Tuesday, September 2, 2014

Abolishing The Corporate Income Tax

THC has been pondering this awhile and the recent coverage over tax inversions and the Burger King/Tim Horton deal made him decide to write this post (and by the way, what an awesome meal concept - burgers AND donuts - that is synergy!).

Before explaining why the federal corporate income tax should be abolished let's clear up one thing about tax inversions which seems to be consistently misreported in the media.  When a U.S. company moves it headquarters outside America it DOES NOT impact its federal tax obligations for its operations in the U.S.- it pays as much tax on that income after as it did before.  What does change, and why inversions are becoming a popular strategy, is caused by America's unique approach among industrialized nations on paying corporate income tax on earnings outside the home country.  The U.S. is the only industrialized country in which the tax rate for earning outside the home country is the same as that for earnings in the home country.   Once a company is based outside the U.S. it does not pay U.S. taxes on income earned outside America but continues to do so for U.S. earnings.  

Why abolish the corporate tax?

While many economists think that as a theoretical economic matter corporate taxation makes no sense, THC will stay away from this controversy and focus on the practical and political benefits of abolition.

The current tax structure discourages reinvestment of earning from outside the United States in the United States.  Right now American companies have hundreds of billions in earning they are not repatriating because of the tax impact.  That bar would be eliminated by abolition.

On a competitive basis, it would create a more favorable investment environment for both American and foreign companies in the United States compared to other industrialized countries.

Most importantly it would allow business decisions to be made based on economics and not on tax policy.  For instance, the current tax code encourages leveraged buyouts because of the favorable tax treatment for borrowed funds versus equity investment.  If you are interested in preventing "looting" of companies by "heartless" investors seeking to lay off employees and inflate asset values you should favor elimination of these taxes.

It also has some favorable political implications.

One of the primary areas for corporate lobbying and political expenditures is over tax policy.  Eliminate the tax and eliminate the lobbying and political expenditures.  If you are really interested in minimizing the impact of money on politics you should support elimination of the corporate income tax.

As THC has said before - if you want less money in politics, make politics about less!  It is the only thing that will work.  Since 1974 we have had generations of campaign finance reform and all it has done is ensure the funneling of more money following ever more convoluted paths into politics.  No matter what reforms you pass, money will always find a way in because as government expands its scope more and more of everyone's (not just companies) lives are impacted.  In today's America you need to spend money on politics just for self-defense purposes! 

The money thing works the other way around.  Most corporate tax 'breaks" are not permanent being authorized for limited periods one to five years.  Why? Because the threat of periodic expiration allows politicians of both parties to extract political contributions from the affected companies and industries in order to keep those breaks.

Let's look at another current controversy; the politicization of the IRS in its assault on incorporate conservative groups.  As THC pointed out in a previous post, contributions to the groups in question are not tax-deductible but there are potential tax consequences for funds still held by a 501(c)(4) group at the end of its fiscal year.  Abolishing the corporate income tax would end this entire controversy.  If you are interested in guarding against the politicization of government agencies shouldn't you support abolition?

No more mind-numbing depreciation schedules.  No more convoluted corporate tax code.  No more tax code driven expenditures and investments.

So, if we do abolish the corporate income tax how do we make up for the revenue that will be lost?

Some have argued that this does not require a static calculation because ending the tax will encourage business investment and growth and more general prosperity resulting in more taxes being collected by the government as overall wealth increases. This has certainly happened with the capital gains tax where cuts in the tax rate have actually seen an increase in federal revenue from capital gains and THC thinks this is a reasonable assumption. However, for our purposes let's assume a static world.

In 2014 about 10% of the Federal budget or around $300 billion comes from corporate income taxes.

Let's start by assuming that if we are going to eliminate corporate income taxes we should also eliminate all Federal subsidies for business.  The difficulty is figuring out what that number is.  THC has been unable to determine it after looking at CBO data and other references.  His best guess is that it is somewhere between $50-75 billion.  Unfortunately, eliminating the Department of Commerce, a good idea in and of itself, does not save that much.  Its annual budget is only $9 billion and some of that may be direct corporate subsidies already counted in the $50 to 75 billion.

What about taxing capital gains and dividends at the same rates as other income like salary?  Today it is taxed at a preferential lower rate which is not unusual as almost all industrialized countries tax such income at lower rates and eleven don't tax capital gains at all.  Again, as with corporate taxation many economists believe such taxation does not make sense.  However, as a political and budget matter if the corporate income tax is eliminated THC believes increasing such taxes is a reasonable step.  Best estimates are that this would raise about $120 billion a year. 

How to fill the remaining gap?  My choice is eliminating the home mortgage interest deduction, phasing it in by steps over a 15-year period.

Are there alternatives that stop short of total elimination?  Possibly but they would not achieve the multiple benefits of complete abolition.

And, in any event, as any economist will tell you the corporate income tax is just an indirect way of collecting taxes from people.  Let's cut out the middle man!

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