Repeal the Corporate Income Tax

– May 19, 2017

An especially controversial feature of President Trump’s proposed tax reform is a cut in the corporate income tax. The current tax is progressive, with rates ranging from 15 to 35 percent on income minus deductions. The Trump tax would have a single rate of 15 percent and would eliminate some deductions.

According to the Tax Foundation, the United States’ top corporate rate is currently the third-highest in the world, “exceeded only by the United Arab Emirates and Puerto Rico.” The foundation also notes that the “worldwide average top corporate income tax rate, across 188 countries and tax jurisdictions, is 22.5 percent. After weighting by each jurisdiction’s GDP, the average rate is 29.5 percent.” Since 2003 the average corporate tax rate has fallen from 30 to 22.5 percent throughout the world, with reductions in every region.

Enthusiasts for stiff corporate taxation often counter that because of tax deductions, few large corporations pay the full 35 percent. But this argument fails to acknowledge that activities undertaken to qualify for deductions and lower the effective tax rate are activities that likely would not have been taken in the absence of the tax. To the extent that this is so, companies’ efforts to lower their tax rate aim not at serving consumers but at reducing their tax liability. Most economists believe the exclusive objective of tax policy should be to raise revenue, not influence — that is, distort — behavior.

Corporate-tax advocates regularly stigmatize any proposed rate reduction as a “break for the rich.” But things are not nearly so simple. In fact, it is unclear who really pays the tax. Calls for taxing corporations appeal to many people for an obvious reason: seemingly impersonal entities garner little sympathy from those who favor government distribution of benefits. Thus corporations appear as a mother lode of wealth that can be tapped at no cost to working- and middle-class individuals. “This very vagueness about who pays the tax accounts for its continued popularity among politicians,” Robert Norton, a former economics editor at Fortune, notes. Or, as economist Roy Cordato writes more bluntly, “Corporate taxes are the most dishonest taxes used by any level of government.” (Many states and localities also tax net corporate incomes.)

However, corporations are groups of people, including workers and shareholders, most of whom are not rich. Retirement funds of people of average income are invested in stocks. “Economists have had great difficulty in assessing the incidence of the corporate tax — that is, determining on which groups of people the burden falls,” Norton writes. Some economists before Adam Smith thought the tax was passed along to consumers in higher prices. But classical economists “thought it could not be shifted because, theoretically, a corporation already charging prices that produce maximum profits could not increase prices further without reducing people’s demand for its goods.” That suggests that the tax falls on owners of capital: shareholders.

These days, however, Norton continues, “modern economic opinion is divided on the incidence of the corporate income tax, but few economists today believe its burden falls entirely on the owners of capital.” For one thing, capital can move to uses with the greatest after-tax returns, particularly noncorporate parts of the economy. This results in a reduction of capital in the corporate sector and “a reduction in rates of return in the noncorporate sector as capital becomes more plentiful there … lower[ing] returns for all owners of capital across the economy.” But this in turn has a further result: less capital means lower labor productivity, depriving workers of higher wages. In a survey conducted 20 years ago, public-finance economists said that on average more than half the tax was paid by workers and others, rather than by owners of capital. Thus, Cordato adds, the corporate tax “gives … self-proclaimed champions of the downtrodden a way to tax the very constituency they claim to represent, while leading that constituency to believe the tax is being imposed on its ‘oppressors.’”

The corporate tax has another serious problem: it constitutes double and even triple taxation, which hardly seems fair. Cordato notes that corporation employees and consumers, who pay individual income taxes, have their incomes reduced again by the government to the extent the corporate tax reduces wages and increases prices. And shareholders are hit three times, as Cordato explains:

First, when any income is taxed, the tax by definition reduces the potential income stream — interest, dividends, and capital gains — that the income can generate. Second, dividends and capital gains are reduced further by the corporate income tax. And third, when dividends and capital gains are finally earned, they are taxed as part of the investor’s personal income.

Since all parties concerned are already subject to the individual income tax, it’s hard to attribute the corporate tax to anything but economic ignorance — or malice. Thus it shouldn’t be cut; it should be repealed.