Federal income tax and business economic implications

Tax Law

The Nature of Federal Income Tax

The Federal Income Tax, History & Implications

Issues in the Taxation process

The need for reform

The tax laws of a country determine the profitability and adaptability of any business. The fundamental consideration in any economic system is the income and income tax. Income tax provides the state with revenue more than any other type of tax, and it has a lot of impact on economic growth and macroeconomic equilibrium in the economy. Consequently individual income tax and corporate income tax are seen as vital source of revenue and also an instrument to control inflation and bring out the economy during recession. For business, the income tax is a deterrent tin many spending and investing avenues, while at the same time forming an important part of the balance sheet, salary consideration and payments. The law therefore is very important in transactions of any commercial nature. The penalties for even inadvertent violations can be quite severe. This paper aims at unraveling the relation between the business economy and the federal income tax which is itself a subject of controversy.

The Nature of Federal Income Tax

Federal taxation is the major factor of funding for the U.S. government. In other words the existence of the Federal government is based on the generation power of its tax policies. The federal government relies on a number of tax instruments; the chief being income tax, the government also relies on excise tax, gift tax and so on. Business decisions are often made without considering the incidence of tax, which proves to be erroneous. Individuals are concerned with personal income tax while corporate ought to be concerned with the corporate income tax. Cost difference exists even between the different types of business entities like companies, partnership and proprietary concerns. The consideration of the tax consequences of any financial transaction or activity is a vital need to be successful in personal and corporate savings on tax. Non-payment or miscalculation of tax payment can have very disastrous consequences.

In the U.S. individual form of income tax is considered to the important factor with regard to revenue, accounting for 55% of government revenue. Corporate income tax after the tax reform act of 1986 created revenue of 35% from corporate entities. Corporations are taxed to almost 52% on their income. Tax evasion is a crime but avoidance is not. When the tax payer does not report an income taxable by suppressing it, an offence is committed that can lead to heavy penalties and even imprisonment. On the other hand tax avoidance is legal and that is one of the economic considerations of transactions. The IRS which is the authority that collects tax considers understatement of income, wrong deduction or accounting lapses. Corporate tax avoidance is important in creating policies, for all transactions including payments to stock holders as these are also taxed. The Internal revenue code, which lays down the rules for assessing tax, does not limit an entity from saving taxes. With this information it is easily possible to see the importance of taxes especially federal income tax and its impact on business.

The chief contribution in tax revenue is by federal income tax - to the amount of over nineteen billion Dollars in 1996 followed by social security to ten billion Dollars, and all other state and property taxes following suit. The economy which is composed of agrarian and business sectors have different tax burdens. For example the agrarian sector can use the cash accounting method to compute tax while the business and individuals have to use the accrual method. The difference in tax on investment in real estate and development is designed to give a boost to the industry. The current subjects of tax in the income tax sphere are individuals and corporations. Every U.S. citizen is liable to be taxed on their annual income from all sources. The tax is computed after deductions legally allowed.

The IRS code defines income as being attained from any source and will also include gains from any situation like interests, alimony, pensions, insurances and most of the earnings will be treated as income. The income of the individual accrues from either service or business activity. Wages and salaries form the major tax subject for individuals. Corporations are legal entities and income of corporations and business is also taxed as for the case of individuals. Under this policy, the income of the company is also paid out as dividend to shareholders, and for this also the company would have paid tax, and the dividend holder also pays tax for the amount as added to his or her private income. This anomaly is called as 'double taxation'. The governments in the economic interest of the country must always strive to avoid double taxation. Some of the deductions allowed are contributions to specified charity, interest available on the mortgages, tax which is being paid on the property, and certain deductions allowed on other taxes paid to the state of residence. These exemptions are available to individuals and corporate entities.

The Federal Income Tax, History & Implications:

The power of the U.S. government to levy the Federal income tax is derived from the 16th amendment to the constitution. The act called as the Federal income tax law came into force in the year 1913. The procedures and codes were later codified into the internal revenue Code in 1939. The code was re written a number of times. The latest - the 'Internal revenue Code of 1986' came to be after the legislature had passed in 1986 the Tax reform Act of 1986. The official orders of the IRS are called revenue rulings, and are procedures to be followed in all aspects of the tax matters. Revenue rulings ought to be obeyed and must figure in transaction cost calculations. Sometimes the authority issues procedure guidelines which also help in keeping up with the tax incidence and if necessary be used of avoidance of tax.

The need for reform

The confusion and the mind boggling procedures, arguments and counter arguments with disgruntlement in the system of progressive taxation and double taxation has prompted alternate suggestions which include separating the income from stocks and limiting its tax. Similarly the insurance companies which could hold a part of their income as future liability have now been restricted in the amount that can be held in this manner. This passes on the incidence of taxation to the end users.

It is pointed out that the subject of the federal income tax both in a legal context and in the context of economic discussions has become so complex that there is no one single solution to alter it and make it universal and functional and keep the principles of the cannons of taxation intact. Some other tax structuring alternatives like VAT or value added tax has come in vogue. However the income tax remains! Some of the alternate to income tax which was promoted as being simple and whole were a national sales tax as discussed, the VAT, and consumption tax which will be flat and for the business a cash flow tax. The income tax was sought to be kept 'pure' with the narrowed down proposal of income. The globalization of the economy and the prospect of American ventures abroad and Joint Corporation or partnering with corporate from other countries have thrown up a plethora of new demands. The opinion held by experts now is that there must be a reform, a reform such that the federal income tax is completely eliminated, which will lower the cost of capital. It is argued that the lowering of the cost of capital will have two implications, one the fund for expansion overseas and second by simplifying the process attract the investment from abroad.

The Opinions and alternate suggestions to the federal income tax are plenty and the arguments for its removal as explored above are also numerous. Some scholars have come out with workable alternate suggestions. The savings in the economy, it is argued is very important for investment and stability. Savings if made is taxed by the income tax and therefore in today's economy the trend is to save less. The savings rate in the U.S. economy is declining very fast. Its impact will be on investments in the future because in a macroeconomic model, savings ought to be equal to investments. Eminent economists like Laurence J. Kotlikoff studied the impact of tax on "U.S. saving, investment, and growth of the total elimination of federal personal and corporate income taxes in favor of a uniform national sales tax." The argument goes to show that when ever a person purchased something a uniform sales tax will ensure that it is paid at the final point of sale thus distributing the tax burden while at the same time doing away with the entangled and complicated law regarding income tax.

Such a switch will be a total departure from the current government system and the new tax must be made so clear and unambiguous that there will not be any room for confusion over assessment. The argument is that "in choosing a national sales tax we also would finally be making a choice between taxing consumption and taxing income, and we would be picking the tax base, namely consumption, that is most conducive to growth of saving, investment, labor supply, and output."

Taxing is based on changes as it is perceived by the authorities and the subject of the tax has been varying from unit to unit. Tax and its subjects are kept changing continuously and this coupled with targeting, like targeting consumption in 1981, and finally the last reform in 1986 has created destabilization in the economy and also a mixed tax structure half way suited to income tax and another half an amalgam of all the policies that were experimented with. It is argued that the solution is to do way with the federal income tax and replace it with a flat national income tax. Eminent personalities and thinkers are of the uniform opinion that the federal income tax is a mammoth that serves the treasury but depletes the economy with un-computed cost in its collection to all the components of the economy and is therefore too costly to maintain further. The general opinion is that it must be scrapped. Various authors have given various view points as to what must replace it. Some of the suggestions like VAT have been implemented in Europe and Asia. However the personal income tax still remains. Corporate tax avoidance can be interpreted by the IRS under section 249 as a sham.

The 'principal purpose' that needs to be established for corporate expenditure as it was stated, can also be avoidance of tax. But the interpretation of every action of a corporate entity has to be assessed by the experts for tax liability on account of the shadow of the federal income tax on the activities. To a great extent this hampers the market forces from operating in the economy. These are some of the greater difficulties and the effects of the law that is pointed out for its abolition. However we must also concede the point that being the greatest revenue earner with no other single agreeable solution in sight, what ever is their stand, any ruling party or government will be very slow and choosy in removing this tax which appears to have outlived its value.

Conclusion

In analyzing the federal income tax laws, we may conclude in the light of substantial evidence that the tax is the most revenue earning source for the federal government with a contribution of over 55% of all revenue. Tax form the corporate sector is 35%. The constant amendments, additions and modification to the law has made it so complicated that it is now costly to sustain it both from the view point of the taxpayers and the view of the establishment. The Internal Revenue Service causes excess burdens and overheads in introducing procedures. We can consider some alternatives like the proposed flat tax. But the arguments that it is not just to impose such a tax which will tend to favor more rich, and alternates like uniform sales tax, and other suggestion shave shown that the act can be replaced. It is true that the complicated nature of the tax and the fear of loss for investors reduced savings and retarded investments. Then the consideration to abolish the tax and seek some other system that can generate revenue exactly in the same proportion is necessary. To avoid stagnation and promote investments, there must be a separation between the income from stocks and other incomes. The globalization of the economy with venture abroad, and foreign investment in the country and the necessity of entering into tax treaties have made tax reform very urgent.

Now is the time when we must consider the method of reform such that the federal income tax is completely eliminated, which will lower the cost of capital. This is imperative to overcome not only the current market slump but also see that economic depression never occurs in the economy as a result of poor savings and investment. Strong supporters of reform have come out with suggestions like a 'uniform sales tax', 'flat national income tax' and so on. They have been examined, and the limits of this paper do not permit discussing the merits of each. However from the readings one fact stands out very clear: The federal income tax while filling the coffers of the state has become a burden on the taxpayer and the economy, and has hampered the free enterprise which is the backbone of the American dream. The tax law requires a battery of trained personnel to cater to the business and individual on account of the complex nature which the code has attained after soma my reforms. The white elephant must go, be phased out or totally scrapped. It ought to be replaced by a law that is simple, and not based on the individual personal income.