by Jay Ackroyd
Number 1 in a Series of Public Policy Suggestions:Drive A Stake Through It
The corporate income tax isn’t what you think. Kill it now, before it sucks the blood of another innocent taxpayer.
Americans love to talk about the failures of taxation. Conservatives complain that everyone is taxed too much. Liberals fulminate that corporate America and the wealthy are taxed too little. Who’s right?
In a sense, both are. But what’s often lost in the rhetoric about corporate taxation in particular—in arguments that revolve around whether businesses deserve tax breaks because they bring jobs and income to municipalities, or deserve to be taxed more because they drain local resources and must be compelled to share their wealth—is that no one really knows exactly who pays corporate income taxes in the first place. One thing is certain: corporations don’t pay corporate taxes at all. Individuals do. It’s just that the people who pay aren’t necessarily the people who own the companies.
Although intended to be borne by shareholders, the corporate tax is really paid by various groups in different industrial sectors. Smokers, for instance, pay tobacco companies’ share of the tax in the form of higher cigarette prices. Blue-collar auto industry workers probably pay the bulk of the tax on profits earned by the companies that hire them, in the form of reduced wages and benefits. Shareholders at Dell Computers probably do pay their corporation’s tax bill, through reduced dividends; and that lowers Dell’s share price.
In general, the rule is: who pays depends on who has the weakest bargaining position among shareholders, employees, and customers of a corporation. The unpredictability implied by that rule is one good reason to get rid of the corporate income tax: if the policy goal is to tax owners of corporations, then a more direct form of taxation is required.
But another reason to eliminate the tax is that it's terribly complicated to administer. Take depreciation schedules, for example. In order for depreciation on capital assets to be figured, someone in some shadowy IRS office somewhere must determine, machine by machine, the usable life of every device used by any company anywhere. Especially in a technologically rich and growing economy, such determinations must be made on a rapid and continuing basis. The risk of error always looms, and yet the numbers that emerge from the arcane process of devising depreciation schedules establish an all important distinction between "profit" and "net cash flow." That distinction is what kept Eastern Airlines in business for years while the company wasn’t making a profit. In fact, the depreciation schedule on jets was so generous that Eastern maintained a positive cash flow on paper while actually losing money.
Some might argue that the solution to this kind of failure is for the IRS to exercise ever more vigilance about what it grants. But if the bureaucratic implications of that sort of simplism are formidable, the political ones are no less so. Industry lawyers and lobbyists are not known for sitting quietly while loopholes are tightened, nor are they prone to passing up legislative opportunity; generous depreciation schedules can give them a stealth method by which to acquire what amount to government subsidies.
For instance, when a baseball owner acquires a team, he now has seven years to write off existing player contracts as a depreciable expense. But there wasn’t always a place in a ball team’s budget for the depreciation of contracts. It was Bill Veeck, owner of the Chicago White Sox and the St. Louis Browns, who got the provision written into law by convincing Congress that baseball players are like race horses, which were already treated as depreciating assets. Although Veeck’s move was cheeky, it’s hardly anomalous: a more notorious, and expensive, provision is the oil depletion allowance granted oil companies in the treatment of their oil fields as special assets.
Another problem with the corporate income tax is that, like other complex taxes, it distorts decision-making and leads to questionable or illegal business practices. Not surprisingly, the IRS recently has announced a crackdown on corporations that create non-profit shell corporations designed solely to receive income on which the parent company doesn't want to pay tax. If there were no corporate income tax, there'd be no incentive for shenanigans like these. But there would also be no incentive for corporations to go to the great lengths they currently do to minimize taxes by strictly legal means.
Aside from helping shareholders avoid paying what they owe, these efforts contribute nothing whatsoever to anybody except lawyers and accountants. (It's no coincidence that the Big Five accounting firms all opposed tax simplification the last time such legislation was put before Congress.) It has been claimed that the cost of compliance with IRS corporate tax requirements currently may be as high as five times the tax paid. If that’s even close to true, then corporations either are succeeding in not paying anywhere near as much income tax as policymakers expect— and are compensating their attorneys and accountants accordingly—or else are having to pay a ridiculous sum in legal and accounting fees simply in order to calculate what they owe the government. Either way, those expenses must get passed on to someone, and there’s no guarantee that that someone is a shareholder.
Corporate income taxation also affects aspects of the economy that people don’t often think about. Pension plans, for instance, are used by employers to reduce taxes. But for a plan to qualify as one that permits deductions to be made from a company's tax bill, it must comply with the Employee Retirement Income Security Act (ERISA). Not surprisingly, ERISA compliance has become a cottage industry. (A Yahoo search returns a veritable cornucopia of consultants. There's even an ERISA lobbying organization) Take away the deductibility rule, and the need for a great deal of this activity—along with its inherent costs—goes away.
But how, one might protest while fidgeting nervously with one’s wallet, can the federal government simply decide not to collect money on which its budget already depends? Who would wind up paying the difference?
Granted, the corporate income tax would be hard to replace if it were a large revenue source. But it isn't. In 1998, the government is projected to have collected less than $190 billion worth of corporate taxes out of the more than $1.6 trillion of taxes levied on all sources of income. (See this U.S. Census Bureau article (Acrobat required).) Because the amount in relative terms is small, no particularly vast legislative maneuvers would be needed to replace receipts lost by eliminating the current corporate tax. The most logical way to make up the shortfall would be to change the tax code to extract revenue from the intended targets of the current, poorly aimed tax: corporate shareholders. And the simplest way to do that would be to focus on tax breaks designed for the wealthy, such as the special treatment of capital gains income, which is taxed at a much lower rate than ordinary income in the highest brackets.
Trading special treatment of capital gains for the elimination of the corporate income tax is just the kind of reform both liberals and conservatives ought to love: conservatives should welcome a reduction of the government’s role in corporate decision-making. Liberals should cheer a tax system that is more clearly progressive. Of course, some conservatives may be less concerned about minimizing government interference in business than they are about guarding the interests of their wealthier constituents. And some liberals will be reluctant to abandon high-minded attempts to punish business for what they’re convinced is its inherent moral unrectitude.
These are political problems; the administrative glitches may be easier to resolve. For instance, an expectation that corporate income taxes will be paid is currently embedded in corporate share prices, so eliminating the corporate tax precipitously would hand a windfall to any shareholders that currently pay it. To minimize that effect, and to allow corporations to prepare for the simplified tax structure, a gradual phase-in of reforms over at least six years would be required, with a reduction in tax rates by a sixth of the starting-year value each year.
The necessity of phasing in reform illustrates just how hard it is to change a tax regime once it has become established. Like households, corporations take taxes into account in their decision-making. Since the mix of activities in an economy reflects any distortions introduced by taxation, a tax whose effects can’t be cleanly measured, and that can be passed on to employees or consumers—or avoided altogether—is a tax that’s bound to engender activities that are unproductive in the sense that they produce no increase in corporations’ output per employee. It may be all well and good that our current tax structure mandates a form of welfare for one happy slice of the legal profession. But no public service beloved of liberals, nor broad economic advantage sought by conservative capitalists, is gained by diverting dollars to lawyers. That money could be spent more productively in other ways, on both sides of the political divide.
Jay Ackroyd is the president of DBSI, Inc., a custom software development company based in New York City.