Donald Trump claimed in both debates that companies are leaving America in record numbers because of the corporate tax rate. For probably the first time in this election, he’s actually right. America’s tax code caused many companies to either leave the country or never to bring overseas profits back home.
America’s top corporate marignal tax rate is 39.1%. It is the third highest in the world and the highest in the world's developed economies.
Companies use a variety of tactics to lower this high tax bill. One of the more controversial methods is buying or merging with an overseas company and simply relocating their headquarters there.
According to Bloomberg Businessweek, more than 50 companies moved their headquarters since 1982 using this method. Some of the more famous examples include Pfizer and Burger King.
Walgreen’s also attempted this but backed out after public criticism, some of which came from President Obama himself. If you look at their SEC annual releases, you’ll see it would've been better if they moved. In 2013 and 2014, Walgreen’s paid 37% and 42% of its earnings in taxes and paid 19.8% in 2015.
Walgreen’s would’ve paid closer to 8.5% if it had gone through with its plan to move to Switzerland. That would’ve saved them nearly $3 billion. Here's the total estimated dollar comparison:
Companies that are major exporters for America have another trick for paying lower taxes: they just never bring the money home. That is what Apple did.
Apple is one of America’s great exporters. Their computers, tablets, music devices, and phones changed their industries and they make much of their money overseas. To avoid paying taxes, they set up a corporation in Ireland and simply deposited their money in Irish banks.
This later caused Apple an awkward problem, which illustrates perfectly how this affects investors too. Apple made a lot of cash from its worldwide operations and no longer had any good ideas on how to re-invest it. They conquered the phone and computer market. They created a whole new market with tablets. They saved the music industry from free music sharing with iTunes. They didn’t have much more to do but improve the products they already built.
Apple is a publicly traded company though and its shareholders wanted it to continue increasing value for them in some way. Usually when a company becomes the top in its industry and can no longer grow revenue quickly, it starts to pay out its earning in dividends.
However, Apple needed cash to pay dividends. A good portion of its cash was tied up overseas and couldn't be brought home without paying taxes.
So what did they do?
They found it was cheaper to borrow money and pay dividends than pay the taxes and bring the cash home. So they sold bonds (better known as ‘iBonds’) to raise cash and paid out the dividends with that money.
This issue of dividends and corporate taxes gets to the heart of why the corporate tax system in America is a tax on retirement accounts.
Dividends go to different types of investors, including:
Individual investors (hobbyists, active investors, wealthy individuals)
Workers with 401ks or some other retirement account
The first two would need to pay taxes on a different level from the third. The third should pay no taxes at all until they retire, depending on the type of account they use.
Americans with 401ks usually indirectly purchase stocks through mutual funds or index funds. However, the trouble is that when a company earns a profit, it pays taxes to the government. That means these shareholders who invest through their retirement accounts are still paying taxes indirectly.
So a tax on publicly traded corporations is not only taxing the wealthy, it's also taxing middle-class investors. Most people don't make this connection though because we often associate corporate income with the upper-class income.
There’s a common perception that wealthy Americans pay a lower share of their taxes. Dividends and capital gains can only be taxed up to 15% and 20% respectively, while the top marginal income tax rate is 39.6%. However, these wealthy Americans who earn dividends taxed at 15% are receiving income that already was taxed once.
So wealthy Americans really are paying their fair share and middle-class Americans are paying more than their fair share...that is until a company moves overseas and reduces their tax rate to almost zero.
This is what leads to the numerous conflicts between corporations, the federal government, retirees, and other investors.
Publicly traded corporations are obligated to look out for the best interests of their investors. Pfizer looked out for their shareholders interests, both rich and poor, when they relocated overseas. Apple did they same by borrowing money instead of bringing their cash home.
Unfortunately, this makes it difficult for the federal government to protect its tax base from companies and wealthier investors who can legally lower their tax bill. Companies can pick up and move to a lower rate country and then pay dividends at the normal tax rate to its wealthier shareholders who live in America, which in effect allows the wealthier shareholders to pay a lower percentage overall.
American citizens with retirement accounts are negatively affected because the earnings they are entitled to from publicly traded companies are taxed, even when they invest through a tax fee account. It also lowers the potential dividend you could receive if those companies choose to stay in America.
So if you own a stock with earnings per share of a $100 and it is taxed $33, the earnings that could be paid in dividends are lowered to $67. Companies may be less likely to pay a dividend at all after this because it still needs to save some of its profit to re-invest and grow its business.
So how do you solve all these problems? What would my solution be?
You simply move the corporate tax rate to the dividend tax rate. Companies would no longer have an incentive to move overseas. Wealthy Americans will be taxed at their income bracket for dividends. Retirement accounts of middle class citizens would no longer be taxed.
Will this ever happen? Hell no. Taxes are one of the most politicized issues ever. Politicians use misperception to their advantage because that matters more than facts.
It is very easy to take someone advocating a reduction in corporate taxes and make them look like they’re advocating a reduction in the wealthy’s taxes, even though our corporate tax rate is higher than socialist, European nations.
We can dream that maybe one day serious tax reform will take hold. Until then, I want the companies I invest in to look out for my interests and lower the amount of taxes it pays.