Don’t demonize Walgreens.

Don’t demonize Walgreens for taking action to legally lower its U.S. federal income taxes.  The Des Moines Register and President Obama are wrong when they say that taking advantage of this legal tax break is unpatriotic.  As the Register reported, Walgreens can save $4 billion in federal taxes over the next 5 years by changing its corporate headquarters to Switzerland.  (See Register article: “Walgreens turns back on taxpayers” 8/3/2014)

The Register asked: “How much profit does a company need?”  “How much is enough?”  They went on to list all of the benefits that Walgreens receives by operating in the U.S. They tried to shame Walgreens for their proposed action, and effectively called for a boycott of Walgreens in protest.

The Register gave lip service to the fact that the U.S. has very high corporate tax rates compared to most other modern countries, and that tax reform is needed to close loopholes and bring down rates.  That should have been the primary message of the editorial, that we need to close loopholes and lower rates, not that Walgreens might take advantage of one.

Many companies and other taxpayers pay substantially lower their taxes by taking advantage of loopholes:  Oil and other natural resource extraction industries have their depletion allowance; hedge fund managers have their “carried interest” bonuses payments.  There are many many types of tax credits and deductions that benefit only politically favored businesses.  Many unfair loopholes go to very wealthy and profitable companies and individuals.  How does Warren Buffet pay less than 20% in federal income taxes?  Loopholes.  Why do some of the largest, wealthiest, most profitable research based companies in Iowa pay no income tax?  Loopholes.  Are all of these people and companies unpatriotic because they don’t pay more taxes than required by law?

In this case, the problem is not Walgreens or the specific loophole.  It is the high corporate income tax rates in the U.S.  The U.S. needs to significantly lower its corporate income tax rates.  Otherwise, over time, companies will actually move their headquarters to lower tax countries.  Given the inherent unfairness of special interest loopholes, and given the unconscionably high U.S. federal debt, it seems obvious that we should close as many of these loopholes as possible, and lower tax rates at the same time in a revenue neutral way.

Full disclosure:  I am a Walgreens stockholder.

Link to Register editorial:  http://www.desmoinesregister.com/story/opinion/editorials/2014/08/03/editorial-walgreens-turns-back-taxpayers/13531911/

Income inequality is not the problem.

Income inequality is not a problem in and of itself.  As long a people earn their income through honest, peaceful and voluntary exchange, then there is no moral reason for our government to redistribute that wealth.  What is a problem is when government places its thumb on the scale and unfairly helps the rich to get richer, or hurts the poor and makes them poorer.  To the extent that a person gains wealth by unequal preferential treatment by government, it is morally correct for government to use its force to take away that wealth.

One good example of the many unfair government policies that wrongly favor the rich is the special low income tax rate on “carried interest” income earned by hedge fund managers.  They call it carried interest, but it is nothing more than a bonus based on performance.   In any other situation, this type of income is taxed at regular income tax rates. Somehow, hedge fund managers have sold politicians on the idea that carried interest is a special kind of income that should be taxed at lower rates.  Another example is the Oil Depletion Allowance for oil companies.  Another is farm subsidies for rich farmers.  We do not need to raise tax rates on ordinary income, we do need to do away with the unfair preferences, tax breaks, and subsidies that go mostly to the wealthy.

A good example of government policy that hurts poor people is that of keeping interest rates low in order to prop up housing prices.  If housing prices had been allowed to fall to their free market levels, housing would be much more affordable for poor people.  Instead, our government tries to fix the problem that it helped to create (unaffordable housing) by giving rent subsidies to the poor – creating more dependency on government, but not fixing the underlying causes of the problem.

To misquote Walter Scott, “Oh what a tangled web we weave when first we practice to use our government to achieve social goals.”  The solution to many of our economic problems today is to reduce the size and scope of our government.  Many unfair crony capitalist subsidies and tax breaks exist because our government has expanded far beyond its Constitutionally limited powers.  The primary just powers of government are to protect our lives, liberty and property; and to resolve disputes.  The scope and powers of our current federal government are clearly way beyond the limited government that our founding fathers created.  Lets start by closing unfair tax breaks and lowering spending to match.

Okay to raise taxes – to close unfair loopholes!

Uncontrolled spending is the primary cause of our federal deficit and our federal debt.  The debt we are creating for our children and grandchildren is immoral.  We must cut spending.  But, that does not mean that we should not close unfair tax loopholes, even if closing those loopholes increases tax revenues.
There are many egregious loopholes that only benefit favored special interests. “Carried interest” should be taxed a ordinary income at ordinary rates, not as capital gains at 15% – 20%.  The “oil depletion allowance” should be ended.  Interest and dividends should both be taxed as ordinary income and both should be deductible by the businesses that make the interest or dividend payments.  Capital Gains should be taxed as ordinary income after the gain has been reduced for inflation.  There are many more loopholes that are clearly unfair or that only benefit special interests.  Closing unfair tax loopholes should be a part of the solution to our deficit problem.

Obama needs to compromise.

President Obama has built his own wall to prevent agreement to avoid the “fiscal cliff”.  There is no public outcry to raise the 35% top income tax rates on those with the highest incomes.  The outcry is against the 15% – 17% average tax rate paid by the super wealthy like Warren Buffet and Mitt Romney, not against high wage earners who pay 35% on most of their income.  If the 1% paid taxes on most of their income at the current top rate of 35%, there would be no problem.  We need eliminate special interest tax breaks.  For example, carried interest (otherwise known as bonuses for hedge fund managers) should be taxes at regular rates up to 35%, not as capital gains at 15%.  Capital gains should be taxed at 15% only if the gains were earned over a much longer period of time, say 10 years.  Currently, the 15% tax rate is applied to gains on assets held for only 1 year or more.  Eliminate the home mortgage interest deduction on second homes.  Cap the  home mortgage interest deduction to loans of up to $250,000.  There are many other special cases where income is taxed at less than the top rate of 35%.  Those are the special tax breaks that we should look at ending – not raising the top rate.

Raise tax rate on capital gains.

The 15% income tax rate on long term capital gains is a very significant tax break for business owners and investors, including the very wealthy.  It is a big part of the reason why Warren Buffet and Mitt Romney pay such a low rate on their income taxes.  A capital gain is the profit made on investments such as stocks, businesses, and real estate.  For tax purposes, a capital gain is considered “long term”, and receives the low 15% rate, if the asset was held for at least one year.  (Short term capital gains, on investments held less than a year, are taxed at ordinary income tax rates – up to 35%.)
One justification for the lower tax rate is to encourage investment.  In theory, if you lower the tax rate on certain investments, more people will put their money in those types of investments.  But, people who save their money in a bank or who buy bonds also encourage investment, and their profit, the interest they earn, is taxed at ordinary income tax rates – up to 35%.  It seems unfair to tax interest and capital gains at different rates.
Another justification for taxing long term capital gains at a lower rate is to account for inflation.  If you doubled your money on an investment, your real profit, (adjusted for inflation), is quite different depending on how long you owned the investment.  If you doubled your money in only one year, you did great.  But if it took you 20 years to double your money, you did rather poorly.  If your investment grows, but at a rate slower than inflation, then you are actually losing spending power.  The fair way to tax capital gains would be to adjust the gains for any inflation that occurred while the money was invested.  Then, tax the real gain, after adjusting for inflation, using ordinary tax rates – up to 35%.
Interest income could also be taxed the same way.  If interest earned was for a period longer than a year, then it could also be adjusted for inflation and the tax would be paid only on the real earnings, after adjusting for inflation.
Capital gains and interest income would both be taxed at ordinary tax rates – up to 35%.  That would be fair for everyone.

End unfair tax break: carried interest

One of the most unfair income tax breaks is the 15% tax on carried interest.  Carried interest is a profit sharing bonus that is received by private equity and hedge fund managers, and general partners in real estate limited partnerships.  Carried interest bonuses are taxed at the favorable 15% capital gains rate on the theory that the manager has his own money invested, and the bonus is part of the capital gain on that investment.  The theory is wrong.  Capital gains on money invested are divided among investors based on the amount of their investment.   To the extent that a manager is also an investor, he receives capital gains just like all other investors.  Carried interest is an additional bonus paid above and beyond any return on money invested.

For example, a hedge fund manager might get a carried interest bonus of 20% of any profits that are above a 10% return to the owners.  If the investment earns 15%, the bonus would be 20% of the extra 5%.  After payment of the bonus, the net return to the investors would be 14%.  If the manager is also an investor, he would receive the 14% return on his investment just like all other investors and would pay capital gains tax on the profit just like all the other investors.  The carried interest bonus is an extra payment based on performance.  In any other business the extra payment would be called a bonus and would be taxed as ordinary income.  The fact that the manager is also an investor should not change the bonus payment into a capital gain.

Those who receive carried interest payments will fight tooth-and-nail to keep the tax break. They might even make political contributions to those they wish to influence.  But politicians need to step back and see these payments for what they are: bonuses that should be taxed just like all other bonuses – as ordinary income.