Comment by sksk | Hacker News Reader

Comment by sksk | Hacker News Reader

I would recommend that people actually read the referenced Economist articles instead of the blog: http://www.economist.com/news/leaders/21651213-subsidies-mak... and http://www.economist.com/news/briefing/21651220-most-western...

For those who don't have the patience to read more on this topic, the key argument is that debt creates perverse incentives. If you follow Basel II or III regulations, you will know how hard it has been for the regulators to convince the banks to increase their tier-1 capital. The banks are happy to pile on more debt rather than raise more equity capital (the purest form of capital) as debt is cheaper and comes with nice tax benefits. The financial crisis of 2008 was exacerbated because of leverage (another way of saying lots of debt).

While this can certainly reduce leverage in the banking sector, the author raises the question of start-ups vs. big companies. Big companies have massive balance sheets and will generally be able to borrow at much better rates whether or not there is tax incentive. If an up and coming start-up is amazing, I am sure there will be 100s of equity investors who will be willing to throw money at it. I wouldn't worry about this impacting them.

That said, this will not fly in the US. So much for logical reasoning.

I read last week's Economist.

I agree that mortgage interest payments should not be tax-deductible for individuals. This distorted house prices in the UK until MIRAS was abolished many years ago, but the same situation exists today in the USA.

I disagreed with most of the rest, which addressed interest paid by businesses. I don't agree that interest payments are a special type of business expense that should be treated differently from others (like rent). If you accept that businesses should be taxed based on the profit they make, then singling out interest as a non-tax-deductible expense means that some businesses would pay profits tax, even when their accounts show zero or negative profit. It would also create perverse incentives:

- If I need capital for my business, but don't want to give up control, I will have to create an additional class of shares, and issue more shares whenever I need to 'borrow' more money

- If I need equipment for my business, I'll try and rent it instead of buying it, even though I intend to use the equipment until it's on its last legs. Oh, and the deal I'll strike will take this into account, so under IFRS it will be classed as a finance lease, so my controller will need to spend time explaining that to the auditors. Yay.

Banks are the only industry where tax deductibility actually makes sense, because a bank is essentially a wholesale broker of debt. You lend to the bank with your current and saving account, it lends to the economy. Tax deductibility will not really result in the bank leveraging less, as the bank is not the ultimate payer of the interest. It will only make it more expensive to borrow from a bank. And the tax will be paid twice (first by the bank, then by the ultimate payer of the interest).

"Double taxation" is a fallacious argument, concocted by lobbyists for the rich to complain about the taxes that impact them personally.

This comic summarizes it perfectly: http://i.imgur.com/Lw61YGs.gif

That comic is idiotic. The dividend is not a payment for a service or purchase. It's simply a transfer of income someone earned.

Taxing dividends would be like taxing ATM withdrawals.

Tax the income not the withdrawal.

Interestingly, the UK didn't used to tax dividends twice. This practice only started in 1999. Prior to that, dividends issued by UK companies were treated as if the recipient had already paid income tax on the amounts received. Only if the recipient was a higher rate taxpayer, were they on the hook for (just) the excess.

http://en.m.wikipedia.org/wiki/Advance_corporation_tax

I'm not sure I understand your point.

Let's say I run a lemonade stand as an individual, and this year the stand makes a profit of $100,000. Let's say individual income tax is 30%. I'd pay $30,000 tax, right? So I'd be left with $70,000 in my pocket.

What if I had decided to set up the lemonade stand as a corporation instead? The corporation would pay some sort of profits tax (say 20%, so $20,000). There's now only $80,000 for me. But I have to pay personal tax of 30% of the $80k, so in this scenario I walk away with only $56k.

Why should the total tax take in the two scenarios be different?

How could I change the second scenario, to preserve the corporate structure, but maximise the money in my pocket?

Why should the total tax take in the two scenarios be different?

Why shouldn't they? They are two different situations. Different situations can lead to different outcomes.

The two situations are economically identical. The economic activity is the same. The same amount of profit has been made in each case.

EDIT: Yes, I realise that corporations have specific legal attributes/benefits. However, taxing their profits twice doesn't seem (i) fair, or (ii) likely to provide good incentives.

A corporation is not just a label. A corporation carries a number of legal obligations and protections. If you want those legal obligations and protections, you pay the price for having them. If you don't want them, don't become a corporation.

The fact that the situation appears economically identical is irrelevant, and actually they're not economically identical. Doing business with a corporation is very different to doing business with an individual, because of those obligations and protections.

As another contrived example, stealing ten dollars from someone is economically identical to having that person gift you ten dollars, but they're not remotely the same thing.

You are right that we must pay the price for any legal protections afforded to corporations. I agree that, today, double taxation is part of that price. However, I believe that double taxation should _not_ be part of that price. The two examples I gave should be taxed in the same way. Sure, the corporation scenario may have some additional administration and filing fees, but I don't believe the poor shareholder should pay almost twice as much tax, just to get the protections afforded by a limited liability structure.

You are right that the situations are not economically identical. That was not a useful over-simplification on my part.

Someone drinks your lemonade and has a heartattack. The family sues the corporation and wins millions. However your corporation is a limited-liability entity and so files for bankruptcy.

Your personal income and savings, paid as wages, are immune to bankruptcy proceedings. The corporation loses its cash and holdings, but you don't lose your house.

This is a staggering fiscal and economic advantage. You absolutely should be paying a lot for it given the net effect on everyone else.

Why shouldn't you pay more for receiving the liability benefits of a corporation?

> What if I had decided to set up the lemonade stand as a corporation instead? The corporation would pay some sort of profits tax (say 20%, so $20,000). There's now only $80,000 for me. But I have to pay personal tax of 30% of the $80k, so in this scenario I walk away with only $56k.

Wages are a pre-tax expense for the corporation.

If you paid out the profit of the corporation as a dividend, and you have owned the corporation for a long time* so those are “qualified dividends” in the US, and your ordinary income tax rate is 30%, then you only pay 15% tax on those dividends. That leaves you with $68k, or only slightly less than the other scenario.

(The required holding period is 60 days during the 121-day period that begins 60 days before the ex-dividend date.)

There's nothing special about a bank's business model that requires its profits to be taxed differently from those of other companies.

Incidentally, your characterisation of banks as wholesale brokers of debt is not strictly true. Sure, banks do broker lending transactions between parties. Sure, they do sometimes act as servicers for paper which is held by other investors. However banks are, in the main, risk machines. They borrow money (on their own account) and lend it to others (on their own account). Depositors are their suppliers, and borrowers are their customers. In this activity, they are not brokers. They are wholesalers/retailers, just like other trading companies.

But in this activity the interest they receive on their assets (their lending) is not a revenue. What is revenue to a bank is the different between the interest received and the interest paid plus any other fee.

And by wholesale broker I also included retail deposits.

What you have written is incorrect.

For a bank, interest it receives on its assets IS revenue. The difference between the interest received and the interest paid is their _profit_.

With regard to retail deposits, bank absolutely do not act as brokers. They are not middlemen. Depositors lend money to the bank. The liability shows up on the bank's balance sheet. If banks were acting as brokers, who is the principal on the other side of the deposit transaction?

EDIT: Don't confuse the terms 'Revenue' and 'Net Revenue' when reading a bank's accounts. 'Net' has a meaning!

EDIT 2: The words 'income' and 'revenue' are generally interchangeable.

EDIT 3: I don't think we agree on the definition of the word 'broker'. When I say 'wholesaler', I mean someone who buys something with the intention of selling it at a higher price. When I say 'broker', I mean someone who brings together two parties, and is paid a commission by one or both parties, for his/her part in helping the two parties making a deal between themselves.

That not the way I read a bank income statement. If we take the example of JPMorgan (p3): http://files.shareholder.com/downloads/ONE/239936797x0x82007...

Revenue is defined as Non interest revenue (fees) plus interest income minus interest expense.

This is typical for banks. And there is a reason for that. A bank is effectively a wholesale buyer (lender) and seller (borrower) of debt, through loans and deposits. The interest paid and received is essentially pass-through.

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