The Equity Tax and Shelter *

Abstract. (See A for a brief summary.) Taxes have major costs beyond the collected revenue: deadweight from distorted incentives, compliance and enforcement costs, etc. A simple market mechanism, the Equity Tax, avoids these problems for the trickiest cases: corporate, dividend, and capital gains taxes. It exploits the ability of the share prices to reflect the expected true annual return (as perceived by investors, not as defined by law) and works only for publicly held corporations. Since going or staying public cannot be forced, and for some constitutional reasons too, the conversion to equity tax must be a voluntary contract. Repeated reconversions would be costly (all capital gains are realized) and thus rare. The converts and their shareholders pay no income, dividend, or capital gain taxes. Instead, they give the IRS, say, 2% of stock per year to auction promptly. Debts are the lender's assets: its status, not the debtor's, determines their equity-tax or income-tax treatment. The system looks too simple to be right. However, it does have no loopholes (thus lowering the revenue-neutral tax rate), no compliance costs, requires little regulation, and leaves all business decisions tax neutral. The total capital the equity taxed sector absorbs is the only thing the tax could possibly distort. The rates should match so as to minimize this distortion. The equity tax enlarges the pre-tax profit since this is what the taxpayers maximize, not a different after-tax net. The wealth shelter is paid for by efficiency, not by lost tax

Regulation and redistribution in utilities

The consumption of utilities (for example, energy and water), along with that of other goods such as food, clothing, shelter, health and education, is often thought of as something that has particular distributional significance. This concern is reflected by the range of welfare and regulatory measures in place that are designed to guard against non-participation or under-consumption. The pricing of these goods illustrates well the conflicting arguments between economic efficiency and equity. The case for charging VAT on fuel, for example, is essentially an efficiency argument which points to the distortionary effects of a tax system that increases the prices of some goods (for example, double-glazing) and not of others (for example, domestic energy). The counter-argument is based upon notions of equity: that it is unfair to tax a necessity because the effects fall hardest on the living standards of poor households.

Seeking True Financial Reform: Ending the Debt-Equity Distinction

This Note identifies the failure of Congress to address tax incentives for leverage as a principal cause of the recent financial crisis and a fundamental flaw of recent financial reform legislation. Specifically, the Internal Revenue Code provides substantially disparate tax treatment for debt and equity financing by allowing firms to deduct interest payments on indebtedness, but not providing an equivalent deduction for equity funding. This “debt-equity distinction” artificially reduces the cost of capital for debt financing relative to equity financing and encourages firms to over-employ leverage in their capital structure. This in turn increases financial distress costs and externalities to the economy and increases the volatility of capital markets. Though some scholars have proposed to allow firms a deduction for dividends paid, such a scheme would create additional distortions and introduce the potential for corporate managers to substantially manipulate their taxable income. This Note offers an alternative solution by proposing: (1) that the deduction for interest on business indebtedness be eliminated, and (2) that policymakers return to the idea of the Cost-of-Capital-Allowance (COCA). A COCA deduction better aligns the incentives of firms with those of capital markets and economies writ large, and encourages managers to seek out the absolute cheapest sources of capital while removing tax shelter considerations from the decision-making process

Trading and the Tax Shelter Value of Depreciable Real Estate

For well-diversified investors in depreciable real estate, the trading decision may be made with the sole objective of maximizing the property's depreciation tax shelter net of all capital gain taxes and transaction costs.This paper develops a dynamic programming model in which the optimal trading strategies and depreciation methods of all investors in a property are simultaneously determined. The effects of inflation, depreciation, recapture and choice of depreciation method are analyzed, and the costs of suboptimal trading are measured. The model is applied to both conventional residential and commercial income properties under post-ERTA tax rules. At single digitinflation rates, properties are traded multiple times, and the costs of suboptimal trading are significant.

Towards Equity and Efficiency in Partnership Allocations

The primary goal of any tax system is to raise sufficient revenue for government. More precisely, taxation is the means by which government supplies necessary things not available from the private market. Taxation allows society to cure distributional imperfections in the market. It is appropriate, therefore, only to the extent that the market cannot provide goods and services for which there is public demand; if private markets equitably supplied food, shelter, health care, education, and common defense, taxes could be greatly reduced if not completely eliminated. The revenue raising goal is thwarted to the extent the taxing system is either inefficient or inequitable. Inefficiency decreases gross national product\u27 and inequity spurs resentment and avoidance. Both consequences - inefficiency and inequity - interfere with the market\u27s ability to supply goods and services and have the perverse effect of provoking more tax levies. The two secondary concerns - efficiency and equity - need not be mutually exclusive, though it is sometimes argued that the pursuit of equity decreases efficiency and vice versa.\u27 Progressive taxation seems inequitable because it imposes disparate nominal burdens on taxpayers. One explanation, of course, is that the marginal utility of each dollar is greater to lower earners than to higher earners. The nominally higher extraction from higher earners is equal to the nominally lower extraction from lower earners. Equity is thereby preserved or attained and, assuming progressive rates are set at optimal levels, the tax system should nevertheless achieve its revenue raising goal