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No More Corporate Taxes?

November 24, 2008

Why get rid of corporate taxation? Because these taxes hurt the poor and middle class. This is easy to understand once you grasp a few basic principles.

The first of these is that any cost imposed on a business is passed on to customers. This is true at all levels. If food and labor costs go up, restaurants raise prices, right? The same is true of large corporations. If a certain return on investment is expected, and taxes on corporations reduce that, investors hesitate to invest. Companies have to raise prices in order to get back to an after-tax profit level that attracts investment.

The second important principle is that all costs – including taxes – are ultimately paid by people. Only people create value, whether through small companies or large corporations, and ultimately only people can pay the costs of things. But who pays, and is there a way we can all pay less? The answer to the last question is yes – but I’ll return to that in a moment.

As pointed out, corporate taxes are simply added to the costs of the things produced, which means the poor and middle class consumers bear the brunt of the burden (since prices affect them more). Consumers are the ones really paying the taxes in the end, the same as when rising property taxes for landlords are passed on to renters, or many other examples we could point to. Is there a better, more just, and more efficient way?

What if we had no corporate taxes? Higher profits would be possible with even with lower product prices. But those higher profits and lower product prices would not just come from the direct impact of eliminating corporate taxes. Corporations currently spend millions of dollars to reduce taxes. They hire whole buildings full of accountants to find loopholes. They structure deals in ways that might not make sense financially if it were not for the tax consequences. It’s all very wasteful and ultimately unproductive.

Without taxes, the whole corporate costs of tax-avoidance and the resulting inefficiencies would be gone. Also, the whole tax accounting industry would be smaller, meaning more people would be in careers that are more directly productive of value (I’m not suggesting for a second that tax attorneys and tax accountants are not productive and needed, but the value they offer is by nature derived from more fundamental value creation, of which there would be more if fewer of them were needed). That would mean a more productive society.

Okay, so you can see that lower prices for goods, more efficient companies and a better economy might result. But what about the lost tax revenue? How would we make that up without raising taxes on all of us? Two basic ways come to mind.

First, the increase in economic activity would mean more income at all levels and therefore more tax revenue, even if existing rates are the same. If corporations hire more, those employees all pay taxes. If you get a raise or make more with your small business, that 15% tax rate on $50,000 means more money collected by the government than 15% on $40,000, right?

The second way we replace the “lost” tax revenue is by not losing it. We would simply have to tax owners of corporations on their share of profits each year, whether or not the corporation retained some of those earnings for future use. Of course, retained profits would be added to the investor’s or owner’s cost basis for figuring capital gains when he or she eventually sells. Some might argue that this latter problem (taxes on retained earnings) would scare off investment, but the increased profitability of the corporations would balance this out I think.

Keep in mind too that there would no longer be a reason to exaggerate expenses or otherwise “hide” profits at the corporate level, since no tax savings accrue to the company by hiding profits. So we could rightly expect that there would be an increase in reported profits because these practices would largely end (at least in publicly traded corporations where the owners/shareholders didn’t directly make such decisions). In other words, this could bring out into the open many profits that owners would then be taxed on as personal income.

Let’s look at that a bit closer, because it is so important. According to a study released by the Government Accountability Office in August, 2008, two thirds of corporations in this country paid no federal income taxes from 1998 through 2005. Many commentators were quick to point out that this didn’t mean they were illegally avoiding taxes. Of course the fact that they may have been legally avoiding taxes just makes my above argument that much stronger.

Some suggested that many corporations were small and had no profits to pay taxes on. That’s true, but could that account for so many paying nothing for years? Not likely. The same study found that 68% of foreign corporations doing business here did not pay taxes during those seven years. It seems unlikely that most foreign corporations doing business here are small family businesses, and it seems very unlikely that most corporations would be around after seven truly profitless years.

The more likely scenario is that they are hiding profits in legal ways to avoid taxes. That would mostly end when there is no longer a reason for it. It is difficult to say how much profit would suddenly appear if there was no corporate benefit for hiding it, but it would all become taxable once it was treated as personal income of shareholders.

As it is now, individuals who own shares in a corporation do not pay taxes on profits (which are taxed at the corporate level), and they pay a special reduced rate of 15% on dividends and capital gains. This is why the wealthy often pay a lower effective tax rate than the middle class (and even the poor if you count Social Security, Medicare and sale’s taxes). Warren Buffet famously pointed out that he pays just 17% on his millions in income while his secretary pays 30% on her $60,000 income.

I’m suggesting that it is more fair to all pay the same on any income, including all profits accrued by owners of corporations. This effectively makes for a more productive economy. It also corrects what has been the unfair treatment of the poor and middle class to the benefit of the wealthy. After all, special tax treatments for various forms of income generally do not benefit those who do not have large assets or investments. They lower contributions to government (taxes) for the wealthy, and we can guess where the slack has to be picked up.

Get rid of corporate income taxes. Only the productivity of real people can pay for government or anything else for that matter. Let’s not hide the facts about who pays behind elaborate and unnecessary tax systems.

(Note: There may be good reasons for some taxation at the corporate level, like to have taxes paid by foreign corporations which do business here and would otherwise receive all the necessary government services (roads, ports, legal system and so on) without paying for them.)

Note: This is part of a series. You can find all of the pages listed and linked to here:

The Redistribution of Wealth to the Wealthy

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Corporate Taxes