Our tax code is screwed up in a thousand ways and there’s scarcely a cohort in America that isn’t hurt by this mess.For instance, we will sacrifice nearly $1 trillion in the next decade to encourage wealthy people to buy bigger homes, while at the same time subjecting millions of middle class households to effective marginal tax rates of over fifty percent, a higher rate than almost everyone who is a denizen of the demonized top one percent. The corporate tax code is even more convoluted, replete with one of the highest rates in the world as well as a plethora of deductions, exemptions, credits and the like that dramatically reduce revenue collected without necessarily providing any salutary economic activity in return.
The current tax code isn’t especially friendly to saving: we double-tax the returns to any savings done outside of tax-preferred accounts, and the little revenue this practice yields comes at the expense of higher growth.
However, there’s one area the tax code actually gets pretty much right: the taxation of S corporations and, in particular, S corporation employee stock ownership plans. While the tax code imposes double taxation on most corporations, taxing both profits of the firm and the proceeds paid to shareholders as dividends, S corporation profits are taxed only once, at the same rate as the other taxable income each shareholder earns. This is a much more efficient than how we tax large corporations, which produces a lot of squawking for very few feathers, in the words of Jean Baptiste Colbert. Worse, it disincentives saving and investment.
Twenty years ago, a Republican-led Congress—working arm-in-arm with the Clinton administration—pioneered an effort to further incentivize savings by allowing Employee Stock Ownership Programs (ESOPs) to own S corporation stock.
ESOPs are retirement plans that vest employees with ownership shares in their companies at no cost to the employee. To put it simply, every year an employee-owner in an ESOP receives company stock. As the company grows, the value of the stock also increases, allowing employee-owners – at all levels of the company – to share in the appreciation. The value of the employee-owners’ shares in an ESOP are taxed at individual income tax rates when the employee-owner withdraws funds upon retirement, the same as a 401(k) plan.