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The Corporate Income Tax Is the Worst Tax; Repeal It and Tax Corporate Earnings under the Personal Income Tax
Raymond Richman, 12/26/2014

There are taxes which treat taxpayers fairly, are progressive in their effects, and have few bad economic effects. The corporate income tax is not one of them. The corporate income tax treats taxpayers unfairly, favors the very rich, and has bad economic effects. It is probably the worst major tax, vastly inferior to the personal income tax, sales taxes, death taxes, or any other major source of revenue.

So who bears the burden of the corporate income tax? As an artificial entity, corporations cannot bear any corporate tax burden. Only living individuals bear the burden of taxation whether it be the corporate income tax, the personal income tax, sales taxes, or excise taxes. Economists are not sure who bears the burden of the corporate income tax. The most common view is that most of the tax is borne by shareholders but some of the tax is shifted forward to consumers in the form of higher prices. The amount shifted depends on the structure of the particular industry. A monopolist has more control over the prices it charges than those in a highly competitive industry or one where much of the productive activity is conducted by proprietorships and partnerships which are not subject to the corporate income tax. (And many economists believe that the corporate income tax is borne by investors in general in the form of higher interest rates and by some special classes of employees, but we’ll ignore that in our analysis.) So shareholders in some corporations bear all or most of the burden and shareholders in others may bear a lesser share of the burden. Consumers of some products may bear much of the burden and consumers of others little of the burden. These considerations make the distribution of the burden of the corporate income tax very uncertain which is one reason that makes it desirable to eliminate it and tax corporate earnings as personal income.

As to economic effects, the corporate income tax penalizes exporters and its high rates encourage inversions (moving corporate headquarters abroad) and outsourcing of factories and jobs. Facing international competition, American exporters have little or no ability to shift the tax burden and the high rate of corporate income tax places them at a disadvantage.

The corporate income tax encourages debt vs equity financing increasing the risk of bankruptcies in the event of a cyclical downturn in economic activity. It encourages retention of earnings because dividends are subject to the personal income tax. It encourages the buying back its own stock instead of declaring dividends because the former results in capital gains which are taxable at lower rates under the personal income tax than is ordinary income.

The corporate income tax, on balance, enables the very rich to avoid the highest personal income tax rates and subjects the middle and working class shareholders to higher rates than they pay under the personal income tax. All of the large corporations are taxed at a proportional rate of 35%. Lack of progressivity of the corporate income tax arises from the fact that corporate earnings are taxed at the same rate regardless of the income of the shareholder. So a millionaire is taxed at the same rate (top rate of 35%) as taxpayers in lower income tax brackets. The personal income tax rate on incomes below $49,400 in 2013 had a maximum marginal rate of only 15%, under $127,550, 25%, and under $206,600, 28%. Their share of corporate earnings, and their IRSs and pension funds are taxed at 35%, the same as millionaires and billionaires who own most of the common stock of the large corporations not held by mutual or pension funds.  

Converting corporate income into capital gains, taxable at lower rates than ordinary income, is a popular sport. Capital gains are taxed at 20% in 2014 (15% in 2013). Most capital gains are created by the reinvestment of retained earnings of corporations, which when invested profitably increases earnings per share and capital appreciation and capital gains. Taxing realized capital gains at lower rates than the future stream of income those gains represent encourages the realization and consumption of capital gains.  This is evident by the corporate practice of buying back its stock instead of declaring dividends. Buying back their own stock raises the price of the remaining outstanding shares and creates an accrued capital gain which shareholders can realize paying the lower rate of tax on capital gains (increased from 15 to 20% last year, about half of the maximum rate).

There would be nothing to be gained by shareholders if realized gains that are consumed were taxed at the same rate as wages and salaries, interest or rental income. Corporations often pay their executives a bonus in the form of stock options. This enables them to retain the stock options until the price of the stock has risen, enabling their sale as a capital gain and taxable at the lower capital gains rate. So we need to reform the tax treatment of capital gains under the personal income tax.

Under current law, the same physical asset can be depreciated over and over again. Such is the case of buildings such as office buildings, hotels, and other rental properties. When the depreciation allowances end or are about to end, the owner is encouraged to sell the property and realize his depreciation in the form of lower-taxed capital gains, while the buyer is permitted to depreciate what he paid for the building. The Empire State Building has probably been depreciated several times, and hotels frequently change hands and are depreciated over and over again.

There are other economic benefits arising from the elimination of the corporate income tax. It would make U.S. corporations more competitive internationally and improve our trade balance. It would end the double taxation of any corporate income. It would satisfy economist’s doubts about who bears the burden of the corporate income tax. And economists are unable to think of any arguments in favor of the corporate income tax.

For centuries, the British taxed corporations and individuals under the Income and Property Tax Acts which date from the middle ages. Shareholders received a credit for the tax paid by the corporations. Apparently, no one in academia or employed by the Congress or President bothered to study Britain’s experience with the income tax.

The corporate income tax allows for repeated depreciation of hotels and office buildings even though the all or most of the depreciation allowance for the original cost of the building has been taken.  The owner who has taken all or most of his depreciation allowance sells the property to a new owner who is allowed to take depreciation on the purchase price he pays for hotels, apartment and office building, often several times greater than the original cost of the building. The Empire State Building in New York City is a case in point. The building cost in 1931was about $25 million, about $300 million in current dollars. In 1961, it sold for $65 million and in 2012 for $2.5 billion. Even allowing for a land value of one-third, the new owner, a REIT, will be able to take a depreciation allowance over time of $1.7 billion, a far cry from the original cost for which an allowance for depreciation had already been taken twice.  

Another area for reform is the elimination of percentage depletion allowances allowed oil and gas drillers. Eliminating those are long overdue. Depreciation allowances should only be allowed for new construction and machinery and the like.

An additional effect of the repeated sale of depreciated real estate is the inflated prices of resales of real estate like office buildings and hotels. The seller reaps the value of the depreciation allowance that will be allowed to the buyer. The new buyer will bid more for a property if he is permitted to take a depreciation allowance on his purchase price notwithstanding that the allowance has already been taken by the seller.

Growth of corporate firms is substantially financed by retained earnings. Retained earnings if corporate earnings are taxed as personal income would equal net income of the corporation minus amount of taxes withheld. Since corporations will no longer pay dividends, corporate retained earnings will actually be greater than they would be under the current corporate income tax. Corporations would withhold what they currently pay in income tax to keep it simple, 35%. Shareholders would receive a tax credit of the amount withheld against their  personal income tax liability, just as the British did for centuries under its income tax.

The revenue from the federal corporate income tax in 2013 was $384.9 billion and total corporate profit in 2013, according to the GDP accounts, was $1,703.8 billion, an effective rate overall of 22.59 percent. All large corporations that were profitable paid the 35% rate. The maximum personal income tax rate was 39.6%, effective at a taxable income of $406,000. The rich, who own most of corporate wealth, would pay much more in taxes if corporate earnings were to be taxed under the personal income tax. Note that dividends are a small share of total corporate earnings. The taxation under the personal income tax of dividends is one reason why corporations prefer not to pay dividends but instead to buy back their shares and pay no dividends at all. The top one percent of taxpayers own 35 percent of all corporate stock and 35 percent of $1700 billion is $595 billion, much more than the $385 billion in corporate income tax receipts.

The current corporate income tax adds to the number of millionaires and billionaires, worsening the distribution of wealth. The value of corporate shares outstanding is the discounted value of the future stream of income. The retained earnings re-invested leads to increased earnings and increased earnings raise share prices creating billions of capital appreciation, paper capital gains.

A couple of years ago billionaire Warren Buffett observed that his secretary paid a higher rate of personal income tax than he did. He would not have been able to make that observation if the corporate earnings were taxed as personal income. He would have paid close to 39.6 percent compared to his secretary’s marginal rate of perhaps 20 percent.  

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

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