If one might say, the news of the year (or even four years), has been what we read on Sunday, September 27, 2020, “New York Times: Trump Paid No Income Taxes in 10 out of 15 years beginning 2020.” The report stated that in both the year he won the presidency and his first year in the White House, Trump paid just $750 in federal income taxes. Trump denied the New York Times story and claimed that he pays “a lot” in federal and state income taxes, as was expected.
“Tax bombshell reveals Trump’s image as a sham” read CNN story. The CNN story further stated that “In 2016 and 2017 each, Trump paid just $750 in federal income taxes — far less than many Americans who are working hard amid a deep recession to stay afloat.”
Here are a few pieces of general knowledge about Income tax in USA:
1. Income Tax of the sort we now know, was started in USA in 1913.
Passed by Congress on July 2, 1909, and ratified February 3, 1913, the 16th Amendment established Congress’ right to impose a Federal income tax. The history of Income tax in USA, however, goes back to 1861. During the Civil War Congress passed the Revenue Act of 1861 which included a tax on personal incomes to help pay war expenses. The tax was repealed ten years later. However, in 1894 Congress enacted a flat rate Federal income tax, which was ruled unconstitutional the following year by the U.S. Supreme Court because it was a direct tax not apportioned according to the population of each state. The 16th amendment, ratified in 1913, removed this objection by allowing the Federal government to tax the income of individuals without regard to the population of each State.(www.loc.gov)
Incidentally, the rate of tax, during 1861-1871, was 3% of all incomes over US $800.
2. What is the share of income tax in Federal revenue?
As of 2019, “About 50 percent of federal revenue comes from individual income taxes, 7 percent from corporate income taxes, and another 36 percent from payroll taxes that fund social insurance programs (figure 1). The rest comes from a mix of sources”, writes Tax Policy Center.
It will not be out of place to state that social insurance (payroll) tax is effectively an earmarked revenue, meaning it will, by and large, go to a predetermined use.
The unearmarked tax revenue is thus only 64%.
Each of the other tax category expressed as a percentage of unearmarked federal revenue will read as follows:
|Individual Income Tax||78.12%|
|Corporate Income Tax||10.94%|
|Excise and Others||12.50|
|Based on numbers provided by Tax Policy Center.|
Rounding off Error 1.56 per cent points.
Clearly, Individual Income Tax contributes the real big chunk of federal revenue. Corporate Income tax is the second best bet to raise money by taxes.
3. What rate of income tax large U.S. Corporations Pay?
The table given at the end shows that select leading corporations of USA pay corporate income tax at an average rate in the range of 1.57% to 4.89%, per year.
a. For computing these numbers, instead of financial numbers of a single year, the financial numbers of the last four years, 20016-2019, have been used. In the matters of analysis of numbers taken from financial statements, average of the last a few years tends to be more robust than a single year.
b. It is also important to note that the annualized income tax rate has been calculated based on EBITDA and Income Tax paid. The rate of tax may also be computed as per cent of Earnings Before Tax (EBT). But EBITDA is a more robust number as it measures cash operating profit. Since EBITDA tends to be greater than EBT, the rate of tax paid show smaller.
A few other interesting facts:
i. Corporate income tax paid doesn’t tell much about the income tax paid by the individual shareholder of a corporation.
ii. It will be difficult to find a person in USA or elsewhere who enjoys paying income tax or who doesn’t try to reduce taxes.
iii. Tax Harvesting is a tax planning strategy often used. Tax harvesting means taking losses, in a planned way, to avoid taxes on gains.
iv. Tax avoidance is legal, around the globe, as tax avoidance is reducing taxes by using ‘permissible’ (under the Income Tax Law of the Land), the tax deductions and exemptions.
v. There is hardly any business which does not pass though certain discretionary expenses. That is why in valuing any business, by income based approach, no one works with Profit or Loss. Everyone likes to work with Seller’s Discretionary Earnings (SDE).
vi. President Trump takes home only $1 as salary and donates rest of his salary of $400,000, per year, to public services. Those who say, some of the earlier Presidents used to pay Income tax of $100,000 or more, may note that President Trump donates much more, though in an alternate way.
vii. Even charitable donations are sometimes used to reduce income tax.
viii. Some of the countries have replaced income tax by expenditure tax. In my opinion, that is much more equitable than any system of income tax.
ix. There are a number of people who are tired of the ‘mechanizations’ of income tax system. They would rather prefer a certain flat percent of tax on personal and corporate incomes, beyond a certain level of income.
x. $800, that was the exemption limit in 1861. Assuming an average inflation rate of 2.5% per annum, $800 today, at the end of 160 years, is $41,582; and assuming 3% inflation is $90,582. I would say with no deductions and exemptions anymore, USA should charge 10% flat on personal income, beyond $100,000; and 5% of EBITDA of any business.
President Trump’s tax return debate should be used to review the current system of income tax in USA. If USA could move to a flat rate or expenditure tax instead of income tax, the productivity of average American will certainly shoot up.
Dr Sat Parashar, PhD is former Director, IIM Indore. He teaches at University of California, San Diego, and is a Financial Services Professional. He may be reached at email@example.com