Kevin Drum suggests (modestly or “modestly”) that “everyone” should love the idea of trading the corporate income tax for carbon and financial transactions taxes. I should just have a chuckle and leave it at that, but then again I get emails from the Tax Foundation that are remarkably lacking in irony. Ezra Klein is happy with his policy-wonk hat on, but thinks there’s a political problem of giving fat cats an obvious break. I argue that the problem is not just political. Drum’s at least semi-serious claim is that taxing corporate income is bad because doing so is a drag on business and ends up getting paid by individuals anyway. Neither necessarily militates against corporate income taxation in the real world.
Whether a “drag” on business or some other tax distortion that reduces private-sector activity (other things equal) is good or bad, on net, depends on the use to which the tax revenues are put. In a world such as ours where public expenditures serve as public capital and intermediate goods in addition to government consumption, it’s straightforward to write a model where distortionary taxes are optimally set at non-zero levels. (I once assisted the late Mancur Olson in doing so.) These models do not even have to appeal to left-leaning aspects of reality such as the economic efficiency of negative-sum redistribution when marginal utility is declining and income and wealth are (very) unequally distributed. So even if Drum’s switch is revenue-neutral and doesn’t stiff the government as such, it may still be improved upon — maybe not from the Tax Foundation’s perspective — by adding the distortionary tax on top of the efficiency-improving Pigovian taxes and spending the proceeds wisely. Moreover, while we’re in tax policy fantasyland, the corporate income tax could be made more efficient without necessarily reducing its revenues by way of reforms that broaden its base and reduce the statutory marginal rates.
Second, merely noting the ultimate incidence of the corporate tax on individuals fails to consider significant issues of which individuals end up paying the tax. Certainly, the tax may be passed onto individuals in part in their role as customers of businesses subject to the tax, but it will also fall on individuals as shareholders in the businesses to the extent the tax can’t be passed through. Since shareholdings remain highly concentrated among the rich, this creates equity issues center-left wonks like Drum and Klein should be happy to entertain.
Moreover, eliminating taxation on corporate income would tend to have knock-on effects making the individual income tax system less efficient. When tax system complexities create categories of income with preferential tax treatment, it creates opportunities for people who can choose how to realize their income to take their income in the low-taxed form. This narrows the tax base and requires higher (and less efficient) rates to produce a given level of revenue. In this case, untaxed corporate income gives retained earnings an indefinite tax deferral, so the incentive is to convert income from shareholdings such as dividends into unrealized capital gains (which also are tax-deferred).
The argument remains that making fat cats fatter is a small price to save for saving the planet for everybody else. I can almost swallow that, but note that much of the noise over reforms seem to be geared towards masking the fact that people with ownership in existing corporations have as much or more to lose from climate and financial catastrophes than the rest of us suckers.
Now that the Supreme Court has ruled that corporations are people and should be afforded the free protections as such, seems reasonable to me they should also pay income taxes.
Dr. Bozzo, you write that corporate taxes “…will also fall on individuals as shareholders in the businesses to the extent the tax can’t be passed through.”
In the long run, isn’t every cost of a going concern passed through to customers?
And if it were possible to institute a tax that could not be passed through, isn’t that a simple confiscation whose effect would be to chill capital investment, and therefore worker productivity, and therefore worker incomes? If FedEx just had wagons and handcarts instead of jets and trucks, its employees would make very little.
I only have six hours of Principles of Economics to my name, but I have strived for a better understanding for decades. I hope you can take time to respond.
Yeah, an infinitely long-lived firm under certain market structures ought to recover all of its costs from its customers (which may or may not resemble the general population) in the limit, but in practice firms have finite lives and exercise market power which may allow them to earn economic profits. So in practice, it’s possible to tax away surpluses that would otherwise accrue to shareholders.
As I said in the post, looking at the notional distortion (“chill[ing] capital investment”) in isolation is inappropriate. Where would FedEx be without airports and highways funded at least in part by way of distortionary taxes?
Great point about FedEx. Sticking with that example, it seems like the whole system would be more efficient if the original distortion were reduced by putting the costs of the airports and highways more directly on the users instead of piling distortion on distortion.
The area of corporate-government interplay that bugs me the most is the existence of “economic development” breaks to companies. States and cities vie for development with breaks paid by all other taxpayers, and the site selection turns into an auction. If the unequal treatment inherent in economic development incentives were abolished, cities and states would compete on the basis of the quality of schools, infrastructure, social amenities, and work force. Instead, we rob the budget for all these things in order to compete at the auctions. The little shop is taxed to provide a gift for Walmart, which will drive up the little shop’s costs and compete for its customers. I have nothing against Walmart, but it is not the most logical recipient of a public gift.
User fees have their place, but they’re not a cure-all. In practice, you don’t so much pile on distortions as trade them — e.g. charging marginal cost (which may be zero) for a public good and funding total cost from “general fund” taxes vs. charging average cost as a user fee.
I do agree in large part on corporate tax breaks justified on ‘economic development’ grounds. BTW, for some good reading on the subject, check out David Cay Johnston’s Perfectly Legal and Free Lunch.
State chartered business collectives receive huge benefits from the state in the form of limited liability. They were originally designed to provide limited liability for specific projects and purposes, but starting in the 19th century, they have been granted greater and greater powers. (Does anyone even use the term ultra vires anymore?)
To start with, limited liability means that the state may have to pick up the pieces if a corporate venture causes external problems, beyond what the corporation can cover in liquidation. It also creates an agency problem, in that the corporation can take on much greater risk than any sane individual would. This protects the owners and management, but imposes costs on the rest of society. Since the government is effectively assuming the excess risk, it should obtain some benefit for the privilege.
Also, that “passing on the cost of higher taxes” argument is bogus. If the corporation could pass on the cost of higher taxes, it would be irrational not to be grabbing that surplus today as profit. Not every corporation is run by a charitable angel. The real problem is that the cost of higher taxes could not be passed on to consumers, at least not all of it, and that would mean less executive compensation. We’ve actually run this experiment. Compare corporate taxes and executive compensation pre-1980 and post-1980.
Personally, I have nothing against collectivism. There are inherently risky operations that we all benefit from, so it makes sense to provide a collectivist structure to manage the risk. On the other hand, we shouldn’t buy so completely into the collectivist myths of capitalism that we lose control of the artificial entities we have created and turn their potential against ourselves.