President-Elect Trump has proposed lowering the Corporate Tax Rate from 35% to 15%. And that’s a good idea – but it doesn’t go far enough. The Corporate Tax Rate should really be lowered to Zero.
Some quick facts: The United States’ 39% marginal corporate tax rate (35% federal and 4% average state and local) is the third highest in the world. It is the highest of the 34 industrialized nation members of the OECD – and it compares poorly with Europe’s average tax rate of 19% (26% weighted by GDP).
Why do we have differing corporate and individual taxation systems in the first place?
Our nation’s tax system evolved in fits and starts with various taxes being implemented and then repealed – some ruled unconstitutional. Our modern tax era began in 1909 – in response to rising political pressure to tax the rich – when Congress enacted an excise tax on corporations at the urging of President William Howard Taft. In a concurrent move, President Taft proposed the 16th Amendment to establish a personal income tax. The excise tax on corporations did not require a constitutional amendment and was originally intended to be a temporary measure until the passage of the 16th Amendment which occurred in 1913. Like all things government, legislation once enacted does not die and so the two concurrent tax systems – corporate and individual were born. And they have been creating inefficiencies and needless complexities for our nation ever since.
Who actually pays corporate taxes?
In one sense, a corporate tax is nothing more than another input cost. More directly stated, corporations do not really “pay” taxes. Corporations are actually tax collectors – legal entities that serve to collect taxes on behalf of the corporation’s owners. Therefore, the true taxpayers are the company’s shareholders – and perhaps, to some degree, labor and customers – not corporations.
As our system stands now, shareholders’ dividends and capital gains (taxable items to the shareholder) are reduced by taxes collected by the corporation. If the corporation did not collect this tax on “behalf” of the shareholder these extra dollars would flow through to shareholders in the form of increased profits and dividends, reinvestment in the business (which generates additional profits) and share repurchases. And these increased cash flows to shareholders would then be taxed at the shareholder level.
If this argument is not sitting well then consider this example. A corporation could, in theory, give year-end bonuses to its workers such that the amount exactly equaled the corporation’s taxable income. After the payment to the workers, the corporation has zero taxable income. Shareholders pay no tax (they received no profits) nor does the corporation. But the workers now have a significantly increased tax bill – and in all likelihood are taxed at a higher overall rate than the corporation would have been. The corporation merely serves as the vehicle or conduit – the legal structure – for tax payments.
What about customers and labor – do they shoulder some of the corporate tax bill through higher prices for goods or lower wages? There is some debate about these two groups. Customers probably don’t pay much, if any, in corporate tax as it is very hard to pass this cost through. While a corporate tax is a real input cost, the ultimate price of the corporation’s end product or service is determined by market forces. And corporations have many differing competitors – including sole proprietorships and foreign corporations with differing tax structures. Market competition determines the final selling price – not taxes. The amount of corporate taxation that labor bears is less clear – the arguments center around the availability and flexibility of capital – the ability to shift production to lower cost areas, etc. The Tax Policy Center has concluded – fairly close to Treasury estimates – that labor bears about 20% of the corporate tax burden.
So the answer to who really pays corporate taxes appears to be primarily shareholders with labor likely sharing in some of the cost. What should be clear is that corporations do not truly pay taxes – they merely collect them on behalf of third parties for payment.
Why are tax rates different at the corporate level versus the shareholder level?
At the heart of the matter, the tax rate is lower for capital gains and dividends paid to shareholders to reduce the impact of double-taxation – profits used to pay dividends have already been taxed at the corporate tax rate. The capital gains and dividend tax rates are arbitrary but the intent has been to pick a number that was not so high as to completely discourage investment into companies by investors.
How much revenue is generated from corporate taxes?
The answer to this question may surprise some – in 2015 the federal government collected about $340 billion in corporate taxes. This compares to the approximately $1.5 trillion in individual taxes and $1.1 trillion in payroll taxes. The amount paid in corporate taxes is not as large as many intuitively expect.
How are corporate taxes from international operations handled?
Corporations have a mandate to maximize profits. Managing their business in a manner that minimizes taxes is the correct approach for any CEO, but the effort to do so creates further problems. One effort that has a received a lot of national attention is the process known as Inversion. Simply described, inversion is a strategy whereby a U.S. corporation merges with a foreign company and then reincorporates, as part of that merger, in the foreign company’s nation. If the tax rate is lower in the foreign country, the newly formed corporation pays less in taxes than it would have if the company had stayed domiciled in America. While the CEO is often the one demonized, he is not the one to blame. Legally minimizing one’s tax burden is something we all do and is part of the duty of any CEO. The fault lies with the flawed tax structure of the U.S. as it encourages this activity.
There is another problem with our corporate tax code. The United States has a “worldwide” tax code – U.S. corporations are taxed at 35% (less taxes paid to foreign governments) no matter where their profits are made. Most other nations use a “territorial” tax system whereby companies are taxed by the country where economic activity takes place. This territorial system is far better suited to the multi-national landscape companies operate in today. Under a territorial system, a multi-national company pays taxes to each of the nations it does business in according to the amount of economic activity done in the nation’s borders and the particular nation’s tax rate. This has the obvious advantage of placing all companies operating within a given nation on the same economic footing from a tax burden perspective.
A further twist exists as part of our worldwide tax code. Corporate profits are not actually taxed until they are repatriated to the U.S. This incentivizes companies to keep cash from offshore operations in the place it was generated – offshore. Estimates vary but there appears to be at least $2.5 Trillion in cash profits residing overseas. This is a staggering level of capital that could be going toward economic investment, production and growth domestically instead of boosting the capital availability and growth of other nations.
Our corporate tax structure creates countless unnecessary complexities and conflicts with our individual tax code. Do away with that structure – even if shareholder taxes are adjusted in a manner that was revenue neutral to the Treasury – and you have gained massive economic efficiencies – in addition to providing instant solutions to the problems listed above.
Some other reasons to abolish the corporate tax:
Removal of political gamesmanship – An entire lobbying force working to get tax breaks for corporations is gone overnight. Gone too are the incentives for politicians to grant their constituencies favors via the tax code. Kill the corporate tax code and you immediately remove a big motivation for corporate money being involved in the political arena – along with special interests.
Legal & Tax Departments – Tax compliance and tax strategy related departments would be rendered obsolete and would result in the saving of literally billions of dollars and countless man-hours. Tax lawyers and consultants would need to find another avenue for work. And smaller businesses would be placed on a more equal footing.
Tax status – there would be no need for non-profit distinction – and the associated games being engaged in – by both companies and the IRS.
The entire tax system would be vastly simpler.
Any corporate tax burden borne by labor is removed.
The increased level of investment by corporations – along with higher dividends – would re-invigorate our entire economy
Corporations would run their companies based on underlying economics without the distorting influence of tax strategy behavior. Corporate CEOs would focus on what are now pre-tax profits.
Foreign investment would flood back into the United States.
The International tax problems and distortions noted earlier would disappear.
The $2.5 trillion in U.S. corporate cash would be repatriated for use domestically.
This is but a partial list of reasons for abolishing the corporate tax rate. Each one makes a strong case on its own merits. The argument appears overwhelming when viewed in its entirety. And President-Elect Trump knows this. I am guessing he believes a reduction in the corporate tax rate to 15% is achievable but perceives the political cost to abolish the corporate tax as being too high. I hope he reconsiders. A 15% percent corporate tax is a great move for the country. Abolishing the corporate tax would be exponentially greater.
newer post Building Better Infrastructure Plans
older post Trump’s Deregulation Gift