End the Corporate Tax

By Kevin D. Williamson

Wednesday, April 26, 2017

Donald Trump’s tax plan calls for reducing the corporate-income tax to 15 percent. That’s about 15 points too high.

Mitt Romney was mocked for insisting “corporations are people,” but he was right: A corporation is a cooperation, a group of people acting together as one corpus for a particular purpose. And it would be easier and more simple to tax the people.

Corporate income is unlike individual or household income in that it is broadly defined as income minus expenses, meaning ordinary business expenses, whereas the individual taxpayer can only deduct certain narrowly defined expenses, such as mortgage interest. The simplified version: If Corporation X makes $1 billion and has $900 million in expenses, then it has $100 million in taxable income, which is subject to a top rate of 39 percent. Most corporate income is taxed at the highest rate.

Even the simplest version of this structure creates opportunities for shenanigans and incentives to pursue them. But the real-world version isn’t simple at all, and it makes things much, much worse. Politicians create tax incentives that reward businesses for doing things they like and punish them for doing things they don’t like, while corporate interest groups invest a great deal of time and energy in lobbying for tax favors. Some of that is pretty crude: Democrats have for years been trying to monkey with business-expense rules to punish companies for outsourcing, so that a cardboard box bought for moving business records from the headquarters in St. Louis to the warehouse across town would be a deductible expense but the same box used to move business records to a new call center in the Philippines would not be deductible. Some of it is more subtle and more complicated, i.e., engineering deals and business units in such a way that artificial capital losses and expenses can be racked up and stored away to reduce (for tax purposes) future income. There’s an old joke that General Electric is the world’s greatest tax-law firm, with a sideline in manufacturing, but consider also that blockbuster films that do billions of dollars in business routinely show little or no profit for tax purposes. Famously, Return of the Jedi has never made a dime, so far as the IRS is concerned.

What would happen if we simply eliminated the corporate-income tax entirely?

It would not represent a tax-free windfall to a bunch of pinstriped boardroom schmucks and Wall Street types and corporate shareholders. There are all sorts of things that businesses could do with that extra 40 percent of whatever they have left over after expenses. But if they pay it out in salaries and bonuses, whether to fat-cat executives or ordinary line workers, those people pay the individual income tax on that money. If they pay it out to shareholders in the form of dividends, the shareholders pay the capital-gains tax on that money. If it is distributed through other capital gains, the same thing applies. If it is used to acquire facilities or equipment, then that money becomes income for another company, which has the same choices about how to dispose of it. The money still gets taxed, but not until it hits someone’s bank account.

You have not eliminated the taxation of that corporate income. You have moved it from the corporate level to the individual level, which has some benefits: Most individuals have far less opportunity and incentive to go to great lengths in pursuit of tax-avoidance strategies: The typical corporate shareholder is not a guy in Manhattan wearing braces and smoking a cigar — it’s a retired teacher in California who owns stock indirectly through the teachers’ union retirement system, and maybe directly through her individual retirement fund. I am very, very skeptical of popular Republican claims about self-financing tax cuts, but it is at least conceivable that some of that corporate income would in fact be taxed at a higher effective rate if there were no corporate income tax. And zeroing out the corporate income tax would also eliminate the double taxation in which income is taxed once at the corporate rate and then again when paid out as dividends.

But the most desirable consequence would not be fiscal, strictly speaking. It would be the fact that GE could stop being a tax-law firm and go back to its core businesses of lightbulbs and jet engines and warmongering or whatever. Putting that capital to productive use would not provide a guarantee of stronger economic growth, as some of my more optimistic conservative friends insist, but it would provide an opportunity for it.

Cutting the corporate-income tax to 15 percent is not enough: Many firms already pay an effective rate of less than that (see shenanigans, above), and merely playing with the rate leaves in place the cumbrous and distorting tax structure that is as much a part of the problem as the rate. The corporate tax accounts for a little more than 10 percent of federal revenue, and much of the notional revenue cost of eliminating it entirely could be offset by two tax reforms that we ought to be enacting anyway: the elimination of the mortgage-interest deduction (the tax break that helped create the housing bubble) and the state-and-local tax deduction (the tax break for rich liberals in California and New York). If Art Laffer and the guys turn out to be right and that forgone revenue ends up not being forgone and we find the federal government in better fiscal shape than expected ten years down the road, so much the better.

(Other fiscal offsets are available in pretty obvious forms, such as spending less money. Ho, ho.)

Because the United States has one of the highest statutory corporate-income tax rates in the world, U.S. firms — especially very successful ones such as Apple — have a very powerful incentive to keep their foreign earnings parked overseas, where they sit until the lawyers figure out a way to make use of them without incurring a 39 percent federal penalty for earning the money. Getting that money back in the game would be a very big deal.

On the corporate tax, my advice is always the same: Don’t fear the tax haven — be the tax haven.