The administration and the Congress are considering reform of the federal government’s corporate income tax by reducing the top rate of the corporate income tax from 35% to as low as 15%.  Cutting the corporate tax rate is not reform.  Real corporate tax reform would treat corporations the same as partnership earnings are currently treated – namely, to tax the earnings of corporations as the personal income of shareholders just as partnership earnings are taxed as the personal income of their partners.

Corporations are simply limited liability partnerships.  The distinction of limited liability no longer exists, since most states enable partnerships to register as limited liability enterprises.  So real major reform would be to eliminate the corporate income tax and to tax corporate earnings as the personal income of the shareholders.

There is precedent for taxing corporate earnings as personal income.  The earnings of partnerships, individual proprietorships, and “S” corporations are already taxed as personal income.  Moreover, there are many other good reasons to tax corporate earnings under the personal income tax.

Economists have long considered the corporate income tax a bad tax.  The corporate income tax violates the principle that persons in equal economic circumstances should receive equal treatment.  The corporate income tax falls with the same weight on the earnings of the very wealthy as it does on shareholders with lower incomes, a significant difference in economic circumstances.  Shareholders in lower tax brackets bear the same tax rate on corporate earnings as millionaires and billionaires.  As a result, their incomes at retirement are much less than they would be if their share of corporate earnings were taxed at personal income tax rates.

It violates the principle of progressivity, that those with higher incomes should pay a higher rate of tax than those of lower incomes.  The case for progressivity rests on the fact that incomes are unequally distributed.  The personal income of most individuals with very high incomes is attributable to monopoly power caused by differences in personal ability, to different degrees of monopoly power inherent in a free-market economy, to real and sometimes illusory product differences, to location, and even serendipity.  Such differences are called economic rents and are essentially undeserved.  Progressively taxing economic rents has little or no negative economic effects.  They make a strong case for keeping the personal income tax progressive.

Economists have long pointed out the negative economic effects of the corporate income tax that the personal income tax does not have.  For example, corporations are encouraged to buy back their stock instead of paying dividends.  The former creates capital gains, which are taxed at a lower rate than dividends.  So it is a tax avoidance scheme for which corporate managers expect to be rewarded.  Another problem is the “double”-taxation of dividends, first as corporate earnings and second as personal income.  Congress dealt with the double taxation of dividends by treating dividends as a limited deduction under the personal income tax.

Because some countries tax corporations at lower rates of corporate income tax, the USA’s high rate has the negative effect of encouraging the movement of factories and corporate headquarters to countries with lower income tax rates and to encourage corporations to retain and reinvest the earnings earned abroad in foreign countries.  Indeed, this is the principal reason given for wanting to reduce the corporate income tax rate.  Corporate income tax rates have no effect on international trade because income taxes have no effect on trade.  Only taxes that affect the costs of producing goods (marginal costs) affect the supply and therefore the ability to compete.  Income taxes have no effect on supply curves.

Congress is considering a border tax – a sales tax that would act as a tariff falling equally on countries with which we have chronic deficits and in countries with which we have a trade surplus.  It would raise revenue to offset the loss of revenue expected from the proposed cut in the corporate income tax rate.  Our state sales taxes are border taxes averaging about 7 percent, so the proposed border tax of 15% would result in a domestic sales tax of 22-25% on all imported products.  Eliminating the corporate income tax and taxing corporate earnings as personal income would be more or less revenue-neutral at current rates of personal income tax, whose top rate is 39.6 percent.  Warren Buffett would no longer be able to claim that he is taxed at a lower marginal rate of personal income tax than his secretary.  His effective tax rate would be slightly less than 39.6%

The burden of the corporate income tax is borne by shareholders, unless the corporation succeeds in passing the tax on to its consumers or workers.  Economists are unsure of who bears the burden of the corporate income tax.  It is believed that the incidence of the tax depends on the degree of monopoly power the corporation has.  For example, the corporate income tax falls with its full weight on farmers and mine owners and other producers of homogeneous products because they have little or no control over the price charged.  All others have some monopoly power based on patents, location, and advertising.

How did we get stuck with the corporate income tax?  The Constitution required federal taxes to be apportioned equally among the states according to population, something obviously impossible with an income tax.  But the corporate income tax got passed as an excise tax and was kept in existence when the 16th Amendment was adopted and the personal income tax enacted.

The only argument that can be made in favor of the corporate income tax is that we have learned to live with it in spite of its defects.  The old adage that an old tax is a good tax probably is its best justification.  But the old tax is clearly under fire for its faults.  The public likes it because the public thinks, contrary to fact, that it is solely paid by the rich.  People don’t realize that the tax may be paid by them as consumers and as beneficiaries of pension funds containing the savings of millions of middle- and low-income families or that it encourages corporations to move their factories and headquarters abroad, costing thousands of jobs.

The personal income tax also needs reform, but most of the proposals can be criticized.  Among the proposals are reduction in the number of brackets, a reduction in the top rate, and elimination of the deduction of state income taxes, mortgage interest on residential properties, local property taxes, and state and local sales taxes.  None of these is a needed reform.  Also being considered is the abolition of the estate tax, a tax that could be important in reducing the inequality of wealth.

Apparently, few members of the Senate and the House of Representatives; few conservatives; and, we are ashamed to say, few economists have analyzed the proposed reforms adequately just as they fail to analyze the corporate income tax adequately.

The writer is prof. emeritus of public and international affairs at the University of Pittsburgh, holds a Ph.D. in economics from the University of Chicago, and is president of Ideal Taxes Inc.  He may be e-mailed at richmanpitt@aol.com.

The administration and the Congress are considering reform of the federal government’s corporate income tax by reducing the top rate of the corporate income tax from 35% to as low as 15%.  Cutting the corporate tax rate is not reform.  Real corporate tax reform would treat corporations the same as partnership earnings are currently treated – namely, to tax the earnings of corporations as the personal income of shareholders just as partnership earnings are taxed as the personal income of their partners.

Corporations are simply limited liability partnerships.  The distinction of limited liability no longer exists, since most states enable partnerships to register as limited liability enterprises.  So real major reform would be to eliminate the corporate income tax and to tax corporate earnings as the personal income of the shareholders.

There is precedent for taxing corporate earnings as personal income.  The earnings of partnerships, individual proprietorships, and “S” corporations are already taxed as personal income.  Moreover, there are many other good reasons to tax corporate earnings under the personal income tax.

Economists have long considered the corporate income tax a bad tax.  The corporate income tax violates the principle that persons in equal economic circumstances should receive equal treatment.  The corporate income tax falls with the same weight on the earnings of the very wealthy as it does on shareholders with lower incomes, a significant difference in economic circumstances.  Shareholders in lower tax brackets bear the same tax rate on corporate earnings as millionaires and billionaires.  As a result, their incomes at retirement are much less than they would be if their share of corporate earnings were taxed at personal income tax rates.

It violates the principle of progressivity, that those with higher incomes should pay a higher rate of tax than those of lower incomes.  The case for progressivity rests on the fact that incomes are unequally distributed.  The personal income of most individuals with very high incomes is attributable to monopoly power caused by differences in personal ability, to different degrees of monopoly power inherent in a free-market economy, to real and sometimes illusory product differences, to location, and even serendipity.  Such differences are called economic rents and are essentially undeserved.  Progressively taxing economic rents has little or no negative economic effects.  They make a strong case for keeping the personal income tax progressive.

Economists have long pointed out the negative economic effects of the corporate income tax that the personal income tax does not have.  For example, corporations are encouraged to buy back their stock instead of paying dividends.  The former creates capital gains, which are taxed at a lower rate than dividends.  So it is a tax avoidance scheme for which corporate managers expect to be rewarded.  Another problem is the “double”-taxation of dividends, first as corporate earnings and second as personal income.  Congress dealt with the double taxation of dividends by treating dividends as a limited deduction under the personal income tax.

Because some countries tax corporations at lower rates of corporate income tax, the USA’s high rate has the negative effect of encouraging the movement of factories and corporate headquarters to countries with lower income tax rates and to encourage corporations to retain and reinvest the earnings earned abroad in foreign countries.  Indeed, this is the principal reason given for wanting to reduce the corporate income tax rate.  Corporate income tax rates have no effect on international trade because income taxes have no effect on trade.  Only taxes that affect the costs of producing goods (marginal costs) affect the supply and therefore the ability to compete.  Income taxes have no effect on supply curves.

Congress is considering a border tax – a sales tax that would act as a tariff falling equally on countries with which we have chronic deficits and in countries with which we have a trade surplus.  It would raise revenue to offset the loss of revenue expected from the proposed cut in the corporate income tax rate.  Our state sales taxes are border taxes averaging about 7 percent, so the proposed border tax of 15% would result in a domestic sales tax of 22-25% on all imported products.  Eliminating the corporate income tax and taxing corporate earnings as personal income would be more or less revenue-neutral at current rates of personal income tax, whose top rate is 39.6 percent.  Warren Buffett would no longer be able to claim that he is taxed at a lower marginal rate of personal income tax than his secretary.  His effective tax rate would be slightly less than 39.6%

The burden of the corporate income tax is borne by shareholders, unless the corporation succeeds in passing the tax on to its consumers or workers.  Economists are unsure of who bears the burden of the corporate income tax.  It is believed that the incidence of the tax depends on the degree of monopoly power the corporation has.  For example, the corporate income tax falls with its full weight on farmers and mine owners and other producers of homogeneous products because they have little or no control over the price charged.  All others have some monopoly power based on patents, location, and advertising.

How did we get stuck with the corporate income tax?  The Constitution required federal taxes to be apportioned equally among the states according to population, something obviously impossible with an income tax.  But the corporate income tax got passed as an excise tax and was kept in existence when the 16th Amendment was adopted and the personal income tax enacted.

The only argument that can be made in favor of the corporate income tax is that we have learned to live with it in spite of its defects.  The old adage that an old tax is a good tax probably is its best justification.  But the old tax is clearly under fire for its faults.  The public likes it because the public thinks, contrary to fact, that it is solely paid by the rich.  People don’t realize that the tax may be paid by them as consumers and as beneficiaries of pension funds containing the savings of millions of middle- and low-income families or that it encourages corporations to move their factories and headquarters abroad, costing thousands of jobs.

The personal income tax also needs reform, but most of the proposals can be criticized.  Among the proposals are reduction in the number of brackets, a reduction in the top rate, and elimination of the deduction of state income taxes, mortgage interest on residential properties, local property taxes, and state and local sales taxes.  None of these is a needed reform.  Also being considered is the abolition of the estate tax, a tax that could be important in reducing the inequality of wealth.

Apparently, few members of the Senate and the House of Representatives; few conservatives; and, we are ashamed to say, few economists have analyzed the proposed reforms adequately just as they fail to analyze the corporate income tax adequately.

The writer is prof. emeritus of public and international affairs at the University of Pittsburgh, holds a Ph.D. in economics from the University of Chicago, and is president of Ideal Taxes Inc.  He may be e-mailed at richmanpitt@aol.com.



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