The Homa Files

Excerpted from Bloomberg, “Misleading on Taxes”,  Kevin Hassett, Aug. 18, 2008

Last week, the Government Accountability Office released a report … that led to an Associated Press story with the startling headline, “Most Companies in U.S. Avoid Federal Income Taxes’

House Speaker Nancy Pelosi piled on, arguing that the data revealed a fundamental unfairness in the U.S. system, and called for reform. “When two-thirds of corporations pay no taxes… American workers are forced to pay too much in taxes even as they cope with rising prices and falling wages.”

The problem is, the study showed no such thing.

First, while it is true that 60 percent to 70 percent of companies in the study paid no tax in a given year, there was a big qualification. The study focused on an Internal Revenue Service tax database that included millions and millions of companies. The vast majority of firms in the study were tiny mom- and-pop enterprises.

Why did the tiny mom-and-pop enterprises pay no taxes? Because they didn’t make any money! The study reported that was the reason about 80 percent of the firms in the sample avoided taxes in a given year. How terrible of them.

How can it be that so many small businesses made no money? Companies tended to have no profits because they had large deductions including wages. Hot dog vendors can pay themselves a wage, in which case they have no profits but pay wage taxes, or they can take their money in profits, in which case they pay profits tax. The data suggest they tend to do the former.

Most of them do this for a simple reason: we still have double taxation of dividends. If you are a hot dog vendor in the top tax bracket and you pay yourself $100, then you pay $35 in taxes. If you keep it as profit and then pay it to yourself as a dividend, you pay a $35 corporate tax, and then a 15 percent dividend tax on top of it. Why would anyone choose the latter? To do so would be to pay more taxes voluntarily.

For big corporations, the story is different. The study found that … almost no companies went through the sample period without paying taxes. 

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For full column:
http://bloomberg.com/apps/news?pid=20601039&sid=aJHKNW1lro9Y&refer=columnist_hassett

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This entry was posted on August 19, 2008 at 6:53 am and is filed under Government & Politics, Taxes, Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.