Abolish The Corporate Income Tax and Tax The Rich

Atlantic columnist Megan McArdle makes the case for why abolishing the corporate income tax (and then taxing capital gains and dividends at the same rate as other income) is a proposal that both liberals and conservatives should be able to agree on:

The incidence of “corporate” taxes is not necessarily progressive. The “employer half” of the payroll tax, for example, is thought by most economists to fall pretty much entirely on the worker; corporations compensate for the extra cost by lowering the wages they offer. Taxes on corporate profits are exactly the same for middle class families who have some shares in a 401(k), and multi-millionaire heiresses.

If we get rid of the corporate income tax, we could eliminate the special treatment for dividends and capital gains. The reason we currently have the special rates is to offset the “double taxation” of corporate profits. You can quibble with the term, but the fact remains that a 35% corporate income tax combined with, say, a 43% marginal income tax rate (once we add in the special Medicare surcharges), would be a hell of a disincentive for the very wealthy to invest; you’re talking about lowering the projected return on an investment by almost 3/4. There’s little question that this would be bad–there’s a reason that not even Sweden attempts to levy those sorts of taxes on capital. But if we get rid of the corporate income tax, we can simply roll capital income into ordinary income–which means that we’ll be taxing corporate income more progressively. The taxes on corporate profits will fall most heavily on wealthy people.

The corporate income tax doesn’t raise that much money It’s not nothing–about $300 billion. But we could recoup a whole lot of that simply by taxing dividends and capital gains as ordinary income, and perhaps tweaking top rates. That might be a bargain conservatives would go for.

Without the corporate income tax, a lot of the incentive for lobbying would go away Not all of it, by any means–I am not trying to paint some halcyon future here. But an enormous amount of effort goes into lobbying for tax laws, and politicians often reward favored constituent businesses with little sweetheart fillips to the tax code. Conversely, apparently neutral changes to the tax code often turn out to be excellent ways to hamstring your competition, particularly small businesses who cannot afford a huge tax department.

Want to get corporate money out of politics? Want to erode the power of the Chamber of Commerce? Take away one of their primary motives to get involved.

28 Responses to Abolish The Corporate Income Tax and Tax The Rich

  • Taxing individuals is messier than taxing corporations and I don’t like using cap gains and dividends as a proxy for high income but I guess it’s better than nothing. I’d still prefer a VAT to replace them all though.

  • My guess is that the U.S.’s corporate tax rate is on the downward slope of the Laffer curve, so you could raise more revenue by decreasing the tax rate.

    The corporate tax is basically a very inefficient disguised VAT, so of course ideally a VAT would be preferable. Politically, though, I don’t see it happening.

  • Only a person who has no understanding of subchapter c would claim that taxing individuals is messier than taxing corporations. The corporate income tax is a set of exceedingly complex rules. McArdle is right that its economic incidence falls on consumers, employees and shareholders in essentially arbitrary but constantly shifting proportions depending of a variety of economic forces. Eliminating the tax does indeed make some economic sense, but the problem is deferral. Unless corporations were required to distribute earnings every year in the form of taxable dividends, then shareholders will expect corporations to defer dividends and therefore defer tax, and corporations will quite sensibly cooperate. The holy grail is called “integration,” whereunder all income would be taxed currently (i.e., as it is earned or realized) one time either at the corporate or shareholder level, but never both levels. Many tax law professors have offered various proposals to do this, but all are fairly complicated — more complicated than subchapter K or S which do something similar with smaller businesses formed as partnerships or s corporations. And anyone who thinks those subchapters are easy to understand is very mistaken.

    In my view, we should impose two types of levies. First, fees designed to pass on concrete social costs to those responsible for creating those costs, such as gas taxes for road maintenance. Corporations should not be immune from such levies. Taxes designed to pay for general governmental services should be imposed only on individuals, and the best approach IMO would be a broad-based consumption tax like that proposed by Harvard’s Wm Andrews and former Senator Sam Nunn. Basically, the idea would be to simply adjust our current income tax to allow for deductions for all additions to savings and tax all subtractions from savings. We essentially do this already with 401(k) plans and IRAs, so it would mainly be a matter of merging and expanding those plans so that there were no limits on contributions or withdrawals. Such a tax would continue to allow for graduated rates. Assuming gifts and bequests are treated as consumption, all lifetime income would be taxed as it is consumed. Economists favor such a tax since it is neutral as between savings and consumption, whereas an income tax favors consumption.
    While one can make the case that our corporate income tax is indeed a very inefficient VAT, a case can also be made that a VAT is a very inefficient broad-based consumption tax.
    Finally, taxing capital gains at ordinary rates may be workable when the top ordinary rate is 28%, as it was immediately after the 1986 Act. But current rates are almost certainly too high to sustain this. Investors will simply refrain from selling investments in order to avoid gain recognition. This so-called “lock-in effect” is well-understood and documented. Aside from the ensuing revenue problem, this behavior causes a misallocation of resources since investors will not move into more appropriate investments because the toll charge is too great. In addition to this practical lock-in problem, there are policy difficulties in that capital gains usually contain a phantom inflation component, which theoretically should not be taxed. The magnitude of this component depends on the magnitude of inflation that exists during the holding period. This risk must be weighed against the fact that capital investments benefit by deferral since it is usually not possible to impose a tax until an investor volunatily decides to sell and thereby cause a recognition event.
    The bottom line is this. This is a healthy discussion to have, and it is good to see a non-conservative such as McArdle try to tackle it intelligently; and it is tricky and complex stuff. People who think that there is some magical easy tax that is simple and fair are naive. But important improvements can be made.

  • Dissent. If a commercial enterprise wishes to have the benefits of limited liability, they can pay for it.

    No one here has suggested that an index be applied to the purchase price of a capital asset in the course of computing tax liability.

  • I find it odd to see a VAT considered favorably here. They may be a somewhat efficient means for the government to fill the coffers by concealing the true cost from the consumer (which is something I oppose), but they are quite regressive (something I oppose even more).

  • RL, the idea that a VAT conceals the true cost from the consumer is simply not true. It only conceals it if you don’t know what it is. That can be remedied simply by requiring that it be printed on all receipts.

    A VAT can be just as regressive or progressive as the current income tax.

  • Mike Petrik, “a VAT is a very inefficient broad-based consumption tax.”

    How so? The difference between a VAT and Nunn’s USA tax is that the latter collects from individuals rather than businesses and it would tax consumption of used goods.

    IMO, the most efficient tax would be a VAT system that gives everyone a tax credit card.

  • restrained,
    How would you make a VAT progressive?

    Limited liability is a privilege afforded by state law, not federal. Consequently, any quid pro could only justify a state level corporate income tax; and most states do impose such taxes. Also, conceptually if limited liability carry substantial social costs, consumers would favor doing business with proprietorships. There is no evidence of this. It must be remembered that the limited liability only extends to investor/shareholders, not the corporation itself or those that act on its behalf such as officers. I have never found the limited liability explanation for the corporate income tax remotely convincing. It is an after-the-fact rationalization, and in my opinion not a good one.

  • VATs are inefficient from an administrability standpoint because administration must occur in each link of every business chain.

    Collecting from individuals is good. Citizens should know what their tax burden is.

    Also, a tax levied on individuals also allows for rate graduation based on ability to pay as measured by consumption level.

    VATs also create fraud opportunities in cross-border transactions.

    Finally, the idea that mechanisms can be established so that individuals are aware of their tax burden may sound good in theory, but it is doubtful that most people really would understand.

  • My preferred method of a progressive VAT would give everyone a tax credit card that’s used at the POS, sort of like a shopper’s card, that instantly discounts the item. Alternatively, we can do as some countries do and give everyone a card but make them pay full price then mail the rebate later. Yet another method is to mail a check to everyone regardless of level of consumption like the FairTax. Finally, we continue income reporting then mail rebates based on income.

    VATs are collected from individuals. They’re just collected by businesses instead of your employer or directly by the IRS.

    Making people aware of the VAT burden would be no more difficult than making people aware of the sales tax burden. Just print it on the receipt. You’ll see it every time you make a purchase.

  • Great Discussion! May I inject a bit of irrationality first, then something of a real problem?

    Restrainedradical: I can just see the more suspicious in our population railing against having to carry and use a government card in order to make a legal purchase. Recall the noise made about a Federal ID card some years ago.

    At least some believe a mandatory card for making purchases would be an equivalent to the “mark of the beast.” While not necessarily a rational stance, it could cause a lot of trouble.

    An unforeseen but real consequence of such a card would be the collection of an individuals purchasing history. The promise of protection of such information, given the private information that is regularly compromised from presumed secure repositories, rings hollow.

    Finally, with regard to the VAT itself: a perceived high tax rate on purchased goods also opens up incentives for black market activity. It is customary in the United States, unlike Europe, to list an item’s price pre-tax, and add the tax at the register. Also, localities, States and the Federal Government have the power to levy tax.

    Assuming that the pricing custom remains, the consumer will see the aggregate of the sales taxes as a single rate and will change behavior accordingly.

  • Death and taxes . . . the power to tax is the power to destroy – that’s why the Federal government cannot tax state, county or municipal governments (e.g., tax-free bond interest).

    The US Internal Revenue Code is about 40,000-plus pages: enough said . . .

    Taxes, nanny-state regulations, and national crushing debt ($13,000,000,000,000.00 and NOTHING to show for it): we the people live and breathe at the government’s discretion.

  • Dissent. If a commercial enterprise wishes to have the benefits of limited liability, they can pay for it.

    They do pay for the benefit of limited liability, just not through taxes. They are required to maintain adequate capital to meet the needs of the business (including lawsuits), and if they fail to do so, the limited liability is discarded.

  • Limited liability corporations pay by not having access to the capital that an unlimited liability business would.

    Dminor, a VAT card would raise privacy concerns. If that’s the route we take, it would have to be voluntary. There would have to be a more onerous alternative like annual reporting of income and savings.

    As for awareness, we can make sellers advertise the full price including tax (unless it’s a multi-jurisdiction ad in which case it would include only the taxes that cover all jurisdictions plus a disclosure like “plus state and local tax”). We can require that receipts print a break down of the taxes. We can mail annual receipts telling every household how much they’ve paid in taxes. Point is, there are lots of ways to get around this problem.

  • “They do pay for the benefit of limited liability, just not through taxes. They are required to maintain adequate capital to meet the needs of the business (including lawsuits), and if they fail to do so, the limited liability is discarded.”

    That is not the case in Illinois. Shell corporations go belly up all the time here and that, by itself, is insufficient under Illinois law to pierce the corporate veil, although it can be a factor in piercing the veil if there are other factors, no observance of corporate formalities, comingling of corporate and private funds, etc, which are also present. Judges have a fair amount of discretion in piercing the veil in Illinois, and in my experience most of them are reluctant to do it, unless the facts of corporate malfeasance are pretty extreme.

  • Limited liability is a privilege afforded by state law, not federal. Consequently, any quid pro could only justify a state level corporate income tax; and most states do impose such taxes.

    I do not see that that follows. They have been granted the status of legal person. I cannot see that the treatment of them as a person needs be confined to the tax collectors of the chartering government.

    I have never found the limited liability explanation for the corporate income tax remotely convincing.

    That is because you are not a proper Poujadiste.

    For a given level of public expenditure, you have to collect the revenue one way or another. Property taxes promote environmental damage and can be subject to caprice in their administration, general sales taxes are regressive, payroll taxes discourage hiring, and taxes on phantom capital gains discourage investment and distort patterns of investment. Given how sclerotic the political system is concerning reform of our wretched tax system, seems you would have other priorities than eliminating corporate taxes.

  • I’m not sure what a Poujadiste is, but I suspect your are right.

    The case for corporate taxation is best made once you decide that you don’t care about horizontal or vertical equity. Few tax scholars are willing to do this (none come to mind). To be sure I don’t view elimination of the corporate income tax as a “priority” at all, but I do think that the policy justifications for the tax are generally pretty weak.

    While sales taxes are generally regressive, a broad based personal expenditure tax as described above would accomodate graduated rates and progressivity. It would also be neutral as between saving and consumption, something universally favored by economists (and how often can one say that!). The key to its success IMO rests in the treatment of testamentary bequests. IMO assets held at death should be regarded as deemed consumed and subject to tax (no need for a separate estate tax). All lifetime income would be subject to tax as it is spent. This is economically desirable and practically feasible.

  • restrained,
    There are, as you say, lots of ways to get around this problem. Pray tell, are there any that aren’t guaranteed beaureaucratic nightmares or invitations to fraud?

  • Mike Petrik writes Thursday, October 28, 2010
    “Finally, the idea that mechanisms can be established so that individuals are aware of their tax burden may sound good in theory, but it is doubtful that most people really would understand”.

    “Most people” = thee, but not me.

    As Richard Feynman said “If you think you understand quantum mechanics, you don’t”.

  • While running a small corporation, I thought about such expenses as rent, electricity, and wondered why taxes were not levies on the same basis. The landlord, the utility companies are not our partners; why should the government be? Why not a Gross Receipts tax? This way we would know the cost.
    My accountant complained: “Are you trying to put me out of business?”.

  • I’m not sure what a Poujadiste is, but I suspect your are right.

    Well, you gotta get with the program.


  • Gabriel,
    The State of Washington does have a gross receipts tax. It applies whether or not you have a profit (that is what “gross” means), and is almost universally despised by the business community. It is also not simple. The only simple tax would be a head tax. All other taxes are compromises between competing objectives — administrability, understandability, revenue objectives, and fairness. And the fly in the ointment is fairness. Fairness is the enemy of simple even if lay folks think otherwise. Most people know no more about taxes than they do about quantum physics, but they seldom let that impair strong opinions.

  • Thanks, Art. I’m afraid that is yet another program that I’ll have to avoid.

  • Fairness is the enemy of simple even if lay folks think otherwise

    Non ci credo. You are beginning to sound like Barber Conable.

  • I would rather expect that, and thank you my friend.

  • It’d never work.
    Firstly, it would greatly increase the taxation of the rich, which is suicide in every developed economy. An exodus of wealthy people giving away the passport would be the consequence, foreign investments in the US would be greatly discouraged.

    Secondly, the lobbying effort would then be directed to lowering the income tax, and rightly so. It is not that corporations owners would accept paying more taxes just because there’s “income tax” written over it.

    The way is reduction of public spending and state invasiveness and reduction of taxation, not increased taxation.

    The rich are those who provide the jobs and create a country’s wealth. Punish them, and you’ll kill the goose that lays the golden eggs. Encourage them to risk and invest and the whole country will prosper.

    (not rich, in case you ask).

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