We should launch into a description of what our plan really involves and, Eric, do you
want to describe basically how we shift away from corporate taxation to a significant extent
and increase the taxation of shareholders?
Eric: Okay, so no tax reform is simple and we'll get into the complexities a little bit
down the road, but I think to start off, the basic idea of our plan is very simple and
that is, as Alan said, to shift the taxation from the corporate level where it's subject
to all these problems of definition of source and residence, to the individual level.
Now for various reasons, we're not getting rid of the corporate income tax entirely,
but our proposal would lower the corporate income tax rate to 15%, which is a major cut
from today's 35% rate and that rate would greatly reduce most of the incentives for
shifting residence and source that we've talked about before.
How would we balance that?
Basically by taxing shareholders on their capital gains and dividends at ordinary income
rates.
So instead of today...when you have a top rate of 39.6% on ordinary income and if it's
interest income with the additional 3.8% tax, it's over 42%...we would cut the rate to 20%.
The current rate rather is 20% or 23.8% including this extra 3.8% surtax.
We would eliminate those preferential rates and tax capital gains and dividends at full
ordinary income rates.
Now what's the problem with that?
The problem is with capital gains, if you tax them at that rate, people would stop realizing
capital gains.
There's a lot of evidence that realizations would fall.
We wouldn't raise revenue and we'd lock people into their existing investments.
Alan: They would know that if they don't pay that tax until they sell and so they'd have
a big incentive to put off selling.
Particularly maybe even to the end of their lives because the tax is basically forgiven
if they don't sell before they die.
Eric: So we have a solution for that.
Alan: We do.
Eric: Alan, talk about that.
Alan: We do and it's a controversial solution, but I think it makes sense when people really
think through it.
Our idea is, let's move away from this idea of waiting until you sell in order impose
this tax.
Let's do an accrual tax or what some people call a market to market tax and again, the
basic idea is pretty simple.
Every year if the stock price goes up and you've become wealthier because your stock
is more valuable, we would say there's a gain there even if you haven't sold and so we would
go ahead impose tax at the ordinary income rates on that gain.
Now if the stock price went down, we would say, "Okay, you've lost value.
You have a loss and you should go ahead and be able to deduct that and you shouldn't have
to sell your stock in order to claim that loss deduction."
So now there's no longer any incentive to delay selling because you're going to pay
your tax or get your loss deduction, regardless of whether you sell or whether you hold on
to the stock.
So it's a radical change from what we do today, but it does mean that you don't have a lock
in effect and also means that you can't avoid or delay tax by putting the money into the
corporation and letting it earn interest there where it's only going to taxed at 15%, because
any money that's in the corporation that's gaining value, it's going to show up in your
share price and we'll go ahead and tax that.
The big advantage is that the tax is no longer...the shareholder tax doesn't depend
on where the corporation is chartered or where it earned its profits or where it booked them.
We're going to impose tax on American shareholders of publicly traded companies, no matter where
those companies are at, that they own stock in.
On the other hand, the shareholder tax won't apply to foreign shareholders.
We're really looking at whether you're an American or whether you're a foreigner as
a shareholder.
We're not looking at those things that can so easily be manipulated and abused.
Now we do...
Eric: And one other thing.
We do want to tax people at their rates, but we don't want to tax them more.
We want to eliminate the double tax on corporate income.
We have one other feature of our proposal and that is we would allow U.S. shareholders
to claim a credit for corporate taxes paid, associated with the profits or the tax they
are paying.
And, basically, we would set the credit rate so we would wipe out, for U.S. shareholders,
the burden of the corporate level tax.
That tax would remain for foreign shareholders and for non-profits and for other tax indifferent
parties.
Alan: Tax exempt retirement plans, for example, would not get the credit because of course,
they're not paying any tax as a retirement plan and so they would bear that 15% corporate
tax that's been pre-collected at the company level.
I think those are the basic building blocks for our plan.
Now naturally when you think about some of the changes we're making there, there are
some problems and questions that arise.
For example, people say...and they're right...the stock market is really volatile, so if we're
going to tax you every year your stock prices go up, some years you might have a really
big tax bill even though you haven't sold the stock and received any cash.
Who knows whether maybe the very next year it's going to go back down in value again.
Of course we'll give you a full deduction then, but it seems awkward to be imposing
the large tax one year and giving the large loss deduction the next year.
Could especially be awkward for small shareholders.
We're very sensitive of that.
That's a legitimate concern and the plan actually addresses those concerns.
We're going to have the gains and losses averaged over a significant number of years, so that
that way there's not going to be as big as swings in the tax liability as you might expect.
Also, we're going to remove small shareholders from capital gains and dividend taxation entirely.
We'll have the first $500 for singles or $1,000 for couples each year of dividends
and accrued capital gains exempt.
And so for the really small shareholders, they're just not going to be dealing with
any of this in any way, shape or form.
And so I think that goes a long way towards resolving those concerns.
Now one other concern that's been brought up a lot is that we do have a very different
treatment in our plan for businesses that are publicly traded where we're going to put
them on the 15% tax and then have this accrual taxation versus the non-publicly traded businesses,
which are still going to be pass-throughs.
So some people have said, "Well, isn't there a problem with a big penalty on a company
that's currently private, but that's expanding?"
It's thinking of going public.
It's getting kicked into this regime where its owner is going to pay tax every year,
even if they don't sell.
So maybe you should describe, Eric, what we've done just briefly to try to address that concern.
Eric: Okay.
The main reason we're doing this, we would like to have the same regime apply to everything,
but it's just not practical, when assets are not publicly traded, to expect valuation of
those assets.
They're not easy to sell, they're illiquid and they're not easy to value.
So for those companies that are privately owned, that are not publicly traded, we're
not going to...we're going to tax them the way they are now as flow-throughs.
The question then becomes, what happens when, as Alan just said, a small company decides
to go...a startup gets to a stage where it decides it wants to go public, which companies
will do when they reach a certain size.
Today what would happen is they would trigger a tax.
The owner would pay...who is retaining some shares in the company...would pay tax on the
amount of shares he or she sells at capital gains rate.
There is a tax penalty for going public today and companies will pay that because of the
wider market for their shares, the greater ability to raise capital and the greater ability
to take money out of the company that they have when they've gone public.
Our plan though is a little different because we want to subject all of the shares of a
public company, not just the shares they sell, to the accrual regime.
So potentially we could vastly increase the tax penalty for going public.
We wouldn't be taxing without special rules, just the 20% of shares that the founder sells.
We would tax all the shares, both the shares he sells and the shares he retains.
We have to do something about it and our solution would be to drastically reduce the capital
gains tax rate on the conversion from private to public so that we don't discourage people
anymore than they're currently discouraged from making that transition.
We do want companies to continue to go public.
That's a dynamic part of the growth of our economy.
Alan: Absolutely.
Speaking of transition, we also have rules just for the general switch over to the new
system for the economy as a whole and I don't want to go into the details on those, which
are in the plan that we released on June 17th, but I'll just mention one thing which is,
that there obviously are some gains that have already been accrued where the stock price
has gone up, before the reform takes effect, but there's been no sale yet.
We had to decide how to treat those.
Our general goal there was to try to find a simple way to tax them, that wouldn't be
any more onerous than what people were expecting under the old systems.
Those gains have already accrued, there shouldn't really be a tax increase or an unexpected
burden on those.
We have a provision to tax those at low rates, lower than today's rates actually, but to
do so over a period of time.
Some of those gains, if the old rules had stayed in place, it might have been many years
before those were taxed and we would be taxing those somewhat earlier.
We'll tax them in the first 10 years of the plan, but we'll make up for that by taxing
them at a lower rate.
About half of what the rates they would have faced under old law.
So we try to avoid putting any unexpected burdens on these gains that have already accrued
while the old rules were in place.