Tuesday, April 5, 2011

Corporate Income Tax: Does It Make Sense?

The fairness and the appropriateness of a corporate income tax are subjects that come and go often. Currently there is some considerable interest. Senator Bernie Sanders sent out a list of large corporations who managed to make a lot of profit while paying little or no tax. There is also a call for a tax holiday so that corporations can repatriate some of their overseas profits without paying a significant amount of tax. Both of those issues bring in factors beyond the issue of the corporate income tax, nevertheless they have served the purpose of raising the point for discussion.

A person’s views on this issue tend to align with his/her politics. Those on the left generally believe that corporations should be required to pay a fair share, while those on the right tend to view the tax as anticompetitive and bad for the economy.

Let’s put the tax in context first. It is claimed that the US rate of 35% is the second highest in the world. Here are some data from other countries (maximum percentage rate).
Argentina        35
Australia         30
Brazil              34
China              25
France            33.33
Germany         29.8
Ireland            12.5
Italy                31.4
Japan             40.69
Norway          28
Switzerland     25
While the US’s rate is on the high side, it really is not very different from that of most industrialized countries. Ireland has a low rate that was chosen to attract international corporations. It worked until they went broke (for other reasons). It is not clear that the EU will allow them to plead for aid while maintaining a corporate tax much lower than that of those who are ensuring its existence. There was not a single country listed that had a zero corporate tax rate.

Another pertinent issue is the rate which corporations actually pay. The tax laws are complex, and loopholes and deductions are plentiful. Here are some figures quoted by the New York Times on the net effective tax rate by industry category.

I am not sure how accurate these numbers are, but it should be safe to conclude that very few companies are actually paying the full tax rate.

If one wishes to claim that the tax rate is too high there is a credible argument to be made based on comparisons with other countries. However, that path does not lead to significant cuts. The average for the European nations listed above is 27%, even with Ireland included. Lowering the maximum rate to about 30% would leave the US roughly consistent with its European trading partners, and consistency is probably a good thing. A dramatic lowering would make the US look more hospitable to international firms from other countries, but that is not necessarily a smart approach towards maintaining good relations with countries with whom you do need to collaborate. In addition there would be loss of revenue that would have to be regained with offsetting tax increases elsewhere.

The Obama Administration is sending the message that it is willing to consider lowering the maximum tax rate, but only in concert with tax reform. This presumably means that they are not willing to lose revenue in the process, and are hoping to at least break even.

Some argue that it is best to lower the corporate tax to zero. One claim that is made is that the tax does no good because the companies merely pass the costs on to consumers or extract it from what they are willing to pay in salaries. But wouldn’t this imply that no tax on any company would be effective? Wouldn’t the same argument be valid concerning the payroll tax that companies pay on their employees? Clearly paying taxes is a business cost and the result shows up in prices charged, but meanwhile taxes have been collected that otherwise would have had to come from somewhere else, and businesses still have to compete on price on a fairly level playing field, both domestically and internationally.

If the country does decide to lower the corporate rate dramatically, even to zero, where does the revenue come from? One could consider taxing the shareholders at a higher level on the assumption that they would earn greater dividends. But companies need not pay out their profits in dividends in order to make the shareholders happy. Most investors would prefer to see a gain in stock price instead of a dividend. The company could easily reinvest its profits hoping for company growth and an increase in share value. The country is still out the funds.

One could arbitrarily raise the taxes on someone else to make up for the loss. The high income groups are always a good target, but is this really appropriate—or even possible? One could counter by saying that it is not fair that shareholders are double taxed, once on their company’s profits and once on their dividends. The answer to this is—so what? Who gets to define what is fair?

The best reason for maintaining a corporate income tax has more to do with civics than economics. Corporations are entities that consume public services. Police and fire departments have to protect them; regulators have to monitor them to keep them from causing too much damage; the government pays for much of the R&D required to develop the products they use in their businesses; the country even goes to war occasionally to protect their interests (we will refrain from suggesting a tie between Iraq and oil companies). These are only a few examples of how they dip into the public’s purse. If they wish to take advantage of all these benefits they are going to have to contribute funds to the common good.

There is another way to look at this. One might consider taxes as the glue that holds a society together. They serve as a kind of contract between the government and the governed. The government says you pay me this tax and I will provide the services you need. The governed say okay, but you better deliver or there is going to be trouble. This continual tension is part of what drives a nation and a society to evolve. This tension must be experienced by corporations. If they wish to share the benefits of society, they have to have some skin in the game—just like the rest of us.

In cruising the web looking for information I came across this quote. I don’t know if it is original, but I had not heard it before. It seemed to bear repeating somewhere. Why not here?
“....economics is essentially philosophy with numerical illustrations....”


  1. Rich,
    Thanks very much! I especially like your reminder to us of WHY corporations should pay taxes - and perhaps especially since they are also "persons" legally. The only poitn I'd disagree with you on is that it might not be a help to raise dividend taxes. I feel that if you can afford to buy stocks in the first place, you can afford to pay the same on dividends as on regular "earned" income. Yes, you're helping the economy to support companies, but you aren't actually doing any 'work": the 15% on dividends is regressive.

  2. A comment on the more narrow issue of "double taxation". It is in the nature of trade and economic exchange that a dollar travels through many transactions in its life -- perhaps in perpetuity if it's not stuffed in a mattress at some point. These transactions typically involve income of some sort for one side of them and it is often taxed -- income, sales taxes, etc.

    So one could argue that this dollar is taxed many times as a matter of course. And, at the same time, those dollars that make up taxes then become income for others as the collected taxes are spent by governments.

    So if corporate profits are taxed and then shareholders are taxed on dividends, this news deserves a big yawn. It's not so much "who decides what's fair?" but rather, that it's no different than anything else. I am charged income tax on my wages and then,lo and behold, these same dollars are subject to sales taxes, property taxes, user taxes, excise taxes, etc. Double taxation?

    Perhaps the underlying bias of the arguers against "double taxation"is that they don't like two income tax transactions in a row, probably because they don't like income taxes period. Wealthy people generally don't. Or perhaps they haven't thought that deeply about it and simply take any available argument and run with it if it suits their interests.

    On the larger issue of whether or not there should be corporate taxation, I find the question intriguing and hope to read more about it.

    But even if on theoretical grounds, the idea to abolish it might make sense (and I'm not saying it does), on a practical political-reality check level alone, I am skeptical. In terms of making sausage, I imagine you wouldn't get what you'd hope for. Rich CEOs and those with economic clout will likely control the process and the ingredients.

    Not to mention that you are losing a tool to promote certain positive policies, namely, incentives through targetted tax reductions -- whether used to promote investment in underserved communities, to help small businesses get a start,to encourage green industries,or some other worthwhile goal. Now I know that such tax breaks are frequently poorly targetted and therefore less effective than they could be. Still, losing this tool entirely may not be a good thing.
    Stephanie Ericson


Lets Talk Books And Politics - Blogged