VAIT - The Value Added Income Tax

By Jalexson c. 1992

     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.

     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 corporate furnishings.

     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. Federal tax rates can discourage corporations from operating at a profit. Government must then 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 plus interest.

     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.

     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.



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