Raymond Richman - Jesse Richman - Howard Richman
Richmans' Trade and Taxes Blog
Tax Corporate Earnings As Personal Income; That Would Be Real Reform
The administration and the Congress are considering reform of the federal government’s corporate income tax by reducing the top rate of the corporate income tax from 35% to as low as15%. Real corporate tax reform would treat corporations the same as partnerships are currently treated, namely, to tax the earnings of corporations as the personal income of shareholders just as partnership earnings are taxed as the personal income of their partners. Corporations are simply limited liability partnerships. The distinction of limited liability no longer since most States enable partnerships to register as limited liability enterprises. So the first real major reform would be to eliminate the corporate income tax and to tax corporate earnings as the personal income of the shareholders. There is precedent for taxing corporate earnings as personal income. The earnings of partnerships, individual proprietorships, and “S” corporations are already taxed as personal income. Moreover, there are many other good reasons to tax corporate earnings under the personal income tax.
Economists have long considered the corporate income tax a bad tax. It violates the principle that persons in equal economic circumstances should receive equal treatment. The corporate income tax falls with the same weight on the earnings of the very wealthy as it does on shareholders with lower incomes. Shareholders in lower tax brackets bear the same tax rate on corporate earnings as millionaires and billionaires. As a result their incomes at retirement are much less than they would be if their share of corporate earnings were taxed at personal income tax rates.
It violates the principle of progressivity, that those with higher incomes should pay a higher rate of tax than those of lower incomes. The case for progressivity rests on the fact that incomes are unequally distributed. The personal income of most individuals with very high incomes is attributable to monopoly power caused by differences in personal ability, to different degrees of monopoly power inherent in a free market economy, to real and sometimes illusory product differences, to location, and even serendipity. Such differences are called economic rents and progressively taxing economic rents has little or no negative economic effects.
Economists have long pointed out the negative economic effects of the corporate income tax that the personal income tax does not have. These include encouragement of corporations to rely more heavily on borrowed capital rather than equity capital because the former is deductible as an expense. Other distortions include that fact corporations are encouraged to buy-back their stock instead of paying dividends. The former creates capital gains which are taxed at a lower rate than dividends. Congress dealt with the double taxation of dividends by treating dividends as a limited deduction under the personal income tax.
Because some countries tax corporations at lower rates of corporate income tax, the USA’s high rate has the negative effect of encouraging the movement of factories and corporate headquarters to countries with lower income tax rates and to encourage corporations to reinvest the earnings earned abroad in foreign countries. Indeed this is the reason given for wanting to reduce the corporate income tax rate, to encourage earnings earned abroad to be repatriated and reinvested in the USA.
Congress is considering a border tax, a sales tax, which would act as a tariff falling equally on countries with which we have chronic deficits and in countries with which we have a trade surplus. It would raise revenue to offset the loss of revenue expected from the proposed cut in the corporate income tax rate. Our state sales taxes are border taxes averaging about 7 percent so the proposed border tax would result in a domestic sales tax of 22-25% on all imported products. Eliminating the corporate income tax and taxing corporate earnings as personal income would be more or less revenue neutral at current rates of personal income tax whose top rate is 39.6 percent.
The burden of the corporate income tax is borne by shareholders, unless the corporation succeeds in passing the tax on to its consumers or workers. Economists are unsure of who bears the burden of the corporate income tax. It is believed that the incidence of the tax depends on the degree of monopoly power possessed by the corporation. The tax falls with its full weight on farmers and mine owners and other producers of homogeneous products because they have little or no control over the price charged.
How did we get stuck with the corporate income tax? The Constitution required federal taxes to be apportioned equally among the states according to population, something obviously impossible with an income tax. But the corporate income tax got passed as an excise tax and was kept in existence when the 16th amendment was adopted and the personal income tax enacted. The only argument that can be made in favor of the corporate income tax is that we have learned to live with it in spite of its defects. The old adage that an old tax is a good tax probably is its best justification. But the old tax is clearly under fire for its faults. The public likes it because they think, contrary to fact, that it is solely paid by the rich. They don’t realize that the tax may be paid by them as consumers and as beneficiaries of pension funds containing the savings of millions of middle and low income families or that it encourages corporations to move their factories and headquarters abroad costing thousands of jobs.
There is considerable pressure to reform the personal income tax as well. Among the proposals are reduction in the number of brackets, a reduction in the top rate, and elimination of the deduction of State income taxes, mortgage interest on residential properties, local property taxes, and State and local sales taxes. Also being considered is the abolition of the estate tax. These proposals will be considered in a separate posting to this blog.
Economy - Long Term
Economy - Short Term
Real Estate Taxation
Journal of Economic Literature:
Atlantic Economic Journal: