Investment Contrarians

Should Taxes Really Go Up and for Whom?

By for Investment Contrarians |

IC_cekerevac_191212We are coming into an interesting time; America’s budget deficit has gotten too large and needs to be reined in. The problem is that this can be a delicate matter, because too much restraint in combating the budget deficit could slow economic growth.

The larger the budget deficit grows, the bigger the nation’s total outstanding debt. This can lead to massive financial problems over the long term, ultimately stifling economic growth under the weight of the budget deficit.

This is not news to anyone, and we are all aware of the dangers of a massive budget deficit. The problem is that during periods of strong economic growth, politicians continue spending during the good times, when they should be paying down the budget deficit and debt accumulated during bad times. With the economy still weak, many are worried that economic growth can be hurt due to overly aggressive tactics in attempting to reduce the budget deficit.

One of the themes from the latest presidential election was tax policy. President Obama has repeatedly stated that the top income earners don’t pay enough in taxes, and this is the main reason why America’s budget deficit is so large.

To start with, I want to emphasize that I personally believe people and corporations should pay taxes, according to the law. We don’t want to become a society like Greece in which many, if not most, people evade their taxes, which leads to a shortfall in revenue and a large budget deficit.

Let’s take a look at two areas of taxes: personal and corporate. The National Taxpayers Union looked at data from the Internal Revenue Service (IRS) and separated the incomes based on percentiles. According to the data, the top five percent of income earners, the threshold being $154,643, paid 58.6% of all federal personal income tax. (Source: National Taxpayers Union web site, last accessed December 15, 2012.)

Do you make more than $66,193? If so, you’re in the top 25%, a group that, in total, paid 87.3% of all federal personal income tax. The question I have is: how much more can we really expect an increase in taxes to help reduce the trillion-dollar budget deficit and not hurt economic growth?

Conversely, there is growing evidence that many corporations are finding loopholes to reduce their tax bill. With America having one of the highest corporate tax rates in the world, it is natural for businesses to look at ways to minimize this cost. However, there is a difference between legally minimizing taxes and evading them.

Reuters recently released a very interesting and in-depth article about an investigative report that it conducted that looked at how Amazon.com, Inc. (NASDAQ/AMZN) has constructed its business in Europe, specifically Luxembourg. According to Reuters’ investigation, Amazon.com’s presence in Luxembourg has allowed the firm to build a multi-billion-dollar cash pile that, as the article alleges, partly stems from America but was not taxed accordingly. (Source: “Amazon’s billion-dollar tax shield,” Reuters, December 6, 2012, last accessed December 15, 2012.)

Amazon.com stated in October 2011 that the IRS is seeking $1.5 billion in back taxes, alleging that this scheme of essentially shell corporations and transfer pricing allowed Amazon.com to lower its tax bill. Amazon.com disagrees with the IRS and is contesting it.

Essentially, the Luxembourg entity holds intellectual property that it charges (perhaps overcharges) its U.S. division, transferring profit overseas. Through special exemptions in Luxembourg, the tax rate paid by Amazon.com on overseas income over the past five years is 5.3%.

While this case is complex, and I am not privy to all of the information, so I can’t pass judgment, it certainly appears that this is one case of many in which corporations are attempting to do their best at not paying their fair share. Billions of dollars might be missing from the government revenue stream, leading to a larger budget deficit.

Another way to look at the situation is that if America’s corporate tax rate was lowered and more in-line with other countries, corporations would not have to go to these lengths to avoid paying taxes. This could be a twofold benefit, helping economic growth and lowering the budget deficit.

If America didn’t have one of the highest corporate tax rates in the world, corporations would now be able to repatriate the billions of dollars overseas, in addition to eliminating such tax avoidance schemes in the future. This would help increase and stimulate economic growth, which would increase government revenue, ultimately lowering the budget deficit.

The world is quite small these days; money and businesses can shift locations very rapidly. America needs to understand that we are competing with every country around the world. By having corporate taxes so high, we are creating incentives for this kind of subterfuge.

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  • Peter Walker

    Joe – it really depends. If you are willing to risk your money in an investment that will expand a business, this is very risky. The risks are needed for an economy to grow and innovate and these risky investments need to have incentives through a slightly lower tax rate.

    Frankly, capital gains should have 0 taxes, since the money you invest there is after tax money – what money you save from your job is already taxed, then you take this money and invest it in a business and get taxed again, even though you are helping the economy create new businesses and jobs – makes no sense

  • vl1969

    you are not getting taxed on the money you invest. only the profit you eqarn get taxed. as in you invest 100,000 into something you earn 20,000 over the year. you pay tax on 20,000 not on 120,000