Is It Time to Repeal The Corporate Income Tax?

By :: September 4th, 2014

In case you missed it, The New York Times’ political and policy blog The Upshot published a fascinating debate throughout August on the question: Should the corporate income tax be abolished?

It’s a query that may be raised on Monday morning, when Treasury Secretary Jack Lew speaks at the Tax Policy Center on business tax reform, a presentation that will be followed by a panel of corporate tax and legal experts. You can watch online or register to attend in person here.

Talk of repeal began after my TPC colleague Eric Toder and AEI’s Alan Viard published an important new paper suggesting the corporate levy could be replaced with a direct tax on shareholders. Toder and Viard raised repeal as one of two possible solutions to the vexing problem of the corporate income tax. Unsurprisingly, this dramatic idea attracted the most attention though the other—a proposal for a new international formula for taxing corporate profits –has also generated some interesting discussion.

To replace the corporate tax, Toder and Viard would tax shareholders on the annual increase in their stock’s valuation, whether they sell their shares or not. Those returns would be taxed at ordinary income rates, not preferential capital gains rates. But because the corporate tax would disappear entirely, corporate profits would be taxed only one time rather than twice as they are today.

Times blogger Josh Barro embraced the idea, arguing, “Corporations aren’t people, so it’s a lot to ask for them to be patriotic, especially when they operate all over the world. But we can ask their American shareholders to pay American taxes on their profits.”

A few weeks later, Harvard economics professor Greg Mankiw (who advised both President George W. Bush and GOP presidential candidate Mitt Romney) also backed the idea of repealing the corporate tax.

But Greg’s idea is very different. Instead of a shareholder tax, he’d replace the corporate income tax with a broad-based consumption tax. Thus, in effect, corporate returns to capital would be exempt from tax. That idea isn’t new—back in 2007, the Bush Treasury suggested one version of such a design, which it called a Business Activities Tax.

A couple of days after Mankiw’s column, Jared Bernstein, senior fellow at the Center on Budget and Policy Priorities, weighed in. Jared, who was chief economist to Vice President Joe Biden, called abolishing the corporate tax “a bad idea.”  He wrote, “If you think we’ve got tax avoidance problems now… we’d have a much bigger problem with a zero tax rate on incorporated businesses.”

Instead, he urged, “mend” the code by ending corporate tax preferences and “closing loopholes.”

Of course, Congress is not about to do any of what Toder, Viard, Mankiw, or Bernstein suggest, at least not any time soon.  And the Obama Administration is grasping for some middle-ground—a corporate tax reform that lowers rates and eliminates some preferences but retains the basic structure of today’s law.  But which repeal plan makes the most sense?

If you buy the theory that it is easier for Congress to do relatively small things rather than big ones, you might take the Bernstein view: Give Congress a chance to address issues such as tax inversions but retain the basic corporate tax.

The downside: In effect, we’d continue the game of whack-a-mole that Congress, Treasury, and corporate tax lawyers have been playing for decades. Congress writes a law, the lawyers find a way around it, Congress eventually writes another law to block that avoidance scheme and so on. Nothing ever quite gets fixed, but the worst of the abuses are held in check—at least sometimes.

There is another view of the corporate code, however. It sees inversions as a symptom of a much larger problem: an extraordinarily inefficient corporate tax notable for both high statutory rates and abundant opportunities to minimize those rates.

This view acknowledges that roughly 10 million businesses already have engaged in self-help tax reform by organizing themselves as pass-through firms (where owners at taxed as individuals but bypass the corporate tax entirely). For all its complexity, the corporate levy generates revenue equal to only about 2 percent of Gross Domestic Product—enough to fund only about one-tenth of the federal government.

From that perspective, mending the code will never resolve its real problems. Thus, repeal looks more attractive.

But how would you replace the corporate income tax? Do you go the Mankiw route and move to a consumption tax? Or do you go down the Toder-Viard road and tax shareholders directly?

Each of these ideas comes with its own political and design challenges. And each represents the kind of major change that Congress usually (but not always) shies away from.

The good news is that while Congress dithers over whether or not to restore a bunch of expired and  largely discredited tax breaks, policy wonks are chewing over some truly ambitious ways to fix the corporate code. And who knows, maybe by the time we have a new president and Congress in 2017, one of those ideas will have gotten some traction.

 

 

 

 

 

8Comments

  1. Ralph H  ::  2:08 pm on September 4th, 2014:

    Interesting topic. Taxing the unrealized gain in net worth is an impractical idea; for one thing that would logically mean that net losses would be credited back. Think 2007 and 2008 and imagine the impact to federal revenues. It would also prompt citizens to buy foreign corporations. I favor elimination of the tax on C corporations but you would have to increase the tax on dividends to compensate or impose a VAT or Net business receipts tax to overcome the loss of treasury income.

    My suggestion would be to make the new rules fairly simple and direct, be revenue neutral, and avoid exceptions. Hopefully it would capture our proportion of end user US sales and/or employment and avoid the taxing of easily manipulated metrics like “US earned profits”. If current pass-through companies want to reincorporate as “C’s” they can.

  2. Michael Bindner  ::  6:25 am on September 5th, 2014:

    I like both the Mankiw proposal for a broad based consumption tax, which should tax profits, just not enough, along with the abolition of individual income taxes for all but the top 20% of income tearners – on the model that I submitted to the Bush Tax Reform Task Force as well as by Michael Graetz. I have little use for good theoretical approaches to tax reform – whether by Jared Bernstein or Toder and Viard – or by Chairman David Camp. The purpose is not to get an A in comparison to prior efforts, its to get the money as easily and equitably as possible. Oh, I would have two separate broad based VATs – one that consumers see that funds domestic military and civil discretionary spending and the other financing entitlements – with deductions for health care and children – so it would not be receipt visible. The high income and inheritance surtax would fund overseas operations, net interest and debt repayment – yes, repayment – and would sunset when the debt is gone and no one is deployed – at least temporarily. Offer that and those who pay the tax will suddenly not be talking to Grover Norquist anymore.

    Can this pass? I can’t even get it scored by TPC or get a hearing on Ways and Means. We are nearing 2016. Anyone wanting a plan in the debate should contact a potential candidate – of course on that score Jared has an inside track if Mrs. Clinton does not run. These debates are not just about what you know, its about who you know.

  3. Robert Bostick  ::  1:25 pm on September 5th, 2014:

    TAXES DON’T PAY FOR ANYTHING SINCE ABANDONMENT OF THE GOLD STANDARD.

    Why does a monetarily sovereign government need to tax to spend?
    The issue is never one of national solvency. The PRIMARY issues are maintaining stability in price levels and an equitable distribution of income. Tax policy should be premised on social not financial objectives since tax revenue is destroyed and never used to fund government expenditures.

    None of you economic/financial mavens “gets” this because you’ve ignored a fundamental implication of Nixon’s abandonment of the gold standard; a government issuing its own non-convertible currency, ex nihilo, with a flexible exchange rate and owes all of its debt in its own currency is never, involuntarily, revenue constrained.

    Corporate and individual income taxes should be adjusted to reflect the need to manage aggregate demand, acceptance of the currency, income distribution, market incentives and measurement of real costs and benefits of government spending,but never to raise revenue for Federal Government spending. Individuals, households, firms and states need income to avoid insolvency because they do not issue a sovereign currency.

    The first reform should be the elimination or suspension of the Payroll tax. Doing so would generate higher incomes, consumption,and corporate profits. SS/M/M benefits would continue to be funded from the the Treasury General Account held at the Federal Reserve Bank of New York. All official payments of the U.S. government are made from this account. There is no cash outlay from any of the Government’s Trust Funds. These Trusts are mere accounting devices … records.

    Next to address the obscene inequities in America’s income distribution marginal tax rates on the top 5% of income earners should be raised to 70%-90% as per the 1946-1981 tax schedule.

    Real effective corporate income taxes should be reduced to 5% when individual, married, head of household marginal rates are legislated as stated above.

    All the Federal government needs to complete the act of spending is an appropriation. It does not need to borrow or tax. When the Federal government borrows it is simply managing, thru Treasury/Fed operations, the term structure of interest rates.

  4. Michael Bindner  ::  12:16 am on September 7th, 2014:

    Actually, we can have such a large debt because internationally dollars are an asset like gold was. If we werer to print them for spending, not only would the world be without a basis for its currency but the dollars printed would be worthless. Tax away the Debt and we will talk about MMT.

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