Seattle’s High-End Wage Tax and Taxing Stock Returns

August 24, 2020

Sometimes random events come together in ways that help clarify our thinking. I had such an event last Friday. I was happy that day because Bloomberg ran a column by me on an idea I’ve toyed with for years: replacing the corporate income tax with a tax on stock returns.

The logic is that this is a simple and largely foolproof method of taxing corporate profits. Since the components of stock returns (capital gains and dividend payments) are public information, corporate tax liabilities could be determined on a simple spreadsheet. And, there is nothing for companies to argue over or contest, we know how much their stock rose and we know what they paid in dividends. If the corporate tax rate is 25 percent, that is what they owe, end of story.

By chance, on the same day, someone e-mailed me a piece from Fortune magazine on how Amazon is offering employees the opportunity to leave Seattle to move to offices in surrounding suburbs or other locations. As the piece indicates, at least part of the motivation for shifting employees out of Seattle is a tax on high-end wages that the city passed this summer.

Under this new tax, mid-size businesses (revenues between $7 million and $1 billion) would pay a tax of 0.7 percent on wages between $150,000 and $399,999. It would pay a tax of 1.7 percent on a worker’s pay in excess of $400,000 a year. Large businesses, with revenue of more than $1 billion a year, would pay a tax of 1.4 percent on wages between $150,000 and $399,999. They would pay a tax of 2.4 percent on a worker’s pay in excess of $400,000 a year.

This means that a mid-size business that pays a worker $1 million a year would pay a tax of $11,950 for that worker. A large company that paid a worker $1 million a year would pay a tax of $14,400. If we carry this out a bit and take a large company (e.g. Amazon) that pays a worker $5 million a year, we get a tax bill of $113,900. If they have ten workers in this category (stock options count as pay) then the tab would be $1,139,000.

I’m not doing this arithmetic to imply that this tax is a huge burden on Amazon. It’s an enormous company and can easily afford this tax hike. It’s also not a problem if this money comes out of the pockets of high-end earners, as would almost certainly be the case over time. Most of the upward redistribution of the last four decades has gone to high-end earners like these Amazon employees, not corporate profits. If these folks at the top see their pay knocked down a couple of percents, that is all to the good in my view.

My reason for pointing out the price tag of this tax is to show how much more it will now cost to keep high-end employees working in Seattle, as opposed to its suburbs, or in other locations around the country. If Amazon can persuade, or force, a worker earning $5 million to switch from Seattle to an office in a nearby suburb, it will save itself $113,900 a year. While Amazon can afford this payment, it is a safe bet that it would rather not make it. The piece in Fortune suggests that they have made this calculation and concluded that it would be a good idea to get much of Seattle’s high-end workforce to move out of the city.   

Whether Amazon’s behavior is typical or exceptional remains to be seen, and we also don’t know what share of their high-end workforce will actually be leaving the city. But clearly it is possible that a substantial portion of the people who were targeted by this tax will be relocating outside of the city.

After all, it is not that difficult for a company to shift the offices of a small number of people to nearby suburbs. We are all used to communicating through the Internet these days and we still have phones. And, nothing prevents people with offices in the suburbs from physically checking in on subordinates and colleagues in Seattle from time to time.

They can do plenty of these in-person visits without violating the law, and even if they did exceed the limits to make themselves a Seattle worker for tax purposes, how would the city enforce the tax law? Would it require logs of hours for Amazon workers who ostensibly don’t even work in the city?

To be clear, I would hope that most employers don’t play games and that Seattle does collect the expected tax revenue. I know several of the people who played central roles in getting the tax implemented. They are long-time friends and political allies. I would hate to see their efforts wasted, but I worry that will be the result.

When it comes to imposing taxes on the rich and corporations, we have to recognize first and foremost, they are not our allies. They do not want to pay higher taxes. There are some civically-minded rich people who will cough up the money they owe, but we should assume that most will do everything they can to try to avoid or evade their tax burden. (Avoiding a tax means using a legal method to get out paying it. Evading a tax means breaking the law by not paying it.)

This is why when we consider tax proposals we have to consider all the ways that they can be circumvented. The rich pay tax lawyers and accountants huge sums to find ways to get them out of their taxes. The arithmetic is straightforward. If we have a tax rate of 60 percent, then the rich will be willing to pay up to 59 cents to hide a dollar of income. Or, to make the numbers more realistic, they would be willing to pay up to $599,999 to hide $1,000,000 of income.

If those of us who don’t spend their lives developing tax avoidance schemes can find a plausible path for tax avoidance in a few minutes, it is a sure bet that the professionals will have the trick perfected long before the tax takes effect. In order to avoid wasted efforts, we have to beat up our tax proposals as best we can to ensure that we are actually raising the expected revenue and not just creating jobs for high-priced tax lawyers.


Taxing Stock Returns

This brings me back to the idea of replacing the corporate income tax with a tax on stock returns. Most progressives would like to see the government raise more revenue from taxing corporate profits. The logic is straightforward, the vast majority of stock is held by people in the top 10 percent of the income distribution, with close to half of all shares being held by the richest one percent. If a corporate income tax reduces the money that corporations give to shareholders, either directly as dividends or indirectly through higher share prices, it will be a highly progressive tax.

The problem with the corporate income tax is that we have had considerable difficulty collecting it. Prior to the Trump tax cut, the nominal corporate tax rate was 35 percent. Due to various loopholes, the actual amount of tax paid was typically in the range of 20 to 22 percent of corporate profits.

The Trump tax cut lowered the nominal rate to 21 percent. The reduction in rates was supposed to go along with an elimination of loopholes so that we would collect something close to a 21 percent nominal tax rate. That is not what happened. In 2019 tax collections were just 13.3 percent of corporate profits. That amounts to a cut in the corporate tax rate of close to 40 percent, a pretty nice gift for the richest people in the country.

If instead of taxing corporate profits we targeted stock returns, we could be certain of collecting the tax rate we had targeted. Stock returns are dividends and capital gains, both of which are public information. We could calculate every public company’s tax liabilities on a simple spreadsheet.

In addition to largely eliminating the possibility for tax avoidance, this switch would also put a huge number of tax lawyers and accountants out of business. The tax avoidance industry itself is an important source of inequality since many of these people get lots of money to reduce the tax liabilities of the rich. We would also save the I.R.S. money on collection and enforcement. They could redirect personnel to reviewing the books of privately traded companies or others who might be ripping off taxpayers.

We’ll see if anyone in the Biden administration, or a hopefully Democratically controlled Congress, is interested in actually collecting the corporate income tax. But the point is that we can write laws in ways that are enforceable, and we have to be sure we do.


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