When Advocating the End of Corporate Taxes, Consider Your Counterfactual!

August 26th, 2014 at 12:11 pm

How about that? I’ve got a rare and welcome chance to have a friendly disagreement with an admired friend. That would be economist and my co-author on many projects, Dean Baker, who has some different, and interestingly nuanced, views from my own on getting rid of the corporate tax.

First, let me summarize my argument. It’s not just that I worry that getting rid of the corporate tax would be a tax cut for the wealthy, as they mostly own the corps and indirectly pay taxes on their profits. It’s that we’d lose a lot of needed revenue that would have to be made up somewhere else, either through larger deficits, spending cuts, or tax hikes on the non-wealthy.

Dean makes a few counterarguments. First, since some minority share–he says 20%–of corporate taxes fall on wage earners, getting rid of the tax would lift their wages a bit.

Jeez, I dunno. Maybe, but I’d bet bargaining power trumps tax-incidence analysis, meaning it’s not at all obvious that the owners of capital would share their tax break with workers absent very tight labor markets, more unions, etc.

Second, Dean makes the better point that by getting rid of the corporate tax, you’d get rid of the corporate-tax-avoidance industry, including PE shops that make lush pickings off of the current setup.

He may well have a point there, but again, I’m skeptical, based on what I wrote in my piece:

The problem is that [abolishing the corporate tax] risks turning the corporate structure itself into a big tax shelter: If income generated and retained by incorporated businesses should become tax-free, then guess what type of income everybody will suddenly start making? Taxes delayed are taxes saved, and with no corporate tax, anyone who could do so would structure their earnings and investments to be “corporate earnings,” untaxed until they’re distributed.

In other words, while you might whack the PE restructurers, it seems implausible to me that the tax avoidance industry will shutter their operations, admitting they’ve been defeated once and for all. They’ll just go back to doing what they always do: redefining the income of their wealthy clients as the type of income that’s least taxed.

Moreover, my skepticism about the ability to make up the lost revenue from the corporate tax on the individual side wasn’t based on gut instinct, but on this research:

One study found that the tax gap — the share of taxes owed but not collected — was 17 percent for corporations and 43 percent for business income reported by individuals. That research is over a decade old, but more recent tax gap research found that business income taxed at the individual level was the single largest source of the gap, and that sole proprietors report less than half of their income to the I.R.S.

Finally, though he doesn’t mention it, I’m pretty sure (based on discussions we’ve had) that Dean agrees with me that a core idea of some anti-corporate-tax folks–taxing the unrealized appreciation in corporate shares held by individuals–would never happen, or at least must be realistically considered a huge political hurdle. That concession alone strikes me as a reason to be extremely cautious about scrapping the corporate tax.

I’d say our disagreement comes down to this. Dean concludes that it’s “…very plausible that we could design a system that will raise as much money from the rich with an increase in personal tax rates, while at the same time destroying the tax avoidance industry.” I would like to believe he’s right–he’s a smart political economist who makes way more correct predictions than others–but I think that flies in the face of history.

And in these days, with this current and near-term-future Congresses, with all the concentrated wealth influencing political outcomes of precisely this type, with the budget pressures we already face, I think it would be a huge mistake to take the bet that he’s right and I’m wrong.

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15 comments in reply to "When Advocating the End of Corporate Taxes, Consider Your Counterfactual!"

  1. Dausuul says:

    Any time Republican politicians are unified in support of a policy that looks to be about transferring lots of money to rich people, it’s a safe bet that the policy will in fact transfer lots of money to rich people.

    • Robert Buttons says:

      That’s true, except it is also true when democrats advocate any policy to help poor people, you can bet it, in effect, benefits rich people.

  2. BillB says:

    Jared said: “If income generated and retained by incorporated businesses should become tax-free, then guess what type of income everybody will suddenly start making? ”

    You can take care of the retained earnings problem by treating all corporations just like S-corps. The tax obligation for retained earnings are passed through to the shareholders, whether an actual dividend distribution takes place or not. There would be no tax-free income.

    Jared said: “To see the relative efficiency of the current arrangement, think about alternative ways of designing a system to tax undistributed corporate profits. What if I held shares for a day? A week? Suppose dividends were paid out that week?”

    The market already handles this situation easily for normal quarterly dividends. Why would retained earnings be any different? Currently a shareholder can choose to buy or sell before the ex-div date, but on the ex-div date, the price of the stock is adjusted by exactly the amount of the dividend. In fact the exchanges automatically adjust the price of any outstanding limit order that are held over night on the ex-div date. Whether you choose to accept the dividend or not by buying right before or right after the ex-div date is financially neutral and already handled by the market.

    For normal dividends currently you have the choice of buying before the dividend and accepting the dividend but seeing your share price decline by exactly the same amount or you can buy after the dividend at the cheaper price but you miss the dividend. The market handles this perfectly, The two are financially identical.

    For non-distributed earnings, you could offer the exact equivalent trade off. If you buy before the ex-div date, non-dividend earnings are distributed as additional shares and subject to ordinary income taxation. You have the choice of buying before the dividend date and getting the new shares but their price declines by exactly the amount of the distribution. Or you could buy after the dividend date, in which case you get cheaper, diluted shares, but you miss the share distribution. The two are financially equivalent. The market can handle this case just as easily as it has handled normal dividend distributions for over a century.

    A share distribution for retained earnings and a dividend distribution would be taxed identically.

  3. smith says:

    Not only are public corporations required to show their Profit and Loss statements, but if they don’t do it accurately, they’re obviously cheating on their taxes, but in the opposite direction, the reporting requirements of each provide some measure of checks and balance.

    I don’t get how the 20% of profits untaxed would find it’s way to labor, but without the current 35% to 40% subsidy, maybe labor would get less (because wages are an expense, so the corporation saves that percentage going to wages that would otherwise go to Uncle Sam as taxes instead of wages to productive workers that create revenue).

    How would someone use tax breaks to help control corporate behavior like encouraging investment in energy, Subsidies might be more honest but harder to implement, but not all loopholes are bad.

    Why would anyone advocate an tax reduction of corporate profits when they are breaking records is outrageous. The loopholes need to be closed, and the top marginal rates raised to collect the excess profits of companies making billions, who can brush aside $16 billion dollar fines as minor cost of business that hurts a few quarters.

  4. Tom in MN says:

    In the current corporate culture any regulation, tax, etc, is simply viewed as something to be avoided by hook or by crook. It’s fine with them right up until they get caught. It used to be that corporations tried to actually do the right thing, but those days are long gone. So I agree that the idea that you could put the tax avoidance industry out of business is wishful thinking.

    I personally would rather pay taxes than pay lawyers, but we all have our own definitions of evil. I just find it odd that the types who wear their patriotism on their sleeves also tend to see no duty in paying taxes.

  5. Kevin Rica says:

    Create a second corporate tax system, a flat tax, at a much lower rate. Catch is, that there can be no exclusions, loopholes, deductions, tax subsidies etc. Just a flat 10 or 12 percent. Put some sort of restriction that if any exclusions are added – the rate goes back up to 35 percent.

    Then let corporations choose between that system and the old one. If they pick the new rate, they pay that rate on all deferred taxes to move to the new system.

    Problem is that cutting corporate taxes (the net, paid amounts, not the rates) will only work if GDP is supply constrained. If it is demand constrained, it will only make over savings worse.

    • Alex Bollinger says:

      So you’re advocating a tax cut for corporations? If your new system will save them money, in which case they pick that one and get a tax cut. For those corporations who would pay more (like the corporations that completely avoid paying any taxes), they’d continue on the old system. So, on average, a tax cut for corporations.

      Add to that that a flat tax would lose many of the benefits of the current system – lots of policy is included in the tax code because that’s the only way to get it in there. Tax benefits for not polluting and whatnot would all be eliminated and the government would lose some control over corporate behavior.

      Overall, sounds like a great deal for corporations and a raw deal for everyone else.

  6. Robert Buttons says:

    From a purely counter-cyclic perspective, with all the slack JB has shown to be in the economy, we need to be putting MORE money INTO the economy with lower taxes.

    • Smith says:

      Corporation are raking in record profits. The amount of retained earnings, and cash held by corporations is also reaching record levels. Cutting corporate taxes will not induce any increase in investment or expansion. It will further enable stock buy backs, further enriching the 1%. Cutting personal tax will aid the 99% by allowing them to lower the still high debt overhang, but that won’t translate into increased spending. Cutting tax on the 1% can’t help since they just got the entire increased productivity the last few years and that didn’t help either. Trickle down doesn’t work.

      Increasing corporate taxes, by closing loopholes without lowering rates, would put more money into the economy immediately. The corporate cash that erstwhile would sit in the bank, be used to buy other businesses and consolidate (thereby increasing unemployment), or used to buy back stock, could instead end up in the government coffers. The federal government could then funnel money to states to restore cuts in spending, no need to wait for shovel ready projects. The government could also hire more people by restoring cuts, or increasing budgets to meet needs of a larger population, increase research and development spending.

      • Robert Buttons says:

        Two sides to every balance sheet:(AKA Oh! Thank you ZIRP)

        “US companies are carrying far more net debt than in 2007

        Another curiosity is this notion that US companies have substantially reduced their debt pile and are therefore cash rich. The latter is indeed true. Cash and equivalents are at historically high levels, but rarely do those who mention the mountains of corporate cash also discuss the massive increase in debt seen over the last couple of years.
        In fact, debt levels have been growing to such an extent that net debt (i.e. excluding the massive cash pile) is 15% higher than it was prior to the financial crisis”

        • Smith says:

          With interest rates so low, as ZIRP stands for Zero Interest Rate Policy, why wouldn’t corporations borrow now? They actually borrow as a tax dodge so they don’t have to repatriate foreign earnings and pay tax. We should close that loophole of course. Net debt means nothing in a ZIRP economy. They are cash rich, the banks are reluctant to lend, and corporations reluctant to spend.

  7. Robert Salzberg says:

    If we combined the elimination of the corporate tax with the elimination of all individual tax expenditures, (replacing the good ones with stand-alone spending programs), then we could take a bigger bite out of the tax avoidance industry and reduce the tax revenue losses on the individual side.

    If we also added a VAT, we could recoup the lost corporate tax revenue. In addition, a well designed VAT could have a built in carbon tax component.

  8. Tax Research UK » Believing that the self interest of tax professionals will save the US corporation tax is not a basis for hope says:

    […] Baker’s comments on the web from one of his close associates and co-authors, Jared Bernstein. He is not persuaded by Dean Baker’s arguments. One way he’s not convinced is that he’s not at all sure  that getting rid of […]

  9. Tom Mullaney says:

    Why not chuck the entire Internal Revenue Code ( an abomination by any standard) and replace it with a PROGRESSIVE CONSUMPTION TAX. Impute corporate income if you must.

  10. Alex Bollinger says:

    I read Dean Baker’s side first since I read his site more regularly, then came here to see what was up.

    Basically, he just assumes that there would be a new tax system in place that would make up at least some of the lost income (he does explicitly mention this assumption, to his credit). It reminds me of the old joke of the economist on the island assuming a can opener….

    This Congress would jump on the opportunity to get rid of the corporate tax and do nothing to replace it (Norquist’s pledgers, Tea Party primaries, rural Dems, etc., would not want to raise taxes, even if they’re cutting other taxes). Moreover, I don’t see how this wouldn’t encourage more income to be defined as corporate income in order to avoid taxation, which then distorts the numbers Baker is working with.

    I would rather there be higher taxes on high incomes and capital gains, but the corporate tax is acting like such taxes and at least it’s part of the status quo.