Here’s an idea that will cause progressives some angst: Let’s eliminate corporate income taxes.
Before getting started, let’s first turn to two articles written by Beardsley Ruml, the former chairman of the Federal Reserve Bank of New York, at the end of World War II (‘Taxes for Revenue are Obsolete’ and ‘Tax Policies for Prosperity’) that lay out the purposes of taxes. Ruml expressed the following purposes of US federal taxation:
(1) as an instrument of fiscal policy to help stabilise the purchasing power of the dollar;
(2) to express public policy in the distribution of wealth and of income as in the case of the progressive income and estate taxes;
(3) to express public policy in subsidising or in penalising various industries and economic groups; and
(4) to isolate and assess directly the costs of certain national benefits, such as highways and social security.
Why should corporate income tax be eliminated?
In 2018, total US federal income tax revenue was about US$3.3 trillion. Of that, corporations paid (following Trump’s 2017 tax cuts) about 6%, or about US$200 billion. Individuals paid about 51%, payroll taxes amounted to about 35% and excise, estate and certain other taxes made up the difference of about 8%.
To put the US$200 billion tax revenue in perspective, a 2016 analysis by the non-partisan Tax Foundation found that the estimated tax compliance costs for US businesses were about US$147 billion with another US$46 billion spent by owners of S-corporations (which pay taxes as a flow through entity). It’s not likely this number went down in recent years.
Add to that the cost of lobbying. Public Citizen, a government watchdog group, reported that over 6,200 lobbyists worked on taxes in 2017, over half of all lobbyists in Washington that year. Opensecrets.org estimated that companies spent some US$3.5 billion on lobbying (not all of which was tax related) in both 2017 and 2018. (Note that lobbying expenses to influence legislation are not tax deductible.)
While the first conclusion many people come to is that corporate tax incidence (who pays) hits well-to-do shareholders the hardest, that’s not really true. While the figures vary, according to an analysis conducted for the Tax Foundation, 50% of tax increases paid by corporations are indirectly paid for by workers in the form of lower wages and benefits. Studies cited by the Tax Foundation show that the tax burden on labour can actually exceed 100%. In fact, since corporations are in business to reward shareholders, the impact of taxes actually falls not only on workers, but also on consumers through higher prices and on the economy as a whole through reduced investment spending (CAPEX), not to mention various tax avoidance strategies. One can look at corporate taxes as a regressive form of taxation.
In addition to the financial implications, corporate taxes impact the economy by distorting business investment via subsidies to some businesses and not others and by incenting the use of off-shore facilities for tax avoidance purposes. Elimination of corporate taxes would end the incentives for corporations to generate and retain profits overseas.
Another argument for eliminating corporate income taxes, favoured especially by conservatives, is the elimination of double taxation, the taxing of corporate income and of distributed dividends. This is a fair argument but, in my view, the problem is more one of unnecessary complexity than unfair taxation.
Finally, one last benefit from the elimination of corporate income taxes would be a significant boost to equity prices as we saw following Trump’s 2017 tax cuts. While this would certainly benefit wealthy investors (I have a plan for that as you’ll read below), it would also be hugely beneficial to individual investors and all owners of individual retirement accounts and 401k (or similar) plans – not a small matter considering the retirement challenges many face today and the widely held view of subdued investment returns for the next decade compared to recent years.
Reform options
Under current US federal procedures, elimination of taxes for one party needs to be generally made up for by some combination of taxes from another party and federal bond issuance (commonly known as federal debt).
In fact, there are much more efficient – and more equitable – ways to collect government revenue than taxing corporate income. Keep in mind that corporate taxes amount to approximately US$200 billion. As long as we have a tax system based on income and not consumption, here are some ideas based on the fact that taxes on corporate income hit middle- and lower-income segments of the society both directly if they own stocks and indirectly through the transmission mechanisms described above:
- According to estimates made by the Wall Street Journal for 2017 and 2018, the latest data available, the top 5% of wage earners paid approximately US$1 trillion. A 10% surcharge for the top 5% of wage earners would raise an estimated US$100 billion.
- A second option would be a “mark-to-market” or “accrual” basis of taxation on capital gains. Under this arrangement, security (stock and bond) values would be taxed at ordinary income rates on the gains since the prior year (realised and unrealised losses would be deductible). In effect, investment gains and losses will be recognised annually rather than at the time securities are sold. According to the Brookings Institution, the money that could be raised in this fashion from equities alone would be about $170 billion per year (investment gains from bonds would be in addition).
While these ideas and any significant change in government policy can have unintended consequences that need to be thought through, some combination of just a portion of these two ideas would completely offset the reduction in federal revenue from the elimination of corporate taxes and place the tax burden on those who can most afford it, not to mention all the other advantages listed above for eliminating the corporate income tax.
Rather than raising corporate taxes to fund progressive policies, the best course of action would be to replace federal corporate income taxes with reforms that would shift the tax burden to the firms’ shareholders. While the US Government does not need the revenue to finance its expenses according to Modern Monetary Theory (MMT) economists, it may be politically necessary to preserve revenue neutrality while shifting taxes from the corporations to individuals. This would almost certainly result in a more progressive tax system, as it would relieve workers and consumers of the portion of the tax that is shifted and replace that with a tax on higher income and wealth shareholders.
“A corporate income tax, which allows interest to be deducted prior to the determination of taxable income, induces debt-financing and is therefore undesirable. A corporate income tax also allows nonproduction expenses such as advertising, marketing, and the pleasures of the executive suites to be charged against revenues in determining the taxable income. As advertising and marketing are techniques for building market power and as ’executive style’ is a breeder of inefficiency, the corporate income tax abets market power and inefficiency just as the corporate income tax abets the use of debt-financing. Elimination of the corporate income tax should be on the agenda.”
Hyman Minsky (Stabilizing an Unstable Economy 1986 edition, p. 340
Alan Luchetti’s comments and observations are very relevant to this article.
A way to pay for the elimination of Corporate income taxes is to have companies pay the deferred income taxes on their balance sheets over a timed schedule. For example. WMT has $14B in deferred income taxes. These could be paid over some time period, say 3 years, allowing the net corporate income taxes collected to stay relatively stable for that time. This tax could be based on the audited financial statements from the prior year so there would be no ability to manipulate the tax due.