I’ve written about some boring and arcane tax issues – most of which are only relevant because we don’t have a simple and fair flat tax.
Depreciation vs. expensing
- Territorial taxation vs. worldwide taxation
- GILTI rules for multinational firms
- Carry-forwards and net-operating losses
- Tax treatment of debt and equity
But I always try to explain why these complicated tax issues are important – assuming we want a competitive tax system that doesn’t needlessly undermine growth.
Today, we’re going to add to our collection of nerdy tax topics by discussing the issue of “book income” vs “tax income.”
I’m motivated to address this topic because the oleaginous senior senator from Massachusetts, Elizabeth Warren, indirectly addressed this issue in a recent column for the Washington Post.
Here’s some of what she wrote.
…scores of giant U.S. corporations pay zero. …In the three years following the 2017 Republican tax cuts, 39 megacorporations, including Amazon and FedEx, reported more than $122 billion in profits to their shareholders while using loopholes, deductions and exemptions
to pay zero in federal income taxes. These companies boosted their stock prices and increased CEO pay by telling their shareholders they raked in hundreds of millions of dollars in profits, while simultaneously telling the Internal Revenue Service that they don’t owe any taxes. …We would require any company that earns more than $100 million in profits to pay a 7 percent tax on every dollar earned above that amount.
To assess Warren’s proposal, here are a couple of things that you need to understand.
- What corporations report to their shareholders is “book income,” and that number is governed by a specific set of rules (“generally accepted accounting principles” or GAAP) determined by the Financial Accounting Standards Board. The goal is to make sure investors and others have accurate information.
- What companies report to the Internal Revenue Service is “tax income” and that number is governed by a specific set of laws (the tax code) enacted over the past 100-plus years by politicians.
In other words, companies are not choosing to play games. They have no choice. They are following two separate sets of requirements that were set up for two separate reasons.
For purposes of public policy, the key thing to understand is that the tax code is based largely on cash flow (what was taxable income over the past 12 months, for instance).
That means it produces annual numbers that can be quite different than book income’s long-run data based on accrual accounting (the GAAP rules).
The Tax Foundation has a recent report, authored by Erica York and Alex Muresianu, that shows why it would be a major mistake to use book income for tax purposes.
Under corporate book income rules, companies spread out the cost of investments across roughly its useful life, also known as economic depreciation. The purpose of this rule is to match costs to the revenues they generate to best inform creditors and shareholders: deducting, say, the entire cost of a new factory the year it’s constructed
could make it seem like a company is unprofitable to shareholders. While the economic depreciation approach makes some sense for accounting purposes, it’s a bad framework for tax policy. Spreading out the deductions over time creates a tax bias against investment. Deductions in future years are worth less than deductions in the current year, thanks to the time value of money and inflation. It also creates a bias against companies that rely heavily on physical capital (think energy production and high-tech manufacturing), and towards companies that mostly rely on labor (think financial services or fast food).
It’s unclear whether Senator Warren (or her staff) actually understand these technical details.
Not that it really matters. Her goal is to play class warfare. She’s engaging in demagoguery (a long-standing pattern) in hopes of enacting legislation that will give her a lot more money to spend.
If she’s successful, it will be very bad news for the economy, as Kyle Pomerleau explained in a 2019 report for the Tax Foundation.
According to the Tax Foundation General Equilibrium Model, this proposal would reduce economic output (GDP) by 1.9 percent in the long run. We also estimate that the capital stock would be 3.3 percent smaller and wages 1.5 percent lower, with about 454,000 fewer full-time equivalent jobs.
…We estimate that the service price would rise by 2.6 percent under this proposal. A higher service price means that capital investment would become less attractive, leading to reduced investment and, eventually, a smaller capital stock. The smaller capital stock would lead to lower output, lower worker productivity, and lower wages. …Taxpayers in the bottom four income quintiles…would see a reduction in after-tax income of between 1.64 percent and 1.95 percent.
And here’s a table from Kyle’s report with all the economic consequences.
P.S. In her column, Sen. Warren also reiterated her support for a destructive wealth tax and more funding to reward a corrupt IRS.
[…] For all intents and purposes, politicians would be creating a second type of corporate income tax. […]
[…] For all intents and purposes, politicians would be creating a second type of corporate income tax. […]
[…] legislation has all sorts of awful provisions, such as shoveling more money at a corrupt IRS, hurting jobs with higher taxes on “book income,” price controls on prescription drugs, and green-energy […]
[…] For all intents and purposes, politicians would be creating a second type of corporate income tax. […]
[…] legislation includes a big back-door tax increase on companies (the provision targeting “book income“), that’s a perfect segue to our first item about taxation and […]
[…] The only good news to share is that the tax being enacted by Democrats is just 1 percent, so the damage will be somewhat limited (the main economic damage will be because of another provision in the legislation, the tax on “book income“). […]
[…] The only good news to share is that the tax being enacted by Democrats is just 1 percent, so the damage will be somewhat limited (the main economic damage will be because of another provision in the legislation, the tax on “book income“). […]
[…] legislation has all sorts of awful provisions, such as shoveling more money at a corrupt IRS, hurting jobs with higher taxes on “book income,” price controls on prescription drugs, and green-energy […]
[…] legislation has all sorts of awful provisions, such as shoveling more money at a corrupt IRS, hurting jobs with higher taxes on “book income,” price controls on prescription drugs, and green-energy […]
[…] don’t like shoveling more money at a corrupt IRS, hurting jobs with higher taxes on “book income,” price controls on prescription drugs, or green-energy […]
[…] don’t like shoveling more money at a corrupt IRS, hurting jobs with higher taxes on “book income,” price controls on prescription drugs, or green-energy […]
[…] For all intents and purposes, politicians would be creating a second type of corporate income tax. […]
[…] For all intents and purposes, politicians would be creating a second type of corporate income tax. […]
[…] look today at the wonky issue of “book income” because it’s an opportunity to point out that there are three types of […]
[…] more background, the crazy left are economic illiterates such as Robert Reich, Bernie Sanders, and Elizabeth Warren (and some guy named Lindsay Owens, who was cited in the […]
[…] the previous instance, he deliberately confused the distinction between the financial concept of book income and and cash-flow concept of taxable […]
[…] the previous instance, he deliberately confused the distinction between the financial concept of book income and and cash-flow concept of taxable […]
[…] which notes that companies are (currently) required to keep two different sets of books (which demagogues then deliberately mix up to advance their false […]
[…] Taxes on so-called book income […]
[…] Taxes on so-called book income […]
[…] Taxes on so-called book income […]
[…] look today at the wonky issue of “book income” because it’s an opportunity to point out that there are three types of […]
[…] look today at the wonky issue of “book income” because it’s an opportunity to point out that there are three types of […]
[…] look today at the wonky issue of “book income” because it’s an opportunity to point out that there are three types of […]
[…] look today at the wonky issue of “book income” because it’s an opportunity to point out that there are three types of […]
[…] look today at the wonky issue of “book income” because it’s an opportunity to point out that there are three types of […]
[…] is just a partial list. There are other policies – such as alternative minimum taxation, book income, loopholes, and extenders – that also can increase the damage of the corporate […]
[…] Elizabeth Warren’s Demagoguery on “Book Income” — International Liberty […]
What we need is not a flat rate tax, that is still not equitable or fair. What we need is to divide the cost of the Federal Government, reduced by taxes other than personal income, and then divide it by every adult in the country. Everyone pays the same. That is the only true, fair and equitable tax rate. Once a person has paid his fair share, not as a percentage of his income but as a percentage of the cost of Government, then everything he earns above that is his to keep. No personal deductions, no tax credits, no charitable deductions. One bill, one amount, the same for everyone. THAT is true participatory government. Since it isn’t based on income, anybody can help anybody else pay their bill. Charities or charitable people can pay other peoples tab. How do you think people will respond to the cost of government when everybody, rich and poor, pays exactly for it?
Just this one issue alone is enough reason to not listen to Elizabeth Warren on financial issues. She either understands the difference between book income and tax income, or she doesn’t. If she does understand, it means she is a cynical, pandering hack. If she doesn’t understand, it means she’s too ignorant to allow anywhere near the levers of financial public policy.
Reblogged this on Gds44's Blog.
Lizzie Warren is just brimful of awful ideas to make Big Gov the micromanager of all business and businesses. At least until full nationalization of it all can finally be forced.
I think she knows what she’s doing is destructive. That’s the point for her. Capitalism is target and she means to destroy it.