The corporate income tax drains corporations of their ability to invest in the economy, create jobs, and fund research. The current system has become far too complex; this complexity invites these corporations to spend significant resources in navigating the code to find loopholes and to lobby politicians enabling them to pay lower effective rates than they should. This industry, created around deciphering and taking advantage of the tax code, requires 1.2 million employees. Over $3 billion was spent to lobby Congress in 2016 for favorable legislation. I propose eliminating the corporate income tax in order to promote job growth, research, and domestic investment.
The US federal corporate income tax ranges from 15 to 35 percent, which is significantly above the worldwide average, however large corporations have been known to pay significantly lower effective rates. According to the WSJ, Apple paid an effective tax rate of less than 10% in 2011, due to its reliance on complex loopholes in the tax code. In order to avoid the abnormally high tax rates of the United States, Apple devotes large amounts of resources to diverting profits overseas, which are not taxed as heavily. These wasted resources represent a loss in efficiency incurred by consumers through higher prices, and this trend seems to be continuing. A recent report estimated that from 2008 to 2012, the profits that American firms were holding overseas doubled to over $2 trillion. This is because overseas profits are not taxed until they are brought back into the United States, so firms are incentivized to find uses for their capital abroad instead of investing in our domestic economy. At first glance, it may be tempting to blame these corporations for avoiding these taxes, however they are working completely within the legal code. Any corporation, which did not maneuver the tax code in this way, would be severely disadvantaged relative to the other companies. For this reason, the legal avoidance of taxes is a completely rational choice, and the fault lies in the tax code itself.
Several policies have been proposed aiming to motivate businesses to bring profits back to the United States. One such policy advocated by the Trump administration is a repatriation tax holiday. Under such a plan, companies would be allowed to bring profits back into the United States and pay a tax rate of only 10%. While the idea sounds promising at first glance, it is a temporary fix that may hurt the economy in the long-run. Past tax holidays have not lead to increased jobs or research, and tax holidays could increase the incentive of firms to hold assets abroad in the hopes of waiting for future tax holidays. Chad Stone of the US news claims that because corporations are paying lower effective tax rates, lowering the tax rate will not make the US a more competitive market, but this argument does not take into account the decrease to efficiency resulting from lobbying to create these loopholes. Additionally, this option of holding profits overseas is available to multinational firms, but can not be taken advantage of by smaller domestic firms, which puts them at a disadvantage. Instead of creating a tax code, which encourages businesses to spend large amounts of resources to finding and exploiting loopholes, the US would be better served by simplifying the process.
In Economics it is critical to establish on whom the burden of a tax falls, and this is no different for the corporate income tax. There is controversy concerning who bears the brunt of the corporate tax, however it is generally thought to affect both shareholders and workers. The Milken Institute Review proposes that this depends on the time frame. They propose that, in the short-term, higher corporate tax rates lower profits, which decreases the amount of dividends paid out to investors, however over time corporations can shift resources overseas where taxes are lower, laying off domestic workers in the process and decreasing demand in the domestic economy. Ultimately, taxing corporations amounts to taxing individuals, but when the profits are still in the hands of the corporation, it is impossible to tell where the profits may go. When the goal is a progressive system, it would be more efficient to only tax the corporate profits, which are paid out as dividends.
Another commonly addressed problem of the corporate income tax rate is that of double taxation. Firms incur large taxes on their profits. The profits are then paid out to shareholders as dividends, which incur even further taxes, albeit at a lower rate. Higher taxes on corporate profits not only motivate firms to invest overseas, but also raise the threshold on the profitability of projects. When firms are conducting a cost-benefit analysis of investment or research they will take into account the tax rate. A higher tax rate will lead projects they undertake to be less financially attractive. This may lead the firm to not pursue projects that they would have otherwise. Additionally, this double taxation creates unnecessary complexity, which also allows for loopholes to be exploited.
The Tax Foundation presents the following example…
In this case, a company makes $100 profit. They must pay a corporate income tax of 39.1% due to federal income taxes combined with state taxes. The remaining $60.90 is the after tax profit, which they decide to pay out to shareholders as dividends. These dividends are then taxed again at a rate of 28.7%, leaving the shareholder with $43.43 of the initial $100 in profits. A large issue with this example is the fact that many companies do not pay out 100% of their profits as dividends. Instead the percentage of profits to be paid out as dividends is a strategic decision decided on by the board of directors and must be balanced against the percent of profits to be reinvested in the company. When the money is reinvested in the company this often leads to hiring more employees, increased innovation, and increased domestic demand. Taxing the profits at this point in time takes money away from the shareholders, but also diverts it from these activities, which greatly benefit the economy.
|Table 1. The Integrated Corporate Tax Rate in the Current U.S. Tax System|
|Corporate Profits||$ 100.00|
|Corporate Income Tax @ 39.1%||$ 39.10|
|Distributed Dividends||$ 60.90|
|Dividend Income Tax @ 28.7%||$ 17.47|
|Total After-Tax Income||$ 43.43|
|Total Tax Rate||56.57%|
My proposal is to completely eliminate the corporate income tax. Despite the fact that federal revenue from the corporate income tax has been falling, it still makes up a sizable sum, without which, the federal government would not be able to function under current expenditure levels. This implies that the revenue will have to be made up elsewhere. When the corporations make profits, this may benefit workers or shareholders. If we wait until the profits are paid out to shareholders, then we more directly target funds that would go to high-income earners instead of workers. Removing the favorable tax conditions on dividends will enable the brunt of this tax to go towards the wealthy, while also granting companies more resources to devote towards hiring, R&D, and investments.