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Wednesday, February 29, 2012

Should We Abolish the Corporate Income Tax?

Bloomberg, Should We Abolish the Corporate Income Tax?, by Peter Coy:

No. Bad idea.

OK, sorry, that was a little blunt. After all, there are a lot of smart people who think President Barack Obama didn’t go far enough in his recent proposal to cut the corporate income tax rate to 28 percent from 35 percent. They would like to see it go all the way to zero. They say trying to tax corporations is a waste of time because they aren’t like people—ultimately they just pass along the cost of the tax to their shareholders, workers, and (to a small extent) customers.

The abolitionists aren’t all conservatives, either. The Atlantic‘s Megan McArdle has said the corporate income tax “may be the stupidest tax we have.” Even a liberal like blogger Matt Yglesias asked on Feb. 24 why the U.S. doesn’t just ditch the corporate income tax. (He decided that getting rid of it now and replacing the revenue in a fair way is politically unrealistic.)

But this just might be a case in which the policy elites of both left and right are wrong—and ordinary Americans, who kind of like the corporate income tax, are right. The strongest argument for the corporate income tax is one that is rarely heard anymore but was widely used at its inception in 1909—namely, that the tax is a brake on excessive corporate power.

The person who has pressed this argument is Reuven Avi-Yonah, a professor at the University of Michigan Law School. Avi-Yonah is well-credentialed, with both a PhD in history from Harvard University and a JD from Harvard Law and consulting work for the U.S. Department of the Treasury and the Organization for Economic Co-operation and Development. His 2004 paper, Corporations, Society and the State: A Defense of the Corporate Tax, is a classic

The Atlantic, Why I Still Think We Should Eliminate the Corporate Income Tax, by Megan McCardle:

One of the first blog posts I ever wrote was on why we should eliminate the corporate income tax.  This is not because I just looooooooove corporations, or wish to put more money into the hands of rich people--on the contrary, I want to pair an elimination of the tax with an end to the special low tax rates for dividends and capital gains, and maybe even an increase in rates for higher brackets if that's necessary to keep the thing revenue neutral.  Which would actually be considerably more progressive than the current system.

Rather, I think the thing's horribly inefficient--companies and rich people spend an exorbitant amount of time arranging their affairs to be lower-taxed, rather than more productive.  Taxing capital once, when it hits a person, as ordinary income, would in one fell swoop eliminate most of the tax-avoidance activity that goes on in this country.  It's also not necessarily as progressive as its proponents think, and well, you can read all my other reasons for disliking it here.

Peter Coy, the economics editor of BusinessWeek, thinks I'm wrong.  He argues that eliminating the corporate income tax isn't first-best policy, not even close. He channels Reuven Avi-Yonah, a law professor at Michigan, to argue that the corporate income tax is necessary to rein in the power of corporate managers.  ...

It's an intriguing argument, but I'm not convinced.  I feel like we have all sorts of vehicles for "supervisory control of corporations", and the IRS is probably not the most efficient. Moreover, it's far from clear to me that the taxing power has ever been very good at reining in the power of corporate executives.  ... [T]the corporate income tax is largely expressive--we like policies which penalize corporations, particularly big ones, regardless of their actual effect on corporate power.

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Comments

We need to shift our tax systems from income-based and production-based taxes to consumption taxes. Getting rid of the corporate income tax and replacing it with some kind of consumption tax would be a good first step. BTW, I am a true blue, liberal, Democrat.

Posted by: Publius Novus | Feb 29, 2012 12:47:06 PM

Opens up serious planning opportunities by storing cash in a private C corp, investing and reinvesting it tax free for the benefit of private individuals, and only paying out dividends when the controlling shareholder is ready to recognize income.

Something similar is happening illegitimately with S corps now, as sometimes people form an S corp to hold service income but avoid paying Medicare tax. John Edwards got caught doing that.

Elimination of the double tax puts more pressure on the IRS to enforce the Accumulated Earnings Tax, to force corporations to disgorge any profits that are not reasonably necessary for the business. Would also enable people to use C corps as a proxy for testamentary trusts, basically holding money forever and then passing down the controlling shares through the family (with tax free step up under current law). Puts more pressure on the Service to monitor for these actions.

The problem gets worse if you raise the top marginal rate on individuals. That just gives the wealthiest and best-represented taxpayers more incentive to pay people to find ways to plan around this.

If you want to reduce gaming of the tax code and distortion by the tax code, the only surefire way is to radically reduce rates and lower the comparative benefits of gaming versus paying. As long as there is a significant tax burden to avoid, large numbers of people will try to find ways to avoid it.

Posted by: NL_ | Feb 29, 2012 2:22:11 PM

I feel like abolishing the tax would probably lead to excessive corporate hoarding of cash. Why would your stock payers want a dividend which triggers a high tax when you can just hoard the money, which would be reflected in your stock price, and then stockholders cod effectively delay recognizing gain for as long as they like.

Posted by: Bob from Ap | Feb 29, 2012 3:38:21 PM

The Avi-Yonah argument is just plain silly,but NL_'s argument in the comment above is the one sound argument for the corporate tax. I've been looking for an article on the kind of problems he describes--- the nitty gritty of how individuals could use untaxed closely held corporations to avoid taxes. Anybody have any suggestions?

Posted by: Eric Rasmusen | Mar 1, 2012 5:37:15 AM

what about stock held by foreigners, tax-exempts and 401(k) plans for which no shareholder-level tax is paid?

Posted by: lv | Mar 1, 2012 5:53:16 AM

I assume that eliminating the corporate income tax means making corporations pass-throughs like certain publicly-traded partnerships, although advocates so far don't really specify. Personally, I'd rather retain the corporate income tax while allowing a deduction for dividends paid. The goal would be to tax at the corporate rate (set to the highest individual rate) any retained earnings, while incentivizing returning earnings to the shareholders (who may be at a lower rate or tax exempt). This may even shift more power away from corporate executives because shareholders would scrutinize the need for retained earnings. Finally, this would also treat debt and equity investments the same.

Posted by: rob | Mar 1, 2012 7:50:49 AM

The current Income Tax system has been falling apart for years!

Its complexity and contradictions have been created by provisions intended to penalize taxpayers. So, on the one hand, politicians will talk about tax breaks that they want to give to certain groups, but on the other hand they sneakily take away tax breaks from smaller and less-favored groups.

According to a recent government report, U.S. taxpayers and businesses spend about 7.6 billion hours a year complying with tax-filing requirements. That is 7.6 billion hours of lost production time that would actually create more revenue for the government if that 7.6 billion hours was spent producing more income as opposed to complying with government filling out paperwork laws.

So there is no doubt in anybody’s mind that the current Income Tax system with its mind numbing rules and regulations that cover the movement of every single penny that transfers from one person or entity to another is not going to be able to sustain itself too much longer. In fact, it is only going to continue to get worse and worse.

What you are hearing now is a concerted push from the American people to end the burdens and nonsense that is inherent in the current U.S. Income Tax system.

And as the Income Tax code continues its downward slide, there is going to be an even stronger push back from the American people until the whole thing is either gotten rid of or extremely simplified.

Posted by: Scott Greene | Mar 3, 2012 8:56:17 AM