Real corporate tax reform will encourage employee ownership in a company. Democrats will like that too.
Donald Trump’s proposal to reduce the corporate rate from 35 percent to 20 percent puts America on a more competitive footing. But a more ambitious tweak to the tax code could create an opportunity society that pleases both conservative entrepreneurs griping about onerous rates and liberal protesters griping about inequality.
The current tax code offers entrepreneurs ways to avoid punitive taxation. But doing so often means forgoing the possibility of granting ownership stakes to employees, a mechanism that proves profitable to workers, capitalists, and society. Fixing this means alleviating concerns over both profits and equality.
To avoid double taxation, entrepreneurs establish ventures as limited liability companies or sub-S corporations. The counter to the upside of avoiding the corporate tax rate and taxes on dividends remains the difficulties in providing employees an ownership stake in the company. That downside, incentivized by the current tax structure, means that employees who might otherwise realize the American Dream by becoming shareholders instead remain tethered to their wages and not to the overall success of the business.
The ability of employees of Microsoft, Google, and other tech companies to become owners of the business they labored for created a more dedicated work force and a more successful business. Members of LLCs or owners of sub-S corporations find it too difficult to pursue this option under the current tax code.
The only reason to put a private business in an LLC is to avoid being taxed twice on income and proceeds from selling the business. The 20 percent tax on corporate income could be combined with a 20 percent tax credit on dividends. Employee stockholders would encounter simple tax returns with one line for dividends and one other line for the tax credit. The alternative is many lines from a Form K-1 and separate state tax returns.
Limited liability companies and sub-S corporations do not mesh with this opportunity society. The double taxation inflicted on businesses opting to incorporate under a different route conflicts with small businessmen hoping to keep more of their profits. Why not abolish both LLCs and S corporations and double taxation?
This would mean that all corporate bodies pay taxes at the new 20 percent rate and that all corporations possess the unhampered ability to make employees shareholders. In any instance in which the government attempts to tax earned income for a second time, such as dividends or through the estate tax, the initial amount paid could work as a credit staving off Uncle Sam. And for other untaxed monies, such as unrealized profits legated in a will, the feds could tax that at the existing applicable corporate or personal rate.
What Friedrich Nietzsche said about poets more readily applies to policy wonks. “They muddy the water, to make it seem deep.” The tax code may appear byzantine. But correcting it need not be. Complicated problems often inspire simple solutions.
Here, the tax man applies the 20 percent corporate rate to all corporations, abolishes LLCs, sub-S corporations, and other artificial entities created by the IRS, and provides a credit to offset attempts to double tax earned income.
This results in entrepreneurs hiring workers rather than accountants, a simpler tax code, and a more productive workforce motivated by a cut of profits. Everybody wins.
Republicans want opportunity. Democrats want equality. A tax code that encourages employee ownership as it eliminates double taxation brings us closer to both.
Hunt Lawrence is a New York-based investor. Daniel Flynn is the author of five books.
Facebook employees in Silicon Valley in 2010 (Wikimedia Commons)