1、1Chapter 17 The Corporation Tax2Introduction A corporation is a form of business organization in which ownership is usually represented by transferable stock certificates Stockholders have limited liability Corporations are independent legal entities Can make contracts,hold property,incur debt,sue,a
2、nd be sued3Why Tax Corporations?Only real people can pay a tax,so why not just tax incomes of corporation owners via the personal income tax?Justification#1:Corporations are distinct entities,and ownership and control are separated Justification#2:Corporations receive a number of special privileges,
3、such as limited liability.Corporation tax simply a user fee.Justification#3:Corporation tax protects the integrity of the personal income tax.Cannot simply accumulate income within the corporation to defer tax payments.6Structure Employee compensation Wages and benefits are excluded from taxable inc
4、ome7Structure Interest payments,not dividends When corporations borrow,interest payments to lenders are excluded from taxable income.When corporations finance activities by issuing stock,dividends are not deductible.8Structure How should durable goods be treated in determining taxable income?Buying
5、a drill press(that lasts for 10 years)is initially just an exchange of assets,not an economic cost.As it is used,it is subject to wear and tear,which decreases its value.This decrease in value,called economic depreciation,is an economic cost to the firm.9Structure Each years worth of depreciation sh
6、ould be deductible from that years gross income.Difficult to measure true depreciation,or even the useful life of durable goods.Instead,the tax law specifies a tax life:For each asset,what proportion of its acquisition value can be depreciated each year,and over how many years.10Structure To calcula
7、te the value of the depreciation allowances in the tax code,compute the present value of the stream of depreciation allowances.Generally,the present value of these allowances for a$1 asset would be:DrDrD TrT112112.11Structure Thus,the presence of depreciation allowances lowers the effective price of
8、 acquiring durable assets from$q to$(1-)q.Tax savings depends on value of T and the function D(n).Tax benefits are more valuable the lower T is,and the more front-loaded D(n)is.12Structure Accelerated depreciation is a scheme to write off assets faster than true economic depreciation.Expensing allow
9、s a firm to deduct from current taxable income the assets full cost at the time of acquisition.13Structure Under current law,T varies from 3 to 39 years.Racehorses are depreciated over 3 years Computers are depreciated over 5 years Nonresidential structures are depreciated over 31.5 years Generally
10、tax lives are shorter than actual useful lives.14Structure Intangible assets some spending,such as an advertising campaign,may increase sales over a number of years.Computing appropriate depreciation is difficult.15Structure No Investment Tax Credit(ITC)Prior to 1986,ITC permitted a firm to subtract
11、 some portion of the purchase price of an asset from its tax liability at the time the asset was acquired.ITC did not depend on corporate tax rate(in contrast to depreciation allowances)Subtracted directly from tax liability,not taxable income16Structure Discussion so far has focused on taxed direct
12、ly paid by corporation.Another issue is the total tax rate on income generated by corporations.Corporate profits may either be retained by the firm(retained earnings)or paid to stockholders(dividends)Dividends not deductible expense from corporations viewpoint,and taxed in the personal income tax co
13、de too.17Structure Recent legislation has moved toward eliminating this double taxation of dividends.Maximum tax rate on dividends received is now 15%at the individual level.18Structure Retained earnings increase the value of the corporation,and this increase should be valued into the stock price.Th
14、ese increased capital gains are not taxed until those gains are realized.Thus,tax system creates incentives for firms to retain earnings rather than pay them out in dividends.19Incidence and Excess Burden Economic consequences of the corporation tax are very controversial.Not a consensus on just wha
15、t kind of tax it is.Tax on Corporate Capital Tax on Economic Profits20Incidence and Excess Burden:Tax on Corporate Capital Firm is not allowed to deduct from taxable income the opportunity cost of capital supplied to shareholders.Therefore,the corporation tax is a partial factor tax.Tax leads to mig
16、ration of capital from the corporate sector until the after-tax rates of return are equalized.21Incidence and Excess Burden:Tax on Corporate Capital As capital moves to the non-corporate sector,the rate of return on capital to all owners of capital is depressed.Reallocation also affects return to la
17、bor.Ultimate incidence depends on production technology and structure of consumers demands.22Incidence and Excess Burden:Tax on Economic Profits Alternative view is that corporation tax is tax on economic profits.Tax base=gross corporate income costs Incidence of profits tax is straightforward,no sh
18、ifting of tax.Tax is borne by owners of firm,no misallocation of resources.23Incidence and Excess Burden:Tax on Economic Profits Problems:Base of pure profits tax is computed by subtracting from gross earnings the value of all inputs including the opportunity cost of the inputs supplied by the owner
19、s.Not the case here.Under certain circumstances,corporation tax is equivalent to profits tax(when corporation can deduct interest payments to creditors).24Effects on Behavior Total Physical Investment Types of Asset Corporate Finance25Effects on Behavior:Total Physical Investment Total Physical Inve
20、stment Do features like accelerated depreciation and the investment tax credit stimulate investment demand?Will discuss three types of models:Accelerator model Neoclassical model Cash flow model26Effects on Behavior:Total Physical Investment Accelerator model Main determinant of the amount of invest
21、ment is changes in the level of output demanded.Depreciation allowances and investment tax credits basically irrelevant27Effects on Behavior:Total Physical Investment Neoclassical model Key variable is user cost of capital the cost the firm incurs as a consequence of owning an asset.Includes direct
22、costs like depreciation and taxes Includes opportunity costs of forgoing other investments28Effects on Behavior:Total Physical Investment An investment will only be undertaken if its return exceeds the user cost of capital.Define:r=return in capital market =depreciation =corporate tax rate t=persona
23、l tax rate29Effects on Behavior:Total Physical Investment The user cost of capital is then defined as:Crt11 Thus,a company would only undertake a project if the return where greater than C.30Effects on Behavior:Total Physical Investment Previous equation did not account for depreciation allowances()
24、or investment tax credits(k).User cost of capital becomes:Crkt111 By taxing corporate income,tax make capital investment more expensive,but depreciation allowances and ITCs lower the user cost.31Effects on Behavior:Total Physical Investment How do user costs affect investment?If the neoclassical mod
25、el is correct,investment does respond to depreciation allowances and ITCs.Econometrically,role of policy expectations in the investment process is critical.Current investment depends on future values of the user cost of capital.Elasticity around 0.4 seems reasonable.32Effects on Behavior:Total Physi
26、cal Investment Cash Flow Model Cash flow is the difference between revenues and expenditures for inputs The more money on hand,the greater the capacity for investment In neoclassical model,internal funds and borrowed money had the same opportunity cost.In cash flow model,cost of internal funds is lo
27、wer than external funds.For example,lenders may view a project as being more uncertain than the management.33Effects on Behavior:Types of Asset Tax system encourages the purchase of certain types of assets,for example those with generous depreciation allowances.Table 17.1 shows that the Tax Reform A
28、ct of 1986 reduced the gap between tax rates on equipment and structures.Table 17.135Effects on Behavior:Corporate Finance Owners must decide how to finance a firms operations,and whether to distribute or retain profits.36Effects on Behavior:Corporate Finance Why do firms pay dividends?If outcomes o
29、f all investments are known in advance and there are no taxes,then the owners of a firm are indifferent between a dollar of dividends or retained earnings.In reality,tax system is not neutral dividends are more highly taxed.Surprisingly,in a typical year,almost 79%of after-tax corporate profits are
30、paid out as dividends.37Effects on Behavior:Corporate Finance Several explanations:Signal of firms financial strength Marginal tax rates of investors vary some firms“specialize”in attracting low marginal tax rate investors,known as the clientele effect.38Effects on Behavior:Corporate Finance Several
31、 econometric studies have found that when the opportunity cost of retained earnings decreases,dividend payments go down.Thus,tax system increases amount of retained earnings.39Effects on Behavior:Corporate Finance In raising money,firm can either borrow money and pay interest(issue debt)or it can is
32、sues shares of stock and pay dividends(issue equity).U.S.tax system allows deductibility of interest payments,but not dividend payments.Thus,built in bias toward debt financing.40Effects on Behavior:Corporate Finance In one econometric study,Gordon and Lee(2001)find that lowering the corporate rate
33、by 10 percentage points lowers the percentage of the firms assets financed by debt by 4 percent.41Effects on Behavior:Corporate Finance Recent corporate scandals Number of firms,most notably Enron,used deceptive and fraudulent practices to inflate earnings and increase stock value.Is the tax system
34、to blame?Dividend payments send a strong signal about the profitability of a firm Tax code discourages firms from paying dividends42State Corporation Taxes Almost all states levy their own corporation income taxes Differ substantially with respect to the rate structures and rules for defining taxabl
35、e income Variation leads to many questions:If a state levies a corporation tax,how much of the burden is exported to citizens of other states?Immobile factors more likely to bear incidence of tax.If capital is more mobile than labor,incidence tends to fall on labor.43Taxation of Multinational Corpor
36、ations The value of assets invested in foreign countries by U.S.firms was$6 trillion in 2001.U.S.multinational corporations are allowed tax credits for taxes paid to foreign governments.44Taxation of Multinational Corporations Complications arise due to:Tax deferral using foreign subsidiaries A fore
37、ign subsidiary is a company owned by a U.S.corporation but incorporated abroad.Tax avoidance via transfer pricing Price that one part of the company uses for transferring resources to another part of the company.45Recap of the Corporation Tax Structure Incidences Effects on Behavior State Taxes Multinational Corporations
