VAIT - The Value Added Income
The United States needs to replace its corporate profits tax with
a Value Added Income Tax(VAIT). The corporate profits tax has outlived
its usefulness. It discriminates against American businesses and hampers
efforts to modernize American factories. A VAIT could increase federal
tax revenues without increasing the burden on most American companies.
It would keep companies from avoiding taxes by setting up offshore shell
The VAIT would treat corporate income in terms of the value added by
the corporation and ignore the whole question of profit and loss. In its
simplest form the VAIT would apply to income(revenue) minus taxed costs,
primarily purchases from VAIT paying businesses and labor costs subject
to employer matching F.I.C.A. tax. The VAIT would be somewhat similar to
the European Value Added Tax(VAT). Tax deductable costs would have to be
related to revenue sources. The cost of purchasing another company's stock
wouldn't be deductable from revenue generated by sale of manufactured goods.
Purchase of imported goods wouldn't qualify as a deductable cost. A more
complex VAIT could disallow deductions for nonessential costs such as expensive
The broader range of income subject to the VAIT would allow a much lower
rate without reducing tax revenue. Ignoring the profitability of corporations
would spread the tax burden among more companies including those that show
a profit for stockholders but not for tax purposes.
The current corporate tax structure has become so complex that the cost
of figuring taxes increases the prices of American goods while reducing
federal tax revenues. Replacing it with a simpler tax system would eliminate
some unnecessary business costs.
Taxing corporate profits made sense decades ago when a business subtracted
its expenses from its revenues at the end of the year and considered whatever
was left profit. Today a corporation's profit is whatever the accounting
department says it is. Changing the way a corporation handles inventory
or depreciation can mean the difference between profit and loss. Some corporations
create public relations problems for all businesses by using accounting
methods that show a profit for stockholders but a loss for tax purposes.
Basing the corporate tax on profits places the highest tax burden on
American manufactured goods. Foreign companies do not pay American profits
taxes and thus purchases of foreign manufactured goods do not generate
the same federal tax revenues as purchases of American made goods. Shifts
in American buying habits have played a greater role in reducing the role
played by corporate taxes than "tax loopholes".
Corporate profits do not provide an adequate measure of corporate income.
A corporation can survive and grow without ever showing a profit so long
as stockholders do not object. A corporation owned by management does not
need to show a profit because managers can reward themselves with higher
salaries or bonuses instead of stock dividends. High management salaries
and benefits have also reduced corporate tax revenues. The corporation
can use depreciation of purchases or show paper losses on financial dealings
to avoid showing a profit. Stockholders may prefer to benefit from increased
stock prices rather than dividends.
From a technical standpoint no American corporation pays income taxes.
"Revenue" is the term for a corporation's income. The term "profit" applies
to stockholders' income. Profits may be distributed to stockholders or
used to enhance the value of the corporation and thus increase the value
of the corporation's stock.
The current corporate profits tax creates economic problems. Exorbitant
federal tax rates discourage corporations from operating at a profit. Government
must create special tax breaks for favored industries to stimulate profitable
operations. Operating a corporation with one eye on the tax situation causes
corporations to make what otherwise would be dysfunctional business decisions.
Businesses and individual investors may become so preoccupied with tax
situation that they ignore income producing opportunities.
The VAIT would ignore the question of profit and loss. The tax would
apply to revenue minus costs upon which federal taxes have already been
collected. The primary reason for deductions should be to prevent double
taxation. A purchase from a business that pays the VAIT could be a deductible
cost. A purchase from a foreign supplier, a non-profit corporation, or
some other non-VAIT paying entity could not be deducted. Manufacturing
costs at plants outside the United States would not be deductible. Partnerships
and other types of businesses would have the option of operating as a corporation
for tax purposes. Employee expenses subject to employer matching F.I.C.A.
tax would be deductible because the corporation would already pay a federal
tax on the expense.
The tax should be revenue and cash flow oriented. Generally revenue
would be taxable during the tax period the corporation received cash or
its equivalent. Relevant costs would be deductible during the period the
corporation expended cash or received revenue. The latter approach would
be especially useful for companies that manufacture products with long
lead times or for research and development expenses. A company wishing
to expand could expend current revenue on additional supplies or equipment.
A company could deduct the cost of some planned purchases of buildings
and equipment by committing cash to such a purchase. Failure to complete
the transaction would subject the company to paying the appropriate tax
Deductions would have to relate to revenue sources. For example, purchase
of raw materials would be deductible from revenue received from the sale
of the finished product. The purchase of stock as an investment would be
deductible only from the sale of investment stock, not from the sale of
the company's manufactured products.
A corporation would deduct the cost of buildings and equipment
when the company used cash from revenues to pay for the purchase. If the
corporation used revenue to pay directly for the purchase, the company
could deduct the total expense at one time. If the corporation used a loan.
the deduction would occur as the company used revenue to retire the principle
of the loan. Interest would be deductible if the loan came from a VAIT
paying entity. A corporation could deduct the appropriate VAIT tax from
the interest it would otherwise pay to non-VAIT paying investors.
Payments using cash raised through sale of the corporation's own stock
would be deductible as the corporation used profits to pay dividends. The
deduction would continue until the amount of dividends paid equaled the
amount of the payment. This procedure could encourage use of stock sales
rather than borrowing to raise funds for expansion.
Purchases using this procedure would have to involve the company's principle
business and involve buildings and equipment. Purchase of another company's
physical assets would be deductible but not purchase of the other company's
stock. The purchase price of stock could only be deducted from the sale
price of stock.
This approach would replace arbitrary assignment of a depreciation period
for building and equipment deductions. Corporations can adapt to technological
changes better if they can purchase the newest equipment and discard the
old as fast as they can generate the necessary revenue. Preoccupation with
depreciation schedules can financially lock a company into outdated equipment.
The need to use depreciation to expense an item may force a company
to borrow money rather than use revenue. Otherwise the company would have
to use the revenue for tax expenses rather than to purchase new equipment.
With borrowing, the company can pay out a amount of cash equivalent to
the amount of depreciation expense. Using revenue could require the company
to pay more because of the difference between revenue and the amount of
depreciation allowed for tax expense.
Assume a company wants to finance a $1 million purchase of buildings
or equipment. Under a VAIT the company could accomplish this goal by spending
$1 million in revenue. Under the current profits tax a corporation using
revenue to expand would be using profits. Assuming a 50% tax rate, the
company would have to have additional profits of $1 million minus allowable
depreciation expense to finance expansion. The additional amount would
be a tax on expansion. Borrowing would allow the company to finance the
expansion without having additional profits for income tax. Assuming the
company can arrange the repayment schedule to avoid the profits tax, the
company would eventually pay an additional amount(possibly exceeding $1
million) for interest.
Attempts to encourage investment in new technology through the current
tax system have been inefficient. Companies may decide to act to take advantage
of the law rather than to purchase what the company needs to remain competitive.
Arbitrary legal depreciation schedules may provide excessive benefits to
some industries and inadequate assistance to others. Some corporations
waste money(in an economic sense) by purchasing other companies rather
than building new plants or otherwise expanding the nation's productive
Allowing deductions for labor expenses subject to employer F.I.C.A.
taxes would protect labor intensive industries. Otherwise the tax could
increase unemployment by increasing labor costs in marginal industries.
This approach could have the effect of taxing various employee fringe benefits
such as medical insurance. Taxing these benefits at the company level(even
if paid to a VAIT paying corporation) would eliminate the problems associated
with attempting to determine the income equivalent benefit for individual
employee/taxpayers. If the VAIT rate is lower than the F.I.C.A. tax, a
corporation might be allowed to deduct additional labor expenses to make
the rates effectively equal. This provision would insure continued employer
support for Social Security.
This deduction would eliminate any need to exempt some industries from
the VAIT. The food industry in particular relies heavily at all levels
upon workers whose salaries are well under the maximum salary for the F.I.C.A.
tax. The VAIT on food would have a lower effective rate than the VAIT on
some other products. The same situation would exist with American made
Industries with many highly paid employees would deduct only a portion
of labor costs and thus pay a higher effective VAIT rate. Sports and entertainment
oriented businesses would pay some of the highest taxes. Among manufacturers,
those facing the least competition, especially foreign competition, would
pay the highest taxes. These companies can afford higher salaries and more
executives than companies facing stiff competition.
A company purchasing goods from a foreign non-taxpaying company could
not deduct the cost of goods. A corporation could not even deduct production
costs at its own plants outside the United States. This provision would
discourage companies from operating foreign subsidiaries at a profit to
avoid American taxes. Increasing the value added to a good outside the
U.S. would increase tax liability by reducing the deductible portion of
the good's final value.
Import taxes would be deductible. The payment of import taxes would
not qualify an item as a deductible expense because tariffs depend upon
various political factors including treaties. Tax rates may vary according
to type of good or nation of origin. Foreign policy considerations might
cause the government to set the rate for a given country's goods lower
than the VAIT rate. The lack of uniformity could give some businesses an
advantage over others.
Purchases from partnerships and other non-corporate entities would not
be deductible. Such organizations might pay taxes at substantially different
rates from the VAIT. Disallowing deductions for payments to outside partnerships,
individuals, etc. would discourage use of highly paid "consultants" to
handle jobs normally performed by highly paid employees. Allowing deductions
to consultants would allow some companies to deduct salaries for attorneys
or some managers by treating them as if they were outside consultants.
Partnerships or individuals wishing to sell goods or services to corporations
would have the option of paying the VAIT under the same conditions as a
corporation. This option would allow partnerships to enjoy the non-tax
advantages of a partnership without having to lose business to corporate
Making the VAIT a corporate tax rather than a business tax would exempt
many small retail businesses, especially "mom and pop" operations, from
the VAIT. These businesses could continue to pay taxes under individual
or other rates. Individual businesses could make their own decisions about
whether to pay taxes as a corporation or not. This provision would help
make the VAIT a corporate income tax rather than a sales tax.
Corporations could deduct some but not all payments to government. The
nature of the payment would determine its deductibility. Federal taxes
would be deductible to avoid double federal taxation. Purchases of goods
or services, particularly rental of government owned buildings, would not
be deductible because government landlords would not be paying federal
Corporations paying reduced rates for rent or government services would
have to treat the difference between their rates and normal rates as taxable
revenue. Profit-making corporations are not charitable institutions. Corporations
receive revenue(cash or some good or service) for providing goods or services.
When a corporation agrees to remain in or relocate to a community and provide
jobs to community residents the corporation is providing a service. If
the local government provides the corporation reduced-rent buildings, tax
breaks, or reduced costs for government provided services the corporation
has received payment(revenue) for its service, providing jobs. This revenue
should be as taxable as a direct payment of cash by government to the corporation.
The above approach would not apply to a corporation forced to relocate
within a community because of government needs for the corporation's current
Corporations seldom need any special financial considerations from local
governments. Some companies like to use the desperation of local communities
for jobs to extort money. These companies claim they need special assistance
in order to obtain minor cost reductions. Successful companies must locate
plants based on broader geographic and economic factors in order to survive.
Marginal companies that must receive government welfare to survive will
probably eventually fail anyway.
State and local taxes would not be automatically deductible. Property
taxes could be deductible to reduce the impact of arbitrary tax exemptions
local governments sometimes grant to favored businesses. An alternative
approach would treat less than normal taxes as taxable revenue rather than
allowing a deduction. Purchases from government owned utilities, including
water, would be nondeductible because a corporation might purchase from
a corporate supplier, produce its own electricity, etc.
Highway taxes would be deductible because of the central role state
expenditures play in maintaining the national highway system. Local airport
taxes and fees would be nondeductible because the benefits apply to the
local community and because a private VAIT paying corporation could own
part or all of the airport. Government owned airports can charge less because
they do not pay the VAIT and do not need to make a profit.
State income taxes would not be deductible because allowing such a deduction
violates the Constitution. The constitutional convention was called in
part to eliminate state control over federal revenue. Allowing deductions
for state income taxes gives state governments the power to control federal
revenues like the states had under the Articles of Confederation. The "people
of the United States" rather than the states themselves created the Constitution.
Allowing the states any control over the national government's handling
of national functions violates the very nature of the Constitution. Nothing
in the Constitution grants the federal government the right to tax the
income of persons(including corporations) in one state at a higher effective
rate than the income of persons in another state.
The same argument would not apply to property or sales taxes because
these taxes become part of regular business expenses. The property tax
is a property maintenance expense. The sales tax increases the cost of
purchases of taxable items.
Some purchases might be partially deductible. For example, payments
for business lunches can be either an employee benefit or a form of advertising.
Allowing a full deduction would mean a company could provide expensive
meals as a fringe benefit to favored employees. Precluding a deduction
could discourage a company from entertaining clients and adversely affect
the restaurant industry. Forcing businesses to keep intricate records so
that some lunches would be deductible would create unnecessary expenses
for companies and the government.
Corporations might also be able to deduct some portion of money donated
to colleges and universities or spent to purchase research and development
services from universities. Allowing such deductions would reduce the amount
government would have to spend to support higher education. Deductions
for research would encourage universities to apply knowledge to improving
society rather than simply passing information along to future professors.
Shifting from the traditional profits tax to a VAIT would require a
transition period whose length would depend upon the business activity
involved and past tax liabilities. Some corporations should begin paying
a VAIT as soon as possible. Others might switch gradually. Treatment of
deductions would shift away from that used for the profits tax to the form
of the VAIT. The tax rate would decline as previously available deductions
Importers who purchase foreign products for resale should begin paying
the VAIT no later than January 1 of the year after adoption of the VAIT.
This same timetable should apply to corporations that have shown no, or
only an insignificant, taxable profit while showing a significant profit
for stockholders. Imposing the VAIT would make more sense than attempting
to levy an arbitrary minimum tax. A minimum tax could place an unfair burden
on marginal companies or industries.
he first step in shifting to a VAIT for many companies would involve
splitting various corporate activities up for tax accounting purposes.
Loses in one area such as stock transactions could not be applied to the
tax liability for manufacturing. Conglomerates would have to handle various
subsidiaries as separate tax paying entities. Losses from a meatpacking
plant could not be deducted from the profits of a sporting goods manufacturer.
Depreciation would pose the most significant problem in shifting from
a profits tax to a VAIT. The VAIT would handle building and equipment purchases
on a cash flow basis rather than using a standard depreciation formula.
One way to handle the transition would involve continuing the depreciation
schedule method for purchases prior to initial implementation of the VAIT
and the VAIT approach for new purchases. Corporations using straight-line
depreciation would have the option of switching to a cash flow based deduction.
Corporations using accelerated depreciation would have to show that their
cash expenditures had equaled or exceeded their previously claimed depreciation
in order to switch to a cash flow deduction.
Purchase of a controlling interest in another corporation would no longer
qualify the purchases to any deductions such as depreciation. A company
would have to integrate the purchased company's assets into its own operations
to take advantage of the purchased company's existing deductible costs,
including any remaining depreciation deductions.
Even if Congress does not adopt the VAIT, it should eliminate the practice
of allowing depreciation deductions on the purchase of corporate stock
when purchase allows one corporation to gain control over another corporation.
The purchase of another corporation's stock involves purchase of a financial
instrument which provides a claim on the physical assets of the corporation
rather than the actual purchase of these assets. Banks and other lenders
often have a stronger claim to buildings and equipment than stockholders
Revenue from the sale of assets to pay for a corporate takeover or buy
out would be taxable. The cost of the takeover would not provide any deductible
expenses. Deductions would have to involve acquisition and maintenance
expenses not previously deducted. The lower VAIT rate would not prevent
sales necessary for business reasons. This approach would reduce profits
and thus provide a neutral way to discourage the practice of buying corporations
and destroying them by selling their assets.
Inventory accounting procedures would also change under the VAIT. Corporations
would no longer have the opportunity to choose between First In First Out(FIFO)
and Last In, First Out(LIFO). The cash flow procedure
under the VAIT would resemble FIFO, except that a corporation might be
able to deduct the cost of unsold inventory already paid for with revenue.
Corporations currently using FIFO would simply switch at some point with
unsold but paid for inventory becoming deductible before its sale. Corporations
using LIFO would have to switch to FIFO under the old profits tax system
with new inventory becoming deductible under VAIT rules.
A VAIT would insure a relatively constant source of revenue regardless
of the country of origin of consumer goods sold in the United States. The
rate could be low enough and uniform enough among competing businesses
to discourage manipulating business decisions to reflect the tax system
rather than economic needs. American companies would not lose sales to
foreign companies because of federal taxes. The tax on American goods would
be the same as comparably priced foreign goods. The VAIT approach would
allow the federal government to increase revenues without increasing the
tax burden on taxpaying American companies or upon individuals.
The corporate profits tax has outlived its usefulness. It imposes double
taxation upon stockholders who as a group pay taxes on their profits(reducing
dividends) and as individuals pay taxes on their dividends. The European
VAT applies the tax to labor costs and thus must be passed along like a
sales tax. The VAIT would apply to corporate income that exceeds most essential
expenses such as purchases and basic labor costs. Importers would have
to pass along the cost of the VAIT because of the lack of deductions. American
manufacturers would avoid part of the VAIT expense by reducing management
salaries and other expenses such as investments in tax shelters. As with
the current profits tax, corporations would pass along as much of the tax
as competition allowed.
The profits tax rewards mismanaged companies that lose money while providing unjustifiably high management salaries and benefits. The VAIT would tax these companies, but would not tax a corporation in a depressed industry if the corporation avoids luxury purchases and its executives work for much lower than normal salaries while attempting to change the company's financial position. The European VAT would continue to tax a corporation's labor costs regardless of the corporation's financial position or attempts to improve its ability to survive.
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