RALEIGH – The way we tax corporate income has always been incoherent and capricious. Now that other countries are reforming their tax codes, our incoherent and capricious corporate tax is becoming increasingly costly.
Why is the corporate income tax incoherent? Because all income is ultimately received and consumed by individuals. There is no good reason to tax corporate-derived personal income at a higher rate than personal income derived from non-corporate forms of business. But that is exactly what corporate income taxes do. Because corporate income taxes could either from lower returns for shareholders, higher prices for consumers, or lower compensation for workers, they effectively increase the individual tax burden to the extent that an individual does business through taxable corporations.
Corporations are not persons. They are not even “fictitious persons,” as is sometimes alleged (because of faulty analogies and misunderstanding about the history of the corporation, dissected at some length here and here). Corporations are simply bundles of contracts among buyers and sellers of goods and services. Corporations can no more “pay” taxes than your car insurance policy can buy a baloney sandwich. An individual can buy the baloney, of course – and figuratively, by thinking of corporations as people separate from the actual human beings who transact business through them – but that’s different.
If the goal is to tax “rich” people more than “poor” people, corporate taxes are a goofy way to do it. The tax incidence isn’t distributed in a predictable fashion for every firm. In some cases, workers and consumers of modest means lose income (and even employment) when corporate taxes go up, while in others wealthy CEOs or investors probably do bear the true cost. Keep in mind, though, that most Americans are now direct or indirect owners of corporate equity. Investors may be disproportionately wealthy, but lots of non-wealthy individuals are investors, and bear the incidence when corporate flows of income are double-taxed.
No, it would be far better to abolish the extra layer of income taxation at the corporate level and then, if you like, impose various tax rates at the individual level. If you want to impose punitive tax rates on the wealth, channeling Marx or Keynes as some are wont to do, then tax them directly on their 1040s. That way, you don’t create artificial incentives either to form non-corporate business structures or to game the corporate-tax system through off-shore transactions or relocations. The cost of tracking corporate income and policing the complex code is so high that the net fiscal benefits of corporate-income taxes are questionable, not to mention the net economic benefits. That’s where the capriciousness of the current system kicks in – large firms tend to evade a significant amount of their apparent corporate-tax liability and while smaller firms get socked, and both large and small firms can be whipsawed by unforeseen tax liabilities thanks to court decisions or legislative tinkering.
Other countries have figured out that incoherent and capricious taxes are anti-competitive. Dan Mitchell of the Cato Institute reports that as recently as 1996, the average corporate-tax rate in Europe was 38 percent, not much different from America’s 40 percent. After a decade of tax reform overseas, the average European rate is only 24 percent, while America’s remains about 40 percent (federal + state).
Factoring in the differing tax treatment of investment returns, the U.S. is surpassed only by Germany in the effective tax rate on capital formation. Britain’s rate is 10 points lower, Australia’s is 14 points lower, and the Scandinavian countries are lower still – yes, they have bigger governments, but the taxes they collect to finance those governments are more rationally structured.
North Carolina could help matters by cutting its 6.9 percent corporate-tax rate, currently the highest marginal rate in our region. I’d bait state lawmakers on the issue by pointing out that our average effective tax rate on capital is about double that of Sweden’s, but I don’t want to be cruel. Besides, legislators are busy at the moment trying to raise taxes on real estate and energy bills in North Carolina by hundreds of millions of dollars a year, so I might have trouble getting their attention.
Hood is president of the John Locke Foundation.