Financial Management Define Progressive Taxes

Financial Management

Define progressive taxes and explain why this is important to a corporation's form of business.

Progressive taxes are imposed upon the wealthy and they are used to fund different social programs for the rest of society. This means that anyone who: earns more income, has high levels of personal net worth or are innovating will be subject to paying greater marginal rates. In America, this is considered to be a very unfair tax by directly going after those individuals who are creating jobs, investing and building the economy. ("Progressive Taxes," 2012)

For many corporations, this is challenging because they will have to pay higher amounts. While at the same time, the partners, officers and shareholders must account for any income that is received. This means that the firm and the individual are paying taxes twice on the same funds. ("Progressive Taxes," 2012)

When this happens, most entrepreneurs and investors will become frustrated. This is the point that they will seek out shelters and other write offs to avoid these issues. For example, in the last Presidential election the challenger Mitt Romney only paid 14.1% in taxes on $20 million that he received in 2011. This is much lower than the 38% that he is supposed to be paying under the normal rate. ("Romney Forgoes Full Charity," 2012)

What makes the situation so troubling; is he is one of the founders of Bain Capital Management. They were buying up firms and showing them how to reduce their costs since the mid-1980s. At the heart of their focus, was to use outsourcing as a way to reduce expenses and tax liabilities. This meant that many of these firms transferred their operations to countries that did not have a progressive tax structure (such as: India and China). ("Romney Forgoes Full Charity," 2012)

This helped to make these firms more competitive by reducing their cost structure and giving them greater flexibility. For a corporation, this increased their bottom line results and the total amounts of income they are generating. When this happens, investors are pleased with the direction of the firm and will reward the managers with lucrative pay packages and other benefits. ("Romney Forgoes Full Charity," 2012)

The reason why this is important is because corporations' can avoid having to pay the same taxes twice under the progressive system. The way that this occurs is the company can take a write off for operations they have overseas. This is because they can argue that the income was not generated within the United States. When this happens, they will be taxed at a lower rate for any kind of profits from these locations. ("Romney Forgoes Full Charity," 2012)

If a firm is generating a certain percentage of their earnings using this strategy, they can reduce their tax liabilities dramatically. This is from not having to pay the progressive taxes in U.S. And the country where they have established operations. When they are reporting their earnings, this will lead to an improvement in their costs and operating margins. ("Romney Forgoes Full Charity," 2012)