In December of last year, Congress passed, and President Trump signed, the Tax Cuts and Jobs Act (TCJA). The legislation, among other things, cut the top marginal rate of the corporate income tax from 35% to 21%. This was a huge step forward in making USA competitive on the world stage. But it did not go far enough — the corporate income tax should be repealed entirely. If revenue neutrality is a concern, then other sources can be made to offset the relatively small portion of the tax base brought in by the corporate tax; however, eliminating the inefficiencies and distortions it causes are of paramount importance.
The problem with corporate taxation is not solely — nor even primarily — that of an ethical concern regarding “double taxation” of corporate profits. Rather, the more salient problem is that of international competitiveness and economic efficiency. In the name of equality, it taxes the wealthy by way of an abstraction; like the Romans who made a desert and called it peace, the corporate income tax destroys efficiency and calls it fairness.
More specifically, there are three primary economic arguments in favor of eliminating the corporate income tax:
- The current structure and relatively high nominal rates of corporate taxation in the United States are still uncompetitive on the world stage;
- Imperfect observability of internal corporate operations ensures that real corporate profits may be difficult to detect (and therefore large, wealthy corporations can use accounting rules and crafty tax attorneys to disguise much of their income from the taxing authorities); and,
- The current method of corporate income taxation is asymmetric between profit and loss—as well as debt and equity—and therefore almost certainly changes preference rankings of alternative investments, on the margin.
There are several problems with proposed reforms, to be sure. Shareholders might receive a windfall from higher share prices and higher eventual distributions. Corporate-level collection may be administratively more efficient. Without reform of the realization requirement on appreciation in the value of capital assets, repealing corporate-level collection could turn corporations into tax-free savings accounts for investors. Moreover, it may be difficult to coordinate taxation of publicly traded and private corporations, as well as to value financial positions in public companies that are not sufficiently traded as to have readily discernible market prices. These concerns are all appreciated. However, they are by no means prohibitive of repealing the corporate income tax. This is because the entity-level income tax is an inefficient and costly anachronism. It was perhaps appropriate for an era where large corporations either manufactured goods with immobile capital inputs, or engaged in financial activities, which only a handful of relatively homogeneous nations had the infrastructure to support, but it is not irrational and destructive to a modern economy.
“A Tiger by the Tail”
The title of this section is taken from a quote attributed to the economist Friedrich Hayek (and a collection of his works by the same name), in which he commented on what he perceived to be the problems with Keynesian macroeconomic policies: “We now have a tiger by the tail: how long can this inflation continue. If the tiger (of inflation) is freed he will eat us up; yet if he runs faster and faster while we desperately hold on, we are still finished.” The idea behind the quote is similarly applicable here. If we hang on to the corporate tax, in its current form, then we will continue to face the same mounting problems of inefficiency and a lack of international competitiveness. Yet, if we free ourselves from the corporate income tax, we will be faced with a deluge of ancillary problems and additional reforms that will have to be dealt with in order to make the tax code adequately equitable and efficient. However, the difficulties resulting from any changes made should not be enough to dissuade us from pursuing repeal.
We should let the tiger go, and deal with the consequences as they turn to come at us. As evidence for this assertion, let us first be clear on the reality of whom the corporate tax is levied against.
The entity-level corporate income tax is assessed against the profits of an abstract entity that exists, in a technical sense, only pursuant to state and federal law. At the same time, the tax is levied directly on the earnings and profits of many other individual persons. The tax is levied on the wages of workers and the profits of shareholders, before personal income taxes and capital gains taxes and dividend taxes are again levied on that same income. What is more, the corporate-level income tax has built-in incentives that favor debt over equity financing — essentially, it is a subsidy to debt and an implicit tax on equity.
Entity-level taxes on earnings and profits are also directly levied against the individuals that make up the corporation, in that if those earnings were not taxed at the entity-level they would trickle down to these individuals in one of three ways. The earnings would either be:
- Distributed to shareholders in the form of dividends or stock buybacks;
- Paid out to workers in the form of wages or other benefits; or,
- Reinvested into the company — in the form of research and development, investment in the capital stock, etc. — in such a way that would likely result in lower prices or better quality goods or services for the consumer.
This third option would possibly pay dividends for workers and shareholders, as well. Increased capital investment, if made profitably, will make workers more productive, which will in turn increase their wages and benefits. Additionally, increased investment in research and development, as well as capital investment, may make the corporation more profitable, which will yield benefits to shareholders either in larger dividend distributions or increasing the value of their stock holdings.
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