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“Thorough Professional Analysis”?
We Report, You Decide

by Philip L. Hinson, CPA

 

The latest wrinkle in the ever shifting saga of Stephen Eldridge’s emotional opposition to (and incessant diatribes against) the FairTax1 is the announcement on his Liberty Radio debate with Steve Curtis that part of his own personal flat income tax plan now includes treating all U. S. corporations as carry-throughs for tax purposes similar to the current treatment of Sub-S’s and LLCs. Like a lot of Mr. Eldridge’s ideas on tax reform, this one may sound reasonable until you analyze the practical effect.

Presumably, this new treatment would apply to companies such as IBM, Microsoft, MMM, Apple, Ford Motor Company, Exxon, Reynolds Aluminum, and the various other members of the Fortune 500, as well as very substantial companies just outside that listing. These companies are all subject to the current corporate income tax (at least in theory), so it stands to reason that this new tax treatment would apply to them, also, since Mr. Eldridge proposed getting rid of the corporate income tax entirely. These companies have shareholder lists numbering in the thousands. Some of these shareholders are individual U. S. citizens while some are foreigners who have never set foot in the U. S. Others are U. S. corporations while some are foreign corporations. Just how does Mr. Eldridge propose that the United States Department of Treasury start to collect federal taxes from both individual foreign nationals and corporations? Will foreign nationals now be required to file U. S. income tax returns? On what authority would the U. S. government be imposing these new tax filing requirements? What happens if a U. S. corporation incurs a loss in one year and a profit the next? If shareholders are allowed to carry a loss forward, it seems that is going to require the filing of individual tax returns, even if a flat 10% on earnings sounds simple at first blush. And if they are not allowed to carry a loss forward, it seems that would spark an enormous push-back from shareholders.

Consider a specific example. Suppose a hair-dresser in Changsha, China really likes her new iPhone and decides to buy a few shares of Apple. Apple’s annual profit is in the billions, but with a few shares, her proportionate allocation would be, let’s say, $200 (U. S.) How does Mr. Eldridge suppose the federal Treasury can collect that money, assuming she does not voluntarily pay it? I suppose you could enter an order for Apple to withhold that amount from her next dividend check. That would be an administrative nightmare (there are reasons that Sub-S’s and LLCs currently have restrictions on the number and types of allowable members), but putting that aside, what about companies that are not currently paying dividends but are making a profit or are paying dividends that are insufficient to cover the tax liability? How happy do you think their shareholders are going to be about coming out of pocket to pay the taxes that the companies they have ownership in generate?

Of course, China also has an individual income tax and it is easily predictable that the Chinese government is going to continue to want its piece of the action. You can bet that foreign shareholders are not going to be very happy about that double taxation situation and that it would undoubtedly have a significant negative impact on the ability of U. S. corporations to generate operating capital.

Let’s look at this on more of a macro level. Suppose a U. S. corporation generates $1 billion in pre-tax income during a given calendar year. Suppose their board decides to distribute $250 million of that income in the form of dividends to their shareholders. They may feel that they need to strengthen their balance sheet and/or make some major investments in plant & equipment to expand their business or to open up new markets. That means that shareholders in the aggregate will receive $250 million in dividends, but have to pay out $100 million in taxes (10% of $1 billion) to the U. S. government. That does not count any additional taxes that foreign shareholders would have to pay to their own governments on the $250 million in distributed dividends. Remember that the federal income tax would be based on the $1 billion in income, while foreign income taxes would be based on the dividends actually distributed – $250 million in this hypothetical case.

An obvious oversight like this might be easier to be magnanimous about were it not coming from a self-proclaimed “tax expert” who claims his tax reform proposals are the product of “thorough professional analysis” (presumably in contrast to the FairTax). This is someone who claims that there are major shortcomings in the FairTax proposal that he alone is astute enough to identify. He also claims that economic forecasts based on sophisticated computer models from professional economists are too unreliable to base important decisions on, and that his emotional and highly subjective informal economic assessments are far superior. If Mr. Eldridge could somehow abandon his visceral emotional opposition to the FairTax and its supporters, he would be able to evaluate the FairTax and its alternatives based on their merits and not on rawemotion. It reminds me of a biblical verse.2

“Thorough professional analysis”? We report, you decide.

 

  1. The main reason that these surprises relative to Mr. Eldridge’s proposal pop up is that Mr. Eldridge has never seen fit to document in written form either of his contributions to the field of tax reform. He is the author of not one, but two, completely unworkable proposals, neither of which exist anywhere in the human universe except between his ears. There is no website, no written summary, no economic studies, etc. And, yes, this is one and the same Stephen Eldridge who says that he doubts the economic research that was done to develop the initial design of the FairTax because he has never seen the documentation. Sounds like quite a double standard?
  2. Matthew 7:3   “Why do you look at the speck that is in your brother’s eye, but do not notice the log that is in your own eye?”

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