Myths and Facts About Corporate Taxes, Part 4: Should We Just Scrap the Corporate Tax Code?
This post is the latest in a series that has aimed to question the conventional Beltway wisdom about the supposed harm to the economy inflicted by the corporate tax code. Today, we’ll take on the idea that’s long been fermenting on the right, but now increasingly popping up in more mainstream outlets, to abolish the corporate tax code entirely. While there are reasons the idea of ceasing to tax corporations makes sense, the idea’s proponents have underestimated its drawbacks.
Getting rid of the corporate code entirely has some intrinsic appeal. Because corporate taxes are ultimately paid out of individuals’ pockets, it can seem desirable to tax these individuals directly—without dealing with all of the exemptions, credits, loopholes, and deductions in the corporate code, not to mention the “tax avoidance industry” such provisions support. This could potentially be a more efficient way to raise the same amount of revenue. However, there are three main obstacles that stand in the way of getting rid of the corporate code entirely.
- The corporate tax code is a progressive revenue raiser. While the corporate code only brings in about 10 percent of federal revenue, that’s still $315 billion in 2014. It’s also really progressive; the lowest fifth of earners pay about 0.9 percent of their income in corporate income tax, while the top 0.1 percent of earners pay 9.7 percent. According to the Congressional Budget Office, about four-fifths of corporate income is held by the top fifth of the income scale, and about half is held by the top 1 percent. Thus, as Jared Bernstein points out, “Unless we could replace it with higher taxes on those same households… scrapping or even just lowering the corporate tax rate would increase after-tax income inequality.” Raising that kind of revenue from the same sources, in the absence of a corporate income tax, is tougher than it may seem. The plan cited by the New York Times’ Josh Barro would replace the corporate tax by taxing individuals’ capital gains at ordinary income tax rates—a proposal long favored by progressives—and that would still only make up half of the lost revenue.
- Unintended consequences. As we’ve seen this year in Kansas’s experiment with eliminating corporate taxation, the unintended consequences are enormous. For instance, if corporations don’t pay taxes, but people still do, what would stop individuals from simply incorporating themselves for tax reasons—thus paying no taxes until their “corporate” earnings are distributed? (Kansas lost out on almost $300 million of revenue over a two-month period this year, for just this reason.) This maneuver would be just the tip of the tax avoidance iceberg if the corporate code were abolished. Getting rid of the corporate tax code and its myriad opportunities to evade taxes would not necessarily result in a system that’s harder to game.
- If you win the race to the bottom, you’re still at the bottom. While scrapping the corporate tax code would represent a “victory” in the international race to the bottom, it would undoubtedly be short-lived, as other countries would certainly react by slashing or zeroing their rates as well. This would be like a game of prisoner’s dilemma in which each suspect ratted out the other and everyone ended up in jail for a long, long time. (Jail in this case would be a hypothetical world in which multinational corporations paid no tax to any country at all.) Currently, every developed country levies a corporate income tax. They may tax different kinds of income and at different rates, but these taxes still exist throughout the world because they provide governments with revenue that would be hard to replace by switching to another tax system.
Again, there is enormous appeal in the idea of scrapping the corporate tax code entirely, especially in light of how adept American multinationals are at exploiting the code; redirecting some of the revenue that now goes to the corporate tax avoidance industry to the Treasury instead would be a positive development. However, for the “scrap the corporate code” idea to succeed, policymakers would have to work out some very thorny problems.
As this short series of blog posts makes clear, one must be very careful when parroting the conventional wisdom that high American corporate tax rates are putting American multinationals at a competitive disadvantage. They are not. Tax reform may be necessary to raise revenue, promote fairness, and smooth economic distortions. But while the corporate tax code is far from perfect, the solutions to fixing it are much more nuanced than corporate America and its friends in Congress would lead you to believe.
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