A common bipartisan refrain in Washington these days is that the US corporate tax system is broken. However, Republicans and Democrats can’t seem to agree on how to fix it.
Scott A Shay, the chairman and co-founder of Signature Bank – a Wall Street bank that serves the needs of privately owned business clients – has a unique and compelling idea for getting the US out of this tax morass.
Shay notes that none of the proposals to overhaul corporate taxes addresses the two major problems facing Americans and their economy — offshoring and automation. He says the twin trends are fueling a rise in unemployment in the US and a lower quality of jobs generally.
He argues that the current corporate tax system in the US encourages these two phenomena by taxing corporate profits irrespective of how and where they are earned. He says it also encourages over-leveraging via tax deductions on interest payments.
To remedy this, Shay and Michael Davis, the managing partner and co-founder of The Plymouth Group, a New York real estate investment and advisory firm, propose that the US corporate tax rate should be tied to companies’ employment of American workers. They recommend a 25% top-tier rate (a globally competitive rate) that can slip to as low as 5%, depending on each individual corporate taxpayer’s domestic job creation.
Shay spoke with Asia Times about his corporate tax proposal, which he hopes will gain broad bipartisan support in Washington.
How is the current US corporate tax code counterproductive, and how does it encourage offshoring and automation?
The current tax system has myriad tax reductions, reliefs and benefits for automation. But there’s nothing really in the current tax code to speak of that encourages employment. The US tax code also is at best neutral when it comes to offshoring. This is because companies can enjoy lower rates of taxation outside the US depending on what happens to transfer pricing (booking profits of goods and services in a different country that may have a lower tax rate) and other factors.
Under such tax practices, offshoring can be a benefit. This is why we’re having a big discussion today about repatriating funds. These are funds that have been locked up because of lower tax rates (overseas) and transfer pricing.
In what ways does your corporate tax proposal address these issues?
On the tax and interest rate issue, the plan that Michael Davis and I offered assumes the elimination of the deduction on interest payments for non-financial institutions. The tax rate would essentially be equalized between debt and equity as opposed to favoring debt. This would be a major disincentive to over-leverage and a positive incentive to using more equity. This would be healthier for the economy. Over-leveraging is not a good thing — and I say this as a banker.
How would each US company compute its corporate tax based on job creation and the other criteria outlined?
For each decile above the median employment expenditures to revenues ratio, the tax rate would decrease by four percentage points. Firms that are between the 40-50% decile would pay taxes at a rate of 21%. Firms in the top decile would pay just 5%. While this would involve some estimation, by the end of December, the IRS would announce the prospective ratios for the next year necessary to qualify for each decile based on previous corporate returns, which must be filed by September 15.
Any tax saved by the decrease in rate below 25% would need to be paid out in dividends within three tax years, if not reinvested in the business. If these funds are reinvested, the tax savings can be indefinitely deferred until dividends are issued.
If cash merely builds up, then the dividends returned would be taxable to individual recipients or, if sent to a tax-exempt entity, they would be subject to the Unrelated Business Taxable Income (UBTI) at a 25% rate. This mechanism of capital re-investment – or quick distribution to shareholders – would actually ensure that the Treasury could fully capture taxes while discouraging oversized corporate balance sheets with underutilized and/or undistributed cash balances.
What other details of your corporate tax proposal would you like to highlight?
First, this system should be resistant to loopholes because personal income tax withholding captures employee costs (through records of salaries and benefits separately reported to the IRS). Second, this system accommodates outsourcing, as vendors would report their own US-employee-cost-to-revenue ratios.
Lastly, this system would provide an incentive against rising US income inequality by computing the US-employment-cost-to-revenue ratio only for salary and bonus costs up to US$250,000, indexed for inflation.
Are over-leveraging and automation serious challenges for the US economy?
Yes. The US economy remains highly leveraged from the private to the public sector. But leverage, in one form or another, is what got us into the 2008 financial crisis. This has been fueled by two factors: No.1 is the tax deductibility of interest and No. 2, currently, is really low rates. Some people call it Libor life support.
That low-rate environment may now be at the point of reversing. But we’ve got a long way to go.
What about the challenges posed by automation?
The second major challenge for the economy is the increasing bifurcation of jobs in the US. The bifurcation is between highly-skilled jobs that require a lot of training and repetitive jobs that are increasingly being automated. The latter are jobs that no one thought could be automated five or 10 years ago.
An example is how some chain pharmacy stores use automated checkouts vs human cashiers. Another is driverless cars and trucks.
How would your corporate tax proposal specifically address such issues?
Our proposal means high revenue/low employee companies such as Facebook and Google, would be taxed at the 25% rate. This would still be considerably lower than current rates. But US companies that employ many middle-income workers would enjoy much lower rates.
Would this encourage say, retailers, to employ humans as checkout cashiers vs scanners?
We certainly hope so. However, it remains the choice of the firm.
Why is your corporate tax proposal different from others?
Firms that exceed the median percentage of employee costs to revenues would benefit from a lower tax rate. The big advantage to our plan is that the 25% top-base rate can be lowered to a single digit rate, namely 5%, depending on the ratio of US employee costs as a percentage of US revenues.
The decision to offshore for a company is also not simply one of “where can I save a dollar?” Under our proposal, it’s also a question of “if I impair my ratio of US employees to revenues, then I risk a change to my overall tax rate.” So it provides a multidimensional encouragement to having employment here in the US. For the first time ever, employment would be benefited by the US tax system. Our proposal also encourages employment on the demand side.
The proposal, moreover, doesn’t require the wholesale adoption of a border tax (a value-added tax levied on imported goods). No one knows for sure how such a border tax will work. The sheer economics of a border tax should mean that the US dollar would dramatically increase, potentially as much as 25% in comparison to our trading partners. That has a huge number of ripple effects — not all of which we can be certain of.
So it’s probably better to be conservative, with a small “c,” when it comes to making wholesale changes to the tax structure. A border tax could be a great idea, but it could also cause worldwide recession.
Aren’t automation and offshoring necessary competitive elements in today’s economy?
Our proposal doesn’t by any measure stop automation or offshoring. It evens the playing field. It puts into place a countervailing incentive to increase employment and keep jobs in the US.
Doug Tsuruoka is Editor-at-Large of Asia Times