The Equity Tax and Shelter

Taxes have major costs beyond the collected revenue: deadweight from distorted incentives, compliance and enforcement costs, etc. A simple market mechanism, the Equity Tax, avoids these problems for the trickiest cases: corporate, dividend, and capital gains taxes. It exploits the ability of the share prices to reflect the expected true annual return (as perceived by investors, not as defined by law) and works only for publicly held corporations. Since going or staying public cannot be forced, and for some constitutional reasons too, the conversion to equity tax must be a voluntary contract. Repeated reconversions would be costly (all capital gains are realized) and thus rare. The converts and their shareholders pay no income, dividend, or capital gain taxes. Instead, they give the IRS, say, 2% of stock per year to auction promptly. Debts are the lender’s assets: its status, not the debtor’s, determines their equity-tax or income-tax treatment. The system looks too simple to be right. However, it does have no loopholes (thus lowering the revenue-neutral tax rate), no compliance costs, requires little regulation, and leaves all business decisions tax neutral. The total capital the equity taxed sector absorbs is the only thing the tax could possibly distort. The rates should match so as to minimize this distortion. The equity tax enlarges the pre-tax profit since this is what the taxpayers maximize, not a different after-tax net. The wealth shelter is paid for by efficiency, not by lost tax.