After Senate Budget Chairman Bernie Sanders (I-VT) launched the budget reconciliation process to move President Biden’s agenda forward, Senators Elizabeth Warren (D-MA) and Angus King (I-ME) and MP Don Beyer ( D-VA) urge the introduction of a new surcharge on the book income of companies. However, your arguments for politics fail to understand why there are differences between a corporation’s taxable income and book income. The reason: The legislature has issued special guidelines that mean that the tax laws differ from the accounting standards.
Senator Warren’s proposal would impose a 7 percent tax on book income over $ 100 million in addition to current corporate income tax. It would not be a minimum tax, but a second, more harmful tax parallel to the existing corporate income tax.
Senator Warren insists that companies take advantage of loopholes to lower their taxable income and effective tax rates, so she wants to tax the income that companies report to their shareholders in their financial statements. As we checked before:
According to Senator Warren, the goal of this policy is to prevent companies that report profits to their shareholders in a given year from paying little to no federal income tax. The senator’s goal is to close the “book tax” profit gap. Under current law, companies have an incentive to report high profits to their shareholders while reporting low profits to the IRS. This tax would be based entirely on book profits to reduce this incentive.
A company that does not pay taxes in a given year even though it has made a financial profit usually means that it has used the standard tax rules passed by Congress. Corporations may have made deductions for investments or reduced their tax liability by using corporate tax credits for activities such as research and development (R&D) or renewable energy generation, which the government believes deserve special support from the tax code. Some companies do not pay corporate taxes for carrying past losses, a normal feature of US tax law that protects against cyclical fluctuations. Book tax gaps disappear over longer time horizons, as they are often caused by time differences between the two sets of rules.
These underlying guidelines, which lead to book tax gaps, could be discussed and changed. To directly address the void, existing policies such as the R&D tax credit, green energy tax credits, write-offs on R&D expenses and other physical investments that benefit workers and promote long-term productivity growth, and provisions for net operating losses that smooth out would need to be , the effects of business cycles are reversed.
However, instead of being straightforward, Warren’s proposal would create two sets of tax rules for businesses, one in which the structure was designed by lawmakers to calculate taxable income and create incentives they deem appropriate and another that companies will certainly reclaim such provisions.
The Tax Foundation’s analysis shows that Senator Warren’s proposal would have a greater negative impact on investment incentive in the United States than a 7 percentage point increase in the corporate tax rate. In other words, the 7 percent tax she proposes would result in more declines in economic output, full-time jobs, and wages than a 7 percentage point increase in corporate tax. This is mainly because companies couldn’t use expense or accelerated depreciation on their investments.
According to the rules of corporate book profit, companies distribute the investment costs roughly over their useful life, also known as economic depreciation. The purpose of this rule is to match costs with revenue generated in order to provide creditors and shareholders with the best possible information: for example, subtracting the total cost of a new factory in the year it was built, it could appear to shareholders as if it were a company unprofitable. While the economic depreciation approach makes sense for accounting reasons, it is a poor framework for tax policy.
Spreading the deductions over time creates a tax bias against investments. Deductions in future years are worth less than deductions in the current year due to the time value of money and inflation. It also creates a bias against companies that rely heavily on physical capital (e.g. power generation and high-tech manufacturing) and against companies that rely primarily on labor (e.g. financial services or fast food). Depreciation causes higher investment costs, which reduces investment and capital accumulation and ultimately hurts workers compared to a full cost system where investments can be withdrawn immediately.
Senator Warren’s proposal could also mean reclaiming new tax credits proposed by the Biden administration as part of the Build Back Better agenda, such as manufacturing and transportation tax credits. The tax also has other problems, as our former colleague Kyle Pomerleau argues:
Other aspects of the award would also distort the investment behavior of companies. It seems that companies cannot carry losses forward into future years. As a result, investments that lose money for several years before making a profit can face high effective tax rates. Based on the descriptions of the plan, the surcharge would also include foreign income in its tax base with no foreign tax deduction or credit. This would make US companies less likely to own foreign investment and would ultimately reduce national income.
The proposal would also violate the promise not to impose taxes on households earning less than $ 400,000. While this would increase the progressiveness of the tax code, it would reduce after-tax income for taxpayers of all income levels, according to the standard analysis, which distributes the corporate tax burden between owners and employees. We should expect the surcharge on workers to fall more than the current corporate tax due to lower wages, since the surcharge falls more on investments than the current corporate tax.
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