David R. Henderson  

Abolition of the Corporate Income Tax

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Megan McArdle has a good post on her case for abolishing the corporate income tax. I say "good," not "excellent," because, in the midst of a comprehensive though succinct analysis, she doesn't get the issue of incidence correctly. She starts out fine, pointing out that the legal incidence--who pays the tax--is different from the economic incidence--who ultimately bears the burden. But then she doesn't pursue that and writes as if she thinks that shareholders bear the burden. We don't know for sure who bears the burden but the larger the elasticity of the supply of capital to the United States, the lower is the percent of the burden borne by shareholders. See Harvey Rosen's and Ted Gayer's Public Finance text for a nice discussion of that. The entry in the Concise Encyclopedia is a nice discussion but doesn't mention the international mobility of capital, which is a good bit higher than it was when many of the burden studies were done in the 1960s and 1970s.

Megan ends by saying, "I hope that liberals will at least consider that there might be a better way than the corporate income tax to achieve their goals." Actually, some "liberals" [I, like Megan, use the term in the 20th century corrupted version that Americans use to mean "statists"] already have. Here's a quote from a well-known liberal economist:

While corporations are legal entities that write checks to government, they do not pay taxes. They simply collect money from someone--their shareholders, their customers, or their employees--and transfer it to government. There is no such thing as taxing corporations as opposed to individuals. This immediately raises the issue of who ultimately pays the corporate income tax. The incidence of the corporate income tax is an area of economics with a large literature and little or no agreement. Depending upon the exact assumptions used, the definition of incidence, and the time periods under consideration, it could be a tax on shareholders, a sales tax on consumers, or a tax on employees. (Personally, I believe that it is a tax on shareholders in the short run and a sales tax in the long run, but my advocacy of its elimination does not hang on that belief.) While there may be a certain perverse political virtue in collecting a tax where no one is sure whether he pays it , simple economic efficiency and equity would seem to call for the elimination of taxes where incidence is uncertain. Only if we do so can we establish a tax system that is fair and has the economic consequences we intend.

Question: Who wrote this? Hint: he was an economic advisor to 1972 Democratic presidential candidate George McGovern.

Update: david got it. The answer is Lester Thurow. This is from his 1980 book, The Zero-Sum Society.

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COMMENTS (19 to date)
Steven writes:

James Tobin?

Dr. Econ writes:

Paul Samuelson?

david writes:

Lester Thurow.

Marcus Nunes writes:

According to the Concise Ency.: James Tobin

Hyena writes:

What I've often wondered about corporate income taxes is whether discouragement of dividends leads to megacorporations. If acquisitions are more deductible, tax law might advantage capital gains which lead to larger, though not better, corporations.

If it did, I think there would be a good place to start talking tax reform to liberals, progressives and anyone else who is wary of some of the largest corporations.

Michael writes:

Even if the incidence fell entirely on shareholders it would not be possible to say whether the tax is progressive or regressive. You would still need to know the income distribution of the shareholders. It is absolutely not a given that shareholders are all rich socialites.

Bill writes:

As is the case with taxes in general, the other issue re incidence (not addressed here) is who benefits from the expenditure of corporate income tax receipts.

Tom writes:

Given the amount of resources companies spend to avoid taxes - a company would spend 2 dollars to save three in taxes - what is the REAL dead-weight loss of the corporate taxes?

Mark Brady writes:

Bill is correct in the sense that we should consider who benefits from the expenditures made possible by tax receipts, but incorrect if he is assuming that we can allocate corporate income tax receipts to particular items of government spending.

Thucydides writes:

Harberger thought that in a global economy, the burden of the US corporate income tax probably fell mostly on labor. I think of the tax as simply a politically convenient way of hiding the tax burden from whomever is paying it. The burden probably varies by industry and by company, depending on individual circumstances. One can't say much for the equity of that.

Wherever the burden falls, it has to be paid initially by the corporation, from funds that in most cases would probably be reinvested.

It is a double tax, because the same income is eventually taxed again at the shareholder level. European tax systems try to avoid this by giving the shareholder a full credit for corporate taxes previously paid.

Axel Kassel writes:

There is not only a variable/ambiguous-incidence issue with the corporate income tax, but also also a hidden-incidence issue. The first whack at the corporate level is implicitly taxing the portfolios of non-profit universities, hospitals, foundations, charities, and individuals who are either exempt from taxes or who have no tax liability. It would make sense to eliminate the corporate income tax and apportion dividend payments and pro-rated portions of retained earnings directly to recipients. This would not only eliminate the double taxation of dividend income, but end the implicit taxation of entities and persons that public policy wishes not to tax.

Rick Stewart writes:

The tax rate is ALWAYS the single most important assumption in a Net Present Value calculation. Its impact is huge - we routinely rejected projects that would have had huge positive NPVs w/o income taxes.

I would think any liberal politician would cringe to watch a single corporation in his/her district reject an investment because of the corporate tax rate. Perhaps we should belt them down and make them watch a few ...

Felix writes:

While initially receptive, I really don't get the argument that corporate income tax is "not paid by the corporation". The problem is that the same argument can be made for any tax. In the end, any taxed entity passes the tax along. The whole system adjusts to taxes where ever they might be.

So appealing to a sense of fairness or even simplicity when arguing to eliminate corporate income tax doesn't seem quite right.

On the other hand, doesn't a corporate income tax favor taxing entities in other countries? That is, doesn't the "system" adjust by moving income away from high corporate taxes? And don't high corporate income taxes favor corporations with multi-country operations - generally larger corporations? How might a liberal respond to that observation?

Brian Crook writes:

Same sentiment, more succinctly and much earlier.

"Corporations do not pay taxes. They merely collect them." - J. P. Morgan, circa 1913 (the advent of the 16th amendment)

ThomasL writes:

"Personally, I believe that it is a tax on shareholders in the short run and a sales tax in the long run..."

I like how he put that. My view is about the same.

What it glosses over is that sales taxes are by and large less distorting, where businesses find certain activities advisable because of the available deductions that they wouldn't otherwise. In the worst instance that goes all the way to subsidy, where they actually gain more in rebates for certain activities than they cost.

That is really the evil of the income tax. How it is used to control behavior, silence speech, etc. That, and how the Federal income tax specifically has been used to subvert the authority of the state and local governments by making citizens and corporations answerable directly to the USG, while at the same time paying state governments off whenever needed by offering them money collected from the other states.

AMW writes:

Robert Reich.

Niclas Virin writes:

I agree with the general idea of the original article by David Henderson. As it is extremely difficult to find support for the idea of abolishing company taxation here in Europe, I was happy to find a well expressed opinion from the other side of the ocean.

See http://niclasvirin.com/documents-eng.shtml

[Comment edited with permission--Econlib Ed.]

Johnalee writes:

The biggest issue that I have with the idea of the corporate income tax is that there is no clear idea of who is paying it. Endless dollars are being pulled from some unknown source, yet no one has a problem?

It isn't just to collect taxes "where incidence is uncertain." Since the government is unsure of who precisely is paying for the corporate income tax, they have no means of measure to decide if it is a fair tax or not. Increases or decreases (ha!) in corporate income taxes could be random without a firm basis on who is funding it.

Fred Foldvary writes:

Much of the incidence of any income or sales tax falls on land rent. The deep dark secret of economics that was known to Alfred Marshall but got lost to contemporary theory is that in competitive industries, most of the "producer" surplus is land rent. Thus taxes that reduces the surplus are, to a great extent, at the expense of land rent. Tenants bid less to rent space because of the taxes.

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