As Congress crafts yet one more finances, it’s time to confront a quiet enabler of America’s rising wealth hole: the best way we tax company income.
The U.S. company tax system is a maze of complexity, distortion and avoidance. On the identical time, the richest Individuals — who personal the lion’s share of company inventory — see their wealth balloon not from earnings, however from capital appreciation fueled by retained company earnings. They pay little or nothing in taxes till they select to promote — if ever.
Right here is a straightforward concept that would rework that system: Substitute the company earnings tax with a flat tax on retained earnings. As a substitute of taxing company income on paper, tax the portion that corporations select to not distribute — these retained earnings that quietly accumulate on stability sheets, inflate inventory values and find yourself driving inequality.
The logic is simple. Retained earnings symbolize income that aren’t reinvested in capital or returned to shareholders. They sit — usually offshore and untaxed — fueling inventory buybacks or just growing guide worth. In the meantime, shareholders can borrow towards these unrealized good points, develop richer by the 12 months and legally keep away from earnings tax altogether.
Underneath the present system, firms face a 21 p.c statutory earnings tax fee. However because of loopholes and world tax arbitrage, the effective rate is commonly a lot decrease — nearer to between 9 p.c and 15 p.c. On the identical time, the highest 1 p.c of Individuals own more than 90 p.c of shares and mutual fund wealth, a lot of which compounds via retained earnings with out triggering taxable occasions.
A 20 p.c flat tax on retained earnings, utilized on the company stage, can be decrease than the statutory earnings tax however a lot more durable to evade. It could simplify the tax code, remove gamesmanship and be certain that income profit society, whether or not distributed or not.
Corporations might keep away from the tax by issuing dividends — thereby transferring the tax burden to shareholders, who would then pay peculiar dividend taxes. Or corporations might reinvest in productive capital expenditures or analysis and growth, which may very well be exempted from the tax base.
Individuals usually complain that the wealthy don’t pay their fair proportion in taxes. A retained earnings tax addresses this immediately, because the rich are by far the most important shareholders. By inducing greater dividend payouts, the tax would convert extra untaxed wealth into taxable earnings — guaranteeing the wealthy pay extra, proportionally and predictably.
This plan is honest. Wealth would not accumulate tax-free inside firms. Extremely-wealthy shareholders would see extra of their earnings circulate to dividends, triggering taxes like peculiar Individuals face on wages.
In 2024, S&P 500 corporations earned roughly $1.9 trillion in pre-tax income. Of that, they paid solely about $248 billion in company taxes — simply 13 p.c of whole income — and distributed round $650 billion in dividends to shareholders. That left properly over $1 trillion in earnings to be retained or used for inventory buybacks.
A 20 p.c tax on simply the retained portion — estimated close to $870 billion — would yield $174 billion yearly. Extra importantly, it will encourage corporations to challenge extra dividends — triggering private earnings tax obligations at charges of 15 p.c to 23.8 p.c. For the primary time in many years, untaxed paper wealth held by the ultra-rich would convert into actual, taxable earnings.
This plan is clear.Retained earnings are already reported as a line merchandise on company monetary statements, so no want for armies of tax accountants. This plan additionally encourages effectivity. Firms can be nudged to both distribute income or reinvest productively — decreasing hoarding, inventory buybacks and monetary manipulation.
The size of revenue hoarding isn’t theoretical. As of late 2024, Apple held over $65 billion in money and equivalents. Microsoft held greater than $71 billion. Alphabet, guardian firm of Google, sat on over $95 billion and Amazon was at $100 billion. These figures symbolize retained capital sitting in stability sheets — largely untouched by taxation. In lots of instances, this hoarded money fuels share repurchases or just provides to paper valuations, thus benefiting the wealthiest shareholders whereas contributing nothing to public coffers.
In fact, this concept has precedents. President Franklin D. Roosevelt experimented with an undistributed profits tax within the Thirties. At the moment, a model survives because the Accumulated Earnings Tax, however it’s hardly ever enforced and straightforward to avoid. This proposal is easier, bolder and broader.
Critics might fear this plan would discourage reinvestment or burden development. However a well-designed system can exempt reinvested earnings tied to clear capital funding or innovation. What this proposal targets isn’t development however extreme hoarding of income that serves solely the rich few.
Others might concern that such a tax would immediate firms to change to various constructions or shift operations overseas. However a retained earnings tax may be utilized primarily based on monetary disclosures for U.S.-based public corporations and expanded to giant LLCs or partnerships. In reality, it could cut back incentives to maneuver income offshore, because it targets the place wealth stays, not the place it’s reported.
The politics are promising. A retained earnings tax is decrease than the present company earnings tax — but might increase extra constant, sustainable income. It eliminates the necessity to police each deduction, credit score and carve-out. It additionally aligns with populist sentiments on each the left and proper: no extra tax-free stockpiling, no extra billionaires (referred to by some as we speak as “oligarchs”) borrowing off their good points whereas avoiding taxes.
Congress has an opportunity to reset how we take into consideration taxing wealth — not by chasing each greenback of earnings, however by focusing on the retained income that silently gasoline inequality and sidestep the tax system. Fixing the company tax code is important not only for elevating income however for restoring equity, transparency and belief within the American financial compact.
Peter D. Wells is principal at Historic Knowledge Consulting.