Potential partners: Michael Shuman, Marjorie Kelly, B-corp staff
No. Benefit corporations are neither nonprofits nor hybrid nonprofits. They are for-profit companies that want to consider additional stakeholders, morals or missions in addition to making a profit for their shareholders. Nonprofits cannot be benefit corporations, but they could create one. Because of the public benefit purpose provisions, expanded fiduciary duties of directors, and additional shareholder rights created within the model benefit corporation legislation, this structure could be useful to operate and scale the earned-income activities of a nonprofit.
No. Benefit corporations do not have to be audited or certified. Not by B Lab; not by anyone. Benefit corporations and Certified B Corps are different. You can learn more about that here.
Many different types of businesses have become benefit corporations since the first law was passed in Maryland in 2010. The benefit corporations currently incorporated in the United States come from many different industries, including retail, manufacturing, tech, service, professional services, private education, and food and beverage production. Benefit corporations also come in all sizes, from small one-person service companies to large-scale international brands with many employees.
A few examples of well-known benefit corporations include Method, Kickstarter, Plum Organics, King Arthur Flour, Patagonia, Solberg Manufacturing, Laureate Education and Altschool. You can see B Lab’s best attempt to track the number of benefit corporations here.
Benefit corporations have raised capital from many different types of investors in the private markets from traditional to impact focused funds. An increasing number of investors are also supporting their own portfolio company’s adoption of benefit corporation status. To see case studies of benefit corporations raising capital and a non-exhaustive list of investors that have a benefit corporations in their portfolio click here. To investigate some of the reasons why investors might like benefit corporations click here. For an investor FAQ click here.
Benefit corporations are also moving into the international and public markets. In October Laureate Education, the largest degree-granting higher education institution in the world, announced that it was filing an S-1, and that it would do so as a benefit corporation. Laureate’s 88 institutions across 28 countries graduate on average nearly 60% of their 1 million students (roughly the same graduation rate as for all U.S. higher education institutions), at least 34% of whom are from underrepresented populations. With over $4 Billion in revenue, Laureate is also the largest benefit corporation in the world. Italy also made news in December when they became the first country outside the US to pass benefit corporation legislation.
Yes, the benefit corporation form was designed to protect the mission of a company when it goes public. There are currently no public benefit corporations. However, in October 2015 Laureate Education, the largest degree-granting higher education institution in the world, announced that it was filing an S-1, and that it would do so as a benefit corporation. Laureate’s 88 institutions across 28 countries graduate on average nearly 60% of their 1 million students (roughly the same graduation rate as for all U.S. higher education institutions), at least 34% of whom are from underrepresented populations. With over $4 Billion in revenue, Laureate is also the largest benefit corporation in the world. Natura, a public company traded on the Sao Paulo Stock Exchance with a $12B market cap, amended it’s articles to include stakeholder comittments similar to the commitments found in the benefit corporaiton statute. Natura’s instiatutional shareholders, including T.Rowe, Lazard and Oppenheimer approved this legal amendment by voting in favor. You can ready Laureate’s S-1 here.
Shareholders retain all the protections that they have in a traditional corporate model. First, they have all their corporate governance rights. They elect the directors and vote on major corporate transactions such as charter amendments or mergers. Conflict transactions will still be subject to a searching entire fairness analysis whenever challenged, so that directors cannot pursue their own interests ahead of the interest of shareholders. Shareholders will retain the ability to bring the same types of lawsuits they can bring against a traditional corporation, including demands to review the company’s books and records, election review proceedings to make sure elections are being conducted fairly, and derivative suits to pursue corporate claims against directors for breach of fiduciary duty. The only change under the benefit corporation model is the value proposition: the idea that true long-term value is built by aligning all stakeholder interests, including the interests of shareholders.
- High vote into and out of form gives shareholders “mission insurance” over the long-term
- Private right of action allows shareholders to enforce mission
- Annual benefit report provides transparency regarding progress towards mission
- In the absence of applicable case law, director decisions will be treated with similar deference to that afforded other business judgements under current law.
If you are starting a new company, you can simply incorporate as a benefit corporation in any state where legislation has been passed. The procedure for incorporation is nearly identical to that followed for any other corporate structure with the addition of a statement that the company is a benefit corporation. For state by state instructions click here.
If you have an existing company, you can elect to become a benefit corporation by amending your governing documents. Amendment requires a 2/3 super-majority vote of all shareholders in most states. The procedure for filing amendments with the state is identical to that followed for any other corporate structure with the addition of a statement that the the company is a benefit corporation. For state by state instructions click here.
Consult state requirements: The specific requirements for benefit reports differ slightly from state to state. More information on requirements for your state is available here.
Follow best practices: B Lab believes that there is a best practice for benefit reporting, which are reflected in the model legislation. More information on best practices is available here.
Choose a third-party standard: Benefit corporations are required to use a third party standard to assess their creation of general public benefit over the course of the previous year, but do not need to be certified or audited by this third party standard. B Lab believes that the B Impact Assessment is the best available standard for benefit corporations. The B Impact Assessment is available for free for those that do not wish to have a verified or certified report. More information on choosing a third-party standard can be found here.
Check out examples of benefit reports.
Yes. To see a listing of these attorneys, click here.
No. Third parties do not have legal standing to sue a benefit corporation, unless granted by the shareholders.
No. B Lab is has not been told by the more than 3000 existing benefit corporations across the country that they have had difficulty obtaining D&O insurance or been asked to pay a higher premium.
This experience is corroborated by meetings with brokers at Marsh McLennan and underwriters from several major D&O (director and officer) insurance carriers, including ACE, Chubb and Zurich.
Some say that over time benefit corporation might enjoy reduced rates as a result of their enhanced governance regime and stakeholder engagement.
Directors must manage the corporation in a responsible and sustainable manner.
Directors must manage or direct the business and affairs of the benefit corporation in a manner that balances the pecuniary interests of the stockholders, the best interests of those materially affected by the corporation’s conduct, and the specific public benefit or public benefits identified in its certificate of incorporation.
Directors must also provide a biennial, annual in Colorado, report to the shareholders on the corporation’s promotion of the public benefit identified in its certificate of incorporation and of the best interests of the stakeholders.
- The benefit corporation acted in accordance with its general public benefit purpose and any specific public benefit purpose in all material respects during the period covered by the report.
- The directors and officers created general public benefit.
- If, in the opinion of the benefit director, the benefit corporation or its directors or officers failed to act or comply in the manner described above, a description of the ways in which the benefit corporation or its directors or officers failed to act or comply.
Some states have passed, “constituency” statutes, which permit directors of traditional corporations to consider the same type of non-financial interests that directors of benefit corporations can consider, However, constituency statutes do not commit directors to considering these other interests, and thus do not create the accountability created by benefit corporation statutes. For a discussion of accountability under benefit corporation law, see here. Moreover, constituency statutes do not provide for any transparency with respect to the board’s consideration of the non-financial interests. For a discussion of transparency requirements under benefit corporation law, see here.
An LLC could currently amend its membership agreement to incorporate any of the benefit corporation provisions. However, because LLC law is based on contract law institutional investors prefer the corporate structure, which is constructed in statute and case law, over LLC’s. Any company with plans to raise outside capital or go public is better off with a corporate rather than an LLC structure. The benefit corporation thus provides the most effective corporate structure for scaling social enterprise and innovation.
Based on our analysis of mission-driven businesses, and because they are legally obligated to create a material positive impact on society and the environment and to consider the impact of their decisions on all stakeholders, there are three primary ways benefit corporations help nonprofits: more charity; more volunteerism; and fewer problems. Due to the imperative to create general public benefit, benefit corporations will be more likely to donate a higher percentage of their profits than ordinary corporations to support nonprofits. Benefit corporations are also more likely create opportunities for their employees to volunteer for nonprofit organizations and are less likely than ordinary corporations to create or exacerbate social or environmental problems as a result of their business practices.
Certified B Corporations (see explanation of the difference between Certified B Corporations and benefit corporations above), are very similar to benefit corporations and empirical data shows they give significantly more than the market average to charities and volunteer more of their employees’ time to charitable causes than their traditional corporate counterparts.
Before embarking on an effort to pass benefit corporation legislation, please contact B Lab. We have been the spearhead of advocacy and education in the passage of legislation in all 27 states and also working on passing legislation in 16 more states. We can provide a wealth of experience, information and materials that can aid in your the legislative and advocacy process. B Lab also works with attorneys from Drinker Biddle & Reath who can draft legislation specifically for your state. You can find more detailed information on B Lab’s recommended best practices for the benefit corporation legislation legislative process here.
B Lab recommends using the model legislation for the basis of any new legislation. B Lab and the pro-bono attorneys at Drinker Biddle & Reath are available to draft a version of the legislation tailored to your state’s specific corporate law. Using the model legislation has several important advantages:
- Expertise. The Model Legislation was drafted by Bill Clark from Drinker, Biddle, & Reath LLP and has evolved based on input from state legislatures, state bar associations, Secretaries of State offices, Attorneys General offices, associations, nonprofit groups and businesses in the states in which the legislation has been passed or introduced. It reflects the expressed needs of business leaders and investors interested in using the power of business to solve social and environmental problems, and has been conformed to local corporate codes by local corporate attorneys.
- Consistency. Using the model legislation ensures that your state remains consistent with the other states that have passed the legislation. This is particularly important for investors who rely upon this consistency to reduce their due diligence requirements when evaluating a company. The ability to recognize that a benefit corporation is the same in Illinois as it is in Florida allows the free market to function effectively.
- Conformity. The Model Legislation has been drafted so that the existing corporation code applies to benefit corporations in every respect except those explicitly stipulated in the Model Legislation. This drafting approach avoids the potential legal and administrative issues that will arise in keeping a new corporate form in conformity to the corporation code as changes to the corporation code occur over time.
It doesn’t. Benefit corporation legislation is cost-neutral or low cost and in some states has been a revenue generator. Benefit corporations are still taxed as a C or S corp and so state tax revneue should not change.
Many benefit corporations are required to publicly publish an annual benefit report that includes “an assessment of [its] overall social and environmental performance against a third party standard.” In most states, the statutes simply require the use of a third party standard as a rubric for producing the report, similar to how we use the third party created Generally Accepted Accounting Principles (GAAP) for financial reporting.
The transparency requirement is intended to help the benefit corporation, directors, shareholders, investors and the general public determine whether the benefit corporation has met its expanded corporate purpose to create general public benefit.
In the model legislaiton, a third party standard is defined as “a standard for defining, reporting, and assessing overall corporate social and environmental performance”.
- Government has no role in determining whether a selected third party standard is acceptable or whether the benefit corporation has met its benefit corporation purpose to create a material positive impact;
- Benefit corporation legislation does not require benefit corporations to adopt any particular third party standard in preparing its annual benefit report; and
- Benefit corporation legislation does not require the annual benefit report to be audited or certified by the standards organization.
It is up to the benefit corporation, the directors, and ultimately the shareholders, to judge whether any particular third party standard fits the statutory definition.
Most importantly, the primary objective of this legislation is to create a new corporate form that can not otherwise be achieved under our current laws and case law. This objective requires the legislation to consider society and the environment, in whatever way the company wishes, and not simply to consider one-off safe harbors that can arguably be done already under law.
The ‘general public benefit’ purpose helps prevent abuse of this legislation by corporations interested in green-washing. Without the ‘general public benefit’ purpose, a corporation could name a single, narrow ‘specific public benefit’ purpose (e.g. keeping the river in back of the factory clean from toxic effluents) and then ‘consider’ and dismiss all other non-financial interests when making decisions, which would not meet the primary objective of this legislation to create a new corporate form whose corporate purpose requires it to create benefit for society generally. Additionally, without the continual consideration of society and the environment a company could choose a short-term safe harbor and still be considered a benefit corporation after the consideration is completed. The legislation prevents this and allows the company flexibility to change with the dynamic forces of the market.
To meet the transparency provisions of model benefit corporation legislation, all benefit corporations are required to create a benefit report. The transparency provisions serve not only to inform shareholders so they are better able to exercise their rights, but also to inform directors so they are better able to meet their duties and finally the public about the overall social and environmental performance of the benefit corporation.
In a benefit enforcement proceeding, judges may also look to a benefit report, or series of annual benefit reports, to determine if the benefit corporation has met its statutory requirement to meet its general, and any named specific, public benefit purpose.
No. Benefit corporations are for-profit entities and do not offer philanthropists the same tax advantages as donating to a nonprofit organization. Benefit corporations seek equity or debt investments that presume a return on investment for the investors, while nonprofits seek charitable donations that presume no return. Benefit corporations simply expand the range of opportunities for individuals or institutions to use their investment capital – not just their philanthropic dollars – to create a positive impact on society and the environment.
Chronicle of Philanthropy, ‘Businesses with a Social Conscience’ by Phillip Henderson, President, Surdna Foundation
A B Corp is like a non-profit in that it must work with the greater public good in mind, and not just the good of a few select shareholders. However, unlike a 501(c)(3) organization, it is still taxed as a business, which doesn’t seem entirely beneficial to anyone who is a B Corp. In fact, B Corps and Benefit Corporations currently receive no specific tax benefits over traditionally incorporated businesses.
Unlike traditional corporations such as an S Corp or LLC, B Corps are subject to rigorous scrutiny of their practices and policies to ensure they are holding themselves to the highest ethical standards.
The way it works is that to become a B Corp, a company must fill out what is called an Impact Assessment. In order to qualify as a B Corp, companies must score at least 80 out of the 200 points available.
The criteria for evaluation encompass a considerably large range of issues, such as: Does the company have a policy of sharing financial information with employees? What percentage of overseas vendors have you visited to tour their facilities? What percentage of employees are women? What percentage of your energy comes from renewable sources?
Author Looks To Other Countries To Rethink America’s Complicated Tax Code
TERRY GROSS, HOST:
This is FRESH AIR. I’m Terry Gross. It’s tax time in two ways. While those of us who are last-minute folks are either trying to make sense of the often incomprehensible tax forms or paying someone else to do it for us, the Trump administration is trying to move forward on the president’s promise to overhaul the tax system. So the timing is perfect for my guest T. R. Reid’s new book, “A Fine Mess.” The mess he refers to is our bizarrely complicated tax code.
The book compares our system with those of other countries in an attempt to figure out what a simpler, fairer and more efficient system might look like. Reid is a former Washington Post foreign correspondent and has lived with his family on three other continents. He has two previous books about subjects that remain urgent – the quest for better, cheaper and fairer health care and the future of the European Union.
T. R. Reid, welcome back to FRESH AIR. So congratulations on writing a book about taxes that I can understand, unlike tax forms…
T R REID: (Laughter) Thank you.
GROSS: …Which I cannot understand. To get in the mood…
GROSS: …For this conversation, I’d like you to quote one or two of your favorite incomprehensible tax instructions from the tax forms.
REID: You know, I – I’m now doing my own taxes because I wrote a book about how hard it is.
REID: Here’s a gem – enter 6 percent of the smaller of line 40 or the value of your Archer MSAs on December 31, 2015, including 2015 contributions made in 2016. Include this amount on Form 1040, line 58A or Form 1040NR, line 56B. Pretty simple.
GROSS: (Laughter) So this is why…
REID: And it doesn’t have to be that way. That’s what’s really galling.
GROSS: You talk about countries where everybody does their taxes in, like, 15 minutes because it’s that simple.
REID: You know, I was in the Netherlands on March 31 – their tax day is April 1 – talking to a – you know, a manager. He makes about 200,000 a year. He has a whole panoply of investments, two kids in private schools, two mortgages. He’d have to fill out 12 forms in the United States.
And I said, Michael, how do you do your taxes? They’re due tomorrow. He says, well, I pop a beer. I go online and see if the government’s got the numbers right. And if they do, I hit a button. Takes five minutes. He says, but you know, sometimes I start checking the numbers. You – he says, you know, you start checking the numbers, it could take almost half an hour just to pay your taxes. He was outraged.
GROSS: Wow. So you have your new book on tax overhaul of the Republicans – are trying to figure out what their plan is going to be because there’s different points of view within the party. But you think the time is really right for a true tax overhaul. You write that, like, every 30 or 32 years, the system is totally revised. That’s not, like, part of the plan. It’s just the way it’s worked out.
REID: That’s right. It’s history repeating itself. So we created the federal income tax in 1913 – very popular tax because the only people who paid it were the Rockefellers and the Vanderbilts. And then it started – grew, the rates went way up to pay for World War I. In 1922, they wrote a pretty complete income tax code. By 1954, it was a mess. It had so many clauses and exclusions and exemptions that President Eisenhower said get rid of it. They rewrote the whole thing. That was the Internal Revenue Code of 1954.
By 1986, same thing. It was a total mess. Nobody could handle it. Ronald Reagan and Tip O’Neill, a conservative and a liberal, agreed to change it. They threw it out. That’s the Internal Revenue Code of 1986. If you look at the pattern there, that’s every 32 years. And sure enough, we’re now 31 years down the line and the thing is a total monster. It’s a mess. Everybody knows we have to fix it, and the time has come.
GROSS: So let’s talk about some of the tax issues that directly affect individuals and families. We’ll look at corporations a little later. President Trump – it’s my understanding that he wants to lower personal income tax. What’s his proposal for that?
REID: Well, he wants to cut rates for all earners and particularly for people who run their own business. If you run your own business, at a certain point you’re paying 39.6 percent in income tax. His proposal would cut that to 15 percent. That’s a huge boon for people who own their own company.
How he’s going to pay for it, he has never made clear. But there is a way to pay for this. I want to point this out, Terry. Other countries have found ways to cut the rates sharply and bring in the same revenue. And the way you do it is you get rid of all the loopholes and giveaways and escape clauses that have found their way into the tax code.
GROSS: So getting back to how Trump wants to cut personal income taxes – like, if you’re not the owner of your own business, has he proposed lower rates for individuals and families?
REID: Well, I’ll tell you the Donald Trump tax plan for individuals. I’ll quote it to you – my tax plan will be so great it’ll make your head spin.
GROSS: (Laughter) And what percentage is that…
REID: We don’t know the numbers.
GROSS: What are the percentages…
REID: They – they’re said to be working on a plan, but we don’t know the numbers. There’s a plan floating around the House that would make three rates – 5 percent, 10 percent and 20 percent. That would be a significant cut for most taxpayers. But, again, they don’t say how they’re going to pay for it, and you can’t really cut those rates sharply without a huge loss of revenue unless you change other parts of the code.
GROSS: So that’s – that would be a progressive tax, but would the rich benefit more from that cut?
REID: Yeah. If you’re paying now at a 12-percent rate and they cut it to 10, that’s a saving. But rich people are paying 39.6 percent. If that gets cut to 20, their tax rate goes down by half.
GROSS: So you say if we cut a lot of the deductions and the loopholes and the exclusions, we could afford to cut taxes and still be ahead of the game. So one of the things that’s often on the table when people talk about ending deductions is the mortgage deduction, which sounds very upsetting because for everybody who owns a home, you can deduct – is it you deduct your mortgage or just the interest from the mortgage?
REID: You deduct the interest, but you only do that if you take the itemized deduction. And only one-third of taxpayers take that. So for two-thirds of American taxpayers, even though it’s there, they don’t get it. And among homeowners, only 20 percent take the mortgage interest deduction. And, of course, they’re the richest 20 percent.
Terry, this deduction costs $103 billion a year. We offer it as a subsidy to the richest homeowners in America. And the argument is, well, we need this to enhance homeownership. No. No, as a matter of fact – Australia, Canada, Germany, Israel, Japan, Netherlands, New Zealand, et cetera, they took away the mortgage interest deduction, and guess what? Higher rates of homeownership than we have.
There’s no indication at all that this thing does its purported purpose which is to enhance homeownership. And it’s only people buying the most expensive homes who get this break. The net result, as I said, $103 billion a year we don’t get that could reduce the deficit.
GROSS: And do you challenge whether it’s fair to give a break to homeowners and not to people who rent?
REID: Well, that’s another issue. Renters – they pay the mortgage of the landlord, but only the landlord gets the tax break. So, yeah, that’s not fair either. And that’s why, you know, it used to be every country had this deduction. And as I said, almost all the rich countries have gotten rid of it and no drop in homeownership rates.
GROSS: So let’s look at charitable deductions. That’s something that you and many people question. Is it worth it? Is it worth it to the individuals who have the charitable deduction? Is it worth it to us as a culture who need taxes to fund the things we need done? So explain how charitable deductions work.
REID: OK. To lead into that, could I just tell you some of the things – many things you get a write-off for in our tax code? You get a write-off for taking a night-school course, paying your property tax, growing sugar cane, moving to a new city, replanting a forest, destroying old farm equipment, employing Native Americans or buying a plug-in hybrid sports car like a Tesla. And we just are full of these things. And one of the biggest ones is the charitable contribution deduction.
It costs the Treasury about $73 billion a year. Again, money that you could use for helping veterans or building a border. And it doesn’t serve its purpose. There’s no evidence anywhere that the charitable interest deduction enhances charitable contributions. For one thing, the most common form of contribution in the United States is when people put five bucks in the plate at church or 10 bucks in the collection box at the soccer club’s dinner. And those are cash contributions. You can’t write them off. They’re not deductible.
Many countries have gotten rid of the charitable deduction. And there’s a pattern. For about one year or two years, there’s a small blip – a drop in contributions. And after about three years, contributions keep going up at the rate of personal income going up.
In other words, Terry, people give money to charities because they want to help others. To me, to give them a tax break for it, it just cheapens the charitable impulse. And also – here’s one more thing. It is so subject to abuse. One of the biggest forms of charitable deduction is giving art to a museum. So you give an old picture to a museum. You hire an appraiser, and she knows that you and the Museum both want the highest possible number. And then you write off this huge number. So the IRS has had to create its own department of art appraisal to judge these appraisals. And guess what? They happen to disagree with the taxpayer 85 percent of the time because people exaggerate this.
Here’s another one I really like. You can do fractional giving. You can give a painting to a museum for three months, you know, while you’re in your summer home in the south of France. And then you come home, you put it back on your dining room wall. And you get a deduction for that. So the thing is really grossly misused, and it doesn’t serve its purpose. It doesn’t enhance charitable contributions. So…
GROSS: Can I do a yes, but here?
REID: Yeah, do.
GROSS: I think for corporations and for wealthy families, they often create foundations or funds that give generously to nonprofit arts and other organizations. And those donations really help keep those organizations going. And mathematically, part of the reason for that is the tax deduction.
REID: Yeah. So here’s my answer to your yes, but – they would give the money to charities that they like whether they got the deduction or not. I mean, what are they going to do? How many Bentleys can you buy? They have all this money…
GROSS: Oh, things don’t work that way (laughter).
REID: They want to help somebody.
GROSS: No, people want profits for their shareholders. But truly, don’t you think, like, for corporations and for very wealthy families that the tax deduction really is an incentive for charitable giving?
REID: Well, I think not. I think corporations want to help their community. And that’s why they match, you know – they match gifts because they want to steer their giving to where their employees want to help. I think they do it out of eleemosynary impulse. They want to help others. And the reason I think I’m right is because in my book, you can look at all these countries that got rid of the charitable deduction, and charitable contributions kept going up at about the same rate that income went up.
GROSS: I just want to clarify. I’m not saying that wealthy families and profitable, you know, corporations wouldn’t give to charity. I just think there definitely is an incentive to do it. And it helps incentivize giving on that scale.
REID: Well, I have to say the Council on Foundations and all charitable development officers would agree with you. But looking around the world, I would tell you, I think that’s wrong, that people give money because they want to help. If you take away the tax deduction for a year or two, they may not, and then they do again.
GROSS: So let’s look at what the Trump administration is likely to be proposing, which includes lowering corporate taxes. So what do you know so far about what President Trump would like to see done?
REID: Our current corporate tax is progressive. But most companies pay at the top rate – 35 percent. That’s just about the highest rate in the world. American companies are being taxed higher than their competitors overseas. Nobody really pays the 35 percent. But even if you take the effective rate – that is, what people really pay – it’s higher for American corporations than elsewhere. This is not working.
Corporations spend tens of millions of dollars to find ways to move their profits somewhere else so they don’t pay the tax. And the result is, even with this high rate of tax, the corporate income tax is now a pretty minor portion of government revenues. In the 1960s, one-third of all revenue came from the corporate income tax. Now it’s about 8 percent because they’ve gotten so good at ducking it.
So it’s just not working. It’s an unfair, competitive disadvantage. We really ought to cut it. And there are various proposals. The Democrats have proposed 35 percent down to 25 percent. The major House plan says 20 percent and Donald Trump, of course – 15 percent.
GROSS: So would there be ways of insuring corporations actually paid it if you lowered the taxes?
REID: Well, one theory is…
GROSS: Because you’re saying there’s so many ways to duck out of paying the money. There’s so many, like, exemptions. You can offshore the money. You could set up, you know, basically fake companies to get around paying taxes.
REID: They all do. I mean, they’re very good at it. I think any chief financial officer whoever paid the 35-percent tax rate would be fired the next morning. None of them does that. Yeah. Just like with the individual income tax, the corporate income tax is studded with loopholes and giveaways and exemptions and credits. There are laws passed by Congress because if you give enough money to your Congress person, she will put in the bill.
And it’s so obscure that most other people don’t fight it. They want to – maybe want to do a favor for one of their constituents down the road. There are hundreds of them in there. And we could dump them. And if we dumped them, then we could lower the corporate income tax rate.
You know, if you have to pay tax at 35 percent or even the effective rate about 26 percent, well then it’s worth it to hire a lawyer or a consultant and spend millions to cut your tax bill. If we got a lower rate and got rid of all those giveaways, then companies would probably pay the tax because it would be cheaper than finding a way to avoid it.
GROSS: If you’re just joining us, my guest is T. R. Reid, author of the new book “A Fine Mess: A Global Quest For A Simpler, Fairer And More Efficient Tax.” We’ll talk more after a break. This is FRESH AIR.
(SOUNDBITE OF MUSIC)
GROSS: This is FRESH AIR, and if you’re just joining us, my guest is T. R. Reid author of the new book “A Fine Mess: A Global Quest For A Simpler, Fairer And More Efficient Tax.” It examines our tax codes and those of other countries to see if there are ways to overhaul our tax system to make it simpler, fairer and more efficient.
So one of the things you found that a lot of countries have which we don’t in America is the VAT, the value-added tax. Would you explain what the value-added tax is?
REID: Yeah. This is the most important innovation in taxation in the last 60 years. This is a tax that’s like a sales tax on steroids. It’s a tax – our sales tax is called a retail sales tax. The tax is only collected when the retailer sells you the book. But on a value-added tax, a tax is collected when the paper mill sells the paper to the publisher and when a publisher buys ink from an ink company and then the publisher sells it to a wholesaler and a wholesaler sells it to a distributor, distributor to the bookstore and the bookstore to you.
That tax is collected at every level, and every time you pay the tax to the other guy, you report it to the government to get a credit for the tax you paid which means every penny of tax that’s paid is reported to the government. So the VAT turns out to be a very easy tax for government to collect and a very hard tax for taxpayers to avoid. And so if you put in a value-added tax, they’re very steady collections, and it’s hard to cheat on.
And you could use that money to reduce the rate of the corporate or the personal income tax. So 176 countries have adopted this innovation. It’s a great idea. The only countries that don’t have it are a bunch of countries so poor they have no taxes and the United States of America. So I say in my book in taxation, Americans are still banging out letters on a typewriter and dropping them in a mailbox, and everybody else is texting and using Instagram.
GROSS: One of the objections to the VAT in the U.S. is that it raises the price of goods because every stop along the way when the goods change hands in the production process and then the sales, there’s a tax that’s added so that – those taxes really mount up by the time you’re purchasing the product.
REID: That’s a fair criticism. It does add to the price of things and creates some inflation, particularly when you first put it in. But as I said, you use those revenues to offset the income tax, so people pay less on April 15, so they have less withheld from their paycheck. And they come out fine.
For the government, it’s easier to collect so you need less bureaucracy collecting the tax. And here’s the other thing. This is a tax that doesn’t tax savings. It doesn’t tax work, doesn’t tax investment. It taxes spending, and economists like that. So that’s why so many countries have it. I went to New Zealand, and they got around to it about 1994. And the finance minister said to me, you know, I knew we needed a VAT, but I couldn’t call it a VAT.
And the reason is every Kiwi who goes to Britain on vacation has to pay the value-added tax, and they hate the VAT. So he produced the same tax, but he called it the GST – the goods and services tax. And I said really? You tax services? He says, yeah, lawyers, interior designers, lawnmowers, you know, we tax all the services.
GROSS: So one more thing about the VAT. It’s not a progressive tax. Everybody pays it. So, you know, people who are poor are paying the same amount on goods and services as people who are rich.
REID: Yeah. That’s a real problem. It could be a problem. It’s a regressive tax. There are two ways to deal with that. One is you exempt stuff that people need – food, medicine, textbooks, diapers, stuff like that – that makes the tax more complicated, but it’s less regressive for lower-income people. I think the better way to deal with that is you charge the same tax for everything and then on the income tax, you give people credit at a certain income level for the VAT they paid. That would work and helps people out.
But this is a reason why liberals don’t like the VAT. They think it’s regressive. As a matter of fact, in most countries, it doesn’t work that way. Conservatives don’t like the VAT because they call it – are you ready? – they call it the money machine. You can raise so much money with it that it bodes higher taxes. But, in fact, when you raise the money with the VAT, then you should use that revenue to lower the income tax rate.
GROSS: My guest is journalist T. R. Reid, author of the new book “A Fine Mess: A Global Quest For A Simpler, Fairer And More Efficient Tax System.” After a break, we’ll talk about the current politics of taxes as President Trump tries to move forward on his promise to overhaul the tax system. I’m Terry Gross, and this is FRESH AIR.
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GROSS: This is FRESH AIR. I’m Terry Gross back with journalist T. R. Reid. His new book “A Fine Mess” is about America’s complicated tax code and what other countries can teach us about how to make it simpler, fairer and more efficient. He’s also been following President Trump’s tax proposals and the reactions of Democrats and Republicans.
From what you’ve heard so far, what stands out in what Republicans are discussing to propose in the tax plan?
REID: Well, I think they’re definitely going to cut the corporate tax rate. Now, everybody wants to do that, and it ought to be done. It makes sense. The question is whether they will pay for it – pay for the lost revenue by eliminating exemptions or with the border tax or something. You know, if you look at the history of what Congress does generally, they don’t pay for it. They give tax breaks. They cut revenues and just add to the deficit.
GROSS: So there’s constantly calls in the world of tax overhaul to decrease capital gains tax. Could you explain how capital gains tax work?
REID: Yeah. Let’s say you’re an executive at an auto company, and you’re paid a salary. And, you know, if you’re paid pretty well, you’re going to pay up to the top rate of 39.6 percent. That’s labor income, and it’s taxed at that rate.
But if you make your money trading stock in auto companies, well, no matter how much you make, those people pay tax at a lower rate. For most people, the capital gains tax – top tax is 20 percent, about half the rate of a rich person on labor income. And the argument for it is what we – it’s risky. It’s risky to invest in a company, so we got to give people a tax break to encourage them to do it.
And what I found around the world is some countries have a lower rate for capital gains. A few countries have no tax on capital gains, but most countries have leveled it off so that the tax on labor and the tax on capital income are the same. And guess what? There is no significant drop in investment or stock prices when you tax the same.
GROSS: You refer to the BBLR – the broad based low rate approach to taxes. Explain what that means.
REID: Well, I went to the International Monetary Fund and the World Bank and said to them what makes a good tax code? Who’s got one? And they said we know, we know fairly simple formula – BBLR. That means broaden the base so you can lower the rates.
Broaden the base means you make everything taxable. You got a paycheck. That’s taxable. Your employer pays your health insurance premium. Well, that’s income to you. We’re going to tax that. Your employer gives you free parking. Well, that would cost 20 bucks a month. That’s taxable. And then no deductions – you want to give money to charity? Boy, that’s great. We’re all for it, but we’re not going to give you a tax break. You have a mortgage interest? Fine, but we’re not going to give a tax break.
And if you do that, that broadens the base, and then you can lower the rates way down. And several countries have done this, and there’s a tradeoff. So people lose their cherished deduction. Oh my, God, don’t broaden my base. I want my deduction. And the carrot is we’re going to give you a lower rate. So in America, a family at the median income – if you take their income tax, their Social Security tax, their Medicaid tax and their health insurance – is paying about 35 percent.
In New Zealand, income tax, social security, health care and education – 17.5 percent for that same family. And the reason is they broadened the definition of income. They took away all the giveaways. And if you do that, you can get the rates way down. And it makes your tax return much easier. You don’t have to fill in 50 lines on all the stuff you want for an exemption.
GROSS: So who’s tried that?
REID: New Zealand did it. Australia did it. Britain did it in a pretty serious way. The Germans did it to a degree. Many countries are – South Korea – are moving in this direction because of two things. First, you get the lower rate, and if you have lower rates, people – compliance is better. People are more likely to pay a tax bill if it’s 12 percent than if it’s 40 percent. And second, it’s much simpler. So that’s the tradeoff. You get rid of cherished deductions, you get a lower rate.
GROSS: If you’re just joining us, my guest is journalist T. R. Reid. His new book is called “A Fine Mess: A Global Quest For A Simpler, Fairer And More Efficient Tax System.” We’re going to take a short break, and then we’ll be right back. This is FRESH AIR.
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GROSS: This is FRESH AIR, and if you’re just joining us, my guest is T. R. Reid, author of the new book “A Fine Mess: A Global Quest For A Simpler, Fairer And More Efficient Tax System.” It examines our tax code and those of other countries to see if there are ways to overhaul our tax code to make it simpler, fairer and more efficient.
So the people who write the tax codes, they’re politicians. And there are competing political philosophies of what taxes should do, how high they should be, how big government which is supported by taxes should be. Can you describe some of the opposing philosophies of taxation that we’re seeing played out now as a tax overhaul proposal is about to be presented?
REID: Yes. Well, we saw part of that philosophical disagreement in the argument over the health bill. The question is how much role should government have in health care? How much role should government have in cleaning up the environment? How much role should government have in regulating businesses? And, you know, a lot of Americans really don’t like the idea of big government. Get it out of my life. And if you cut the size of government, then theoretically you can cut the taxes that pay for government.
GROSS: What are some of the opposing philosophies within the Republican Party right now?
REID: Well, some Republicans want to sharply cut rates on individuals. Some say the thing to do is sharply cut rates on corporations. And in order to pay for that cut, we’d have to keep a fairly steady flow of income from individuals. Many Republicans think we should sharply cut or eliminate taxes on investment and capital gains because that generates the investment we need to grow the economy. Republicans are all over the map and guess what? So are Democrats. There’s really not much consensus, but there was a time in the United States when we had consensus – 1986.
GROSS: So what happened in 1986?
REID: A Republican – conservative Republican president Ronald Reagan and a very liberal House of Representatives led by Tip O’Neill from Massachusetts agreed on a major change in U.S. taxes. And here’s what they did. They took away all sorts of exemptions and deductions and that broadened the base, and then they were able to lower the rates. In the 1980s, the top marginal rate in income tax went from 70 percent to 28 percent, brought in the same revenue because they got rid of all the other stuff. In other words, the pain of losing the deductions was offset by the gain of the lower rates. And that’s how you do tax reform.
A guy in New Zealand told me when they rewrote their tax code, he said the most important thing was don’t do it piece by piece. You got to do a big. You’ve got to do the whole thing. And then for everything somebody doesn’t like in the change, there’s something else they do. And you can pass it, and that’s how the U.S. could do it.
GROSS: You quote something that Donald Trump said before he became president which is that the U.S. is the highest taxed country in the world. Is that true?
REID: That’s an alternative fact, Terry. As a matter of fact, if you take the standard measure of tax burden – it’s called overall tax burden – the United States is one of the lowest taxed of all the rich countries in the world.
Overall tax burden – the International Monetary Fund computes this – you take all the federal, state and local taxes paid in the whole country, add them all up and take them as a percentage of GDP of overall wealth, by that measure of the 35 richest countries, the U.S. ranks 32nd. We pay much lower taxes. We pay lower gas taxes, tobacco taxes, income taxes, Social Security taxes, sales taxes than people in other countries.
GROSS: And we don’t have a value-added tax.
REID: We don’t have a VAT. If we did, our sales tax would presumably be higher. No, we’re a low-tax and a low-effort – they describe it as low effort. If you don’t collect much of the wealth in your country and tax, that’s called low effort. I don’t know if that makes anybody feel better as they’re struggling with Form 1040, but you’re paying less than a German would. You’re paying less than a Brit would, even though it’s harder to pay here.
The places we’re higher are the corporate income tax where we have almost the highest rate in the world, and the estate tax. This is a tax that’s paid by rich people when they die, and their heirs have to pay the tax. If you remember critics have called this the death tax. But I think that’s wrong because it’s the living heir who pays. It’s the lucky rich kid who did nothing and inherited 50 million bucks.
GROSS: How much does your estate have to be worth before it you pay the estate tax?
REID: If you’re single – $5.5 million dollars. If you’re married and leave half of it to the spouse – $11 million. One in 70,000 Americans has to pay the estate tax. So I think it’s a good tax. It doesn’t tax labor. It doesn’t tax investment. It only taxes lucky people who can afford to pay it.
But interestingly, several countries that we would consider pretty lefty have eliminated the estate tax recently. Sweden has no estate tax. Canada got rid of the estate tax, and the slogan in Canada to dump the estate tax – I really like this – was no taxation without respiration.
GROSS: So Paul Ryan, the speaker of the House, is going to try to get through, you know, a tax overhaul in Congress. How would you describe his philosophy of taxation and how that’s combined with his philosophy of government?
REID: Yeah. Well, Paul Ryan, like many Republicans, wants a smaller government. There are a lot of things government does like providing health care that he thinks the private sector could probably do better. So he wants government to get out of the way, and he wants government to get out of our personal income and not tax it so much. And so he has a plan that would cut rates for all corporations and would cut rates for all individuals.
So far, we have not seen in Paul Ryan’s better-way plan how he would make up for the lost revenue. At the moment, it just seems to add to the deficit. But that’s also contrary to Republican principles, so they need to come up with a way to broaden the base if they’re going to lower the rates so they can bring in the same revenue. At the moment, that doesn’t exist.
And, you know, it’s kind of the same pattern we saw on the health care reform, Terry. They had a plan, but the numbers never added up because they never really filled in all the blanks. And so far, that’s the case with the Republican tax plan, too.
GROSS: There are two impulses that seem to be in direct contradiction to impulses within the Republican Party and conservatives. One is cut taxes, and the other is cut the deficit that if you have less money coming in, the deficit is going to grow unless you cut a lot of government which is usually on the table, too.
So I think it’s fair to say that the Republican proposal will have cutting taxes, cutting the deficit and also cutting a lot of services and agencies in government. What do you think the biggest conflicts are going to be over?
REID: Well, so far their plans don’t cut the deficit because all the money they’re saving on civilian agencies, they’re putting into a bigger military. They’re going to build a whole new aircraft carrier task force, et cetera. So far from what we’ve seen, they don’t cut the deficit. President Trump released this budget outline, and it didn’t say anything about revenues. It just said what they were going to spend. So we don’t know. But so far, we don’t see any plan to cut the deficit. Basically if you want to cut taxes for everybody, you can’t cut the deficit.
If you want to cut the deficit, you’ve got to keep your tax revenues the same. If you want to spend more on the military, it’s very hard to cut the deficit. So, you know, Terry, we always get these plans on paper. I’m going to cut this. I’m going to cut that. The classic term is waste and fraud. We’re going to cut waste and fraud, and that’s going to magically balance the budget. I hate to say it, but it’s never worked.
GROSS: So Ted Cruz when he was running for president wanted to eliminate the IRS. Is that a popular proposal? Does that have any support?
REID: When people say I’m going to eliminate the IRS, crowds cheer. I mean, it’s ridiculous. Somebody is going to collect that tax. I mean, Ted Cruz wants to be paid for being a member of the Senate. Ted Cruz wants a strong military. We’ve got to pay for that some way. Taxes is how we pay for it, and somebody has to collect the tax. You could change the name – the People Service Bureau instead of the Internal Revenue Service, but somebody is going to be there whether you call it the IRS or not.
GROSS: Has the IRS shrunken in recent years?
REID: Yeah. I think this is really dumb. According to the IRS figures, they spend 35 cents for every $100 they bring in. In other words, it’s the only federal agency that brings in more than it costs. You would think as a business proposition, you wouldn’t cut your biggest profit center, right? Wouldn’t you make it bigger and take in more?
But to punish the IRS because Americans don’t like taxes and Republicans particularly don’t like taxes, they’ve been cutting the budget. The result is many fewer audits, fewer answers to taxpayer questions and much lower collections then we would have with a bigger staff. So I just don’t see shrinking the IRS – you can’t shrink the IRS and expect to bring in enough money to cut the deficit. Those two don’t go together.
GROSS: Are you concerned that in fixing the tax code we might fix it in a direction that will favor the rich more than they’re favored now and will add to the debt?
REID: That’s how things seem to work in the United States because our Supreme Court – no other court in the world has said this – our Supreme Court has said that giving money is the same thing as free speech, and, therefore, it’s hard to limit. And sure enough, rich people invest in politicians to get the things they want.
But, you know, if you go back to 1986, although rich people got a much lower rate, they lost a lot of the goodies they used to have because Congress stood up to them and said the only way we can make our tax code work is to make it apply equally to everybody. So if we could get that mindset in the U.S. Congress and the White House, yeah, we could, but – I hate to say it – but generally in the U.S. Congress, rich people get what they want.
GROSS: So if you were designing the tax code from scratch, what would it look like?
REID: Our tax code would have virtually no exemptions, deductions, credits, giveaways, and therefore it would have very low rates, rates, say, from 5 to 12 or 15 percent for individuals, maybe 5 to 18 percent for corporations. We’d raise the same revenue because the base would be broader. And it would be much simpler to pay.
I would have the IRS fill in the form for almost all taxpayers, so all you had to do is check the numbers and say, yeah. And then April 15 would be just another sunny spring day. And I think we definitely have to pick up this great new innovation – the value-added tax. It taxes consumption, not labor. It’s easy to collect. It’s hard to evade, and it lets you cut the rates of all the other taxes.
T. R. Reid is the author of the new book “A Fine Mess: A Global Quest For A Simpler, Fairer, And More Efficient Tax System.” This is FRESH AIR.