and it definitely would not if estate assets did not get the benefit of a stepped up basis at death.

Taxes on earnings should not depend solely upon the business structure of the entity holding or dealing with an asset.

Earnings of a Standard “C” type corporation

Items of the income of a C corporation should be taxed only once.

That is to say double taxation on corporate earnings and thereafter on distribution of corporate earnings to the individual shareholders or other owners having equity is not productive of the smooth and efficient flow of capital within the economy. It encourages C corporations to hoard cash they possibly do not need. A great example of this is Apple Computing, which has about 100 billion in excess cash, derived in part from the use of foreign entities with lower tax rates.

  • If a corporation has earnings and does not need the cash for current or future corporate needs, including expansion, future acquisitions, etc., the cash should be distributed to the shareholders, taxed to the shareholders, and deducted by the corporation, reducing its tax burden. 
    • At present quite often unnecessary cash which could be put to better use by the shareholders is retained by the corporation even though there might not be a current use for the cash. The U.S. Treasury would not suffer because it would receive a nearly identical tax amount from the recipient shareholders.
  • If the corporation needs the funds for one purpose or another, it should pay the taxes but still receive an ultimate deduction when the amount upon which taxes are paid is ultimately distributed.
    • Simultaneously with this deduction the recipient taxpayer would receive taxable income upon which he or she would pay taxes at the applicable rate, which would be the same rate as that which the corporation has previously paid.
    • If this subsequent deductible distribution of previously taxed income results in a loss to the corporation, this loss could be carried over and constitute an offset against the possible corporate income in subsequent years.

Moreover, this new structure would reduce the frequency of stock buybacks. The reason for this is that if the C Corporation were to buy back its stock “to increase shareholder value” rather than declare a dividend, it would lose the right to deduct the amount of cash distributed to its selling shareholder (although paper book value of the corporation’s stock might be increased), and, if the shareholder sold his stock in the transaction at a gain, taxes would still be due from the shareholder.

Earnings of a partnership type entity

Partnerships, subchapter S, etc., income of an entity will be deemed taxable to the partners, to the extent that the agreement between them so provides essentiality as it is at present. If the entity is a “flow through” type identity, only the shareholder will pay the tax (even though the corporation may, in accordance with the controlling document, retain and to use the cash). Subsequent distributions of cash to the partner-shareholder of the previously taxed cash should not be taxed subsequently. This does not change the current rule.

As at present, individuals and entities could continue to take such tax deductions as Congress allows. This would include business tax deductions.

CONCLUSION

Reasons exist why a new format will at least partially inhibit restrictive devices which clog the flow of capital to economic entities and persons where it might be the more useful than at present. It is suggested that wider distribution of capital and a higher frequency of exchange would tend to diversify purchasing power, and through frequency of use provide a generally higher quality of life for a larger population.