Corporate Tax Jujitsu
The business conservatives are screaming for a corporate income tax cut. They claim that the tax rate that US corporations must pay is far higher than their overseas competitors. They are right...kind of. Some are screaming for the rate to be dropped to 25%. We should publicly agree and take it to the extreme by calling for the rate to be cut to 0%.
The Green Party ought to apply a surprising jujitsu move by coming out strongly in favor of the complete elimination of corporate income taxation. After you lift your jaw up off the floor, hear me out.
The only business form that pays a separate income tax is the standard "C" corporation. Sole proprietors, partnerships, subchapter S corps, and regular limited liability companies do not. (Some LLC's opt to be treated as a C corp for tax purposes and they are the exception.) All those other forms of business legal structure have to pass through their income and capital gains to the owners during the tax year. The individual owners then have to pay income taxes on the income and capital gains at their individual personal income tax rate.
If C corp's were treated like all other business forms, then they would no longer have an income tax to pay -- essentially reducing it to zero. However, forcing wealthy individuals to account for that income at their personal marginal tax rates would provide a huge boost in tax receipts. And it would be highly progressive. Whereas, the current corporate income taxation is in actuality just another cost of doing business and is passed on to the consumer via cost-plus pricing.
Passing the cost on to consumers in this way is no different than a sales tax, which is very regressive in nature. We fix that problem and increase tax receipts at the same time while also making US corporations more competitive in the global market.
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If you eliminate the income tax paid by corporations, then you also erode the validity that a corporation deserves access to our government in ways that should be reserved for citizens. The no taxation without representation argument goes right out the door. However, that's not to say that wealthy individuals won't still use their resources to influence politicians. At least they aren't doing it on the shareholders' dime.
You are absolutely right that this is a major problem. In addition to assuming natural persons rights, it's used as a vehicle for deflecting punishment onto shareholders away from management. Citibank for example was fined hundreds of millions of dollars for illegal activities in the Enron collapse rather than the perpetrators of the crimes. Corporations can be charted to conduct many activities but not a single state, not even Delaware, allows corporations to be incorporated for illegal activities. If the actors were performing acts for which the corporation is not charted, how can they be acting on behalf of the corporation?
As Steve says, the problem is corporations don't pay the tax anyway.
The corporate income tax is in effect a cartelizing device, that heightens the privileged status of favored corporations twice over.
For one thing, it serves as a base for deductions and tax credits, which give a competitive advantage to favored sectors of the corporate economy. Corporate tax loopholes go overwhelmingly to those engaged in capital-intensive (depreciation) or high-tech (R&D tax credit) forms of production, or to those actively involved in concentrating capital (the interest deduction for corporate debt). Cumulatively, they mean that the largest corporations in the commanding heights of the economy--capital intensive, high-tech firms--often pay zero or near-zero corporate income tax. The practical effect is exactly the same as if we started from a corporate tax rate of zero, and then imposed a punitive tax only on those sectors engaged in non-favored forms of activity.
Second, the largest corporations are able to pass on whatever income tax they *do* pay to the customer, on the basis of cost-plus markup, because they are in oligopoly industries that can resort to administered pricing. The only corporations that actually pay the tax themselves are those in the competitive sector.
So at the very least, I would advocate closing all corporate tax loopholes and deductions and then lowering the corporate tax rate sufficiently to make it revenue-neutral.
As for the corporate privilege itself, it shouldn't exist. Some libertarians argue that the corporate form established by general incorporation statutes could be achieved purely by private contract. If so, more power to them. But eliminate the statutory basis which establishes a ready-made and automatic procedure, and thus reduces the transaction costs of negotiating corporate status. Let their lawyers negotiate the corporate entity status directly with creditors, from scratch, if they think it can be done.
Incidentally, Schumpeter argued that double taxation of corporate profits was one of the most powerful devices ever created for promoting the concentration of capital, because it created an incentive to reinvest profits. If those same profits were issued as dividends, they might be reinvested by individual investors in different startup firms, instead. But reinvestment within the corporation means the large corporate sector is driven to overaccumulation.
Kevin Carson
Mutualist Blog: Free Market Anticapitalism
http://mutualist.blogspot.com
Deductions also pass through. Corporations are often capable of zeroing out their income with deductions through various accounting and tax planning practices, and can still do this with a different incidence of tax.
The idea of universal pass-through treatment has been floated before, and poses enormous practical problems. Consider the pension funds and mutual funds that are substantial owners of much of the stock market, where millions of individuals have small pieces of hundreds of companies a piece. Such pass-through treatment might foist off all sorts of extra costs to be absorbed by a broad range of working Joes.
If you want to get more revenue out of the rich, eliminate the capital gains preference. If the GOP bitch too much, just ask them how wrong it can be if Reagan did it in '86.
I agree with you on the realized capital gains tax rates. However, the tax loophole that is the size of the Lincoln tunnel in the tax code is the treatment of unrealized capital gains -- especially when they are used as collateral for loans.
The tax code penalizes the use of borrowing against some types of unrealized capital gains (and deferred income) on the preferred middle class personal savings vehicles -- such as pensions, IRA's and other tax-qualified plans. For example, one cannot borrow against IRA assets without triggering a taxable event. There are limited exceptions made for some types of tax-qualified vehicles such as 401(k) assets. However, there are no limitations on non-qualified savings vehicles across most classes of financial assets and real estate assets. That favors wealthy savers at the expense of the "bottom" 90%.
So, we need to not only address the realized capital gains tax rates, but we need to address the bigger piece of the pie -- unrealized and/or collateralized capital gains. The best way to approach that regarding financial assets is by requiring C corps to pass through their income and capital gains each fiscal year.
Now, you make an interesting and contrary point about two things that I haven't found are empirically supported. First, you wrote:
The prime directive of corporate management is to maximize shareholder wealth (within the legal and social constraints applied by the government that grants them their charter). This means that they are directed to not only maximize profit, but that they also minimize risk. Since risk is commonly defined today as variability of net earnings from period to period, it is both deductively sound and empirically supported, by the way, that corporations seek to consistently maximize their profits.
What's more, there is a strong deductive link and huge amounts of historical data to support the conclusion that common stock price is valued within a reasonably narrow price-to-earnings ratio given the growth rate and risk level of the particular company. Warren Buffett has done quite well based on the idea of such objective intrinsic valuation. He would show that short-term market (subjective) sentiment creates bargains, but over the long-term prices regress to objective values.
My obvious point is that there is not a logical or empirical basis for corporate managers to reduce profits (given a constant level of risk). If they did, then they would do more harm than good for their shareholders and they would be cutting their own throats when they sought to issue additional stock to raise more capital!
The Investment Company Act of 1940 provide the foundational and still paramount laws regulating investment funds like open-end (mutual) funds and closed-end funds. Closed-end funds have been around since the 1890s and the now more popular open-end funds since the 1920s.
I am glad you mentioned mutual funds since that is the best way to understand the pass through concept. Under the above Act, open-end and close-end funds are legally defined and regulated. They both must pass through all income and capital gains during the fiscal year. C corps and closed-end funds are very similar in structure and both should be required to pass through income and cap gains distributions.
As you probably are aware, closed-end funds are similar to open-end mutual funds except that they trade their shares on the open secondary market on major exchanges like corporate stock. Investors may opt to automatically reinvest their dividend and cap gains distributions (and they are fully taxable under 'constructive receipt'), but the fund has to make 100% of the distributions available to the shareholders. Thus, dividend policy is controlled by the shareholders in the aggregate and not management – this is good for another reason unrelated to this pass-through topic.
To sum it up, I don't see the “enormous practical problems” that you hinted at. Would you be more explicit?
PS. You may have already noticed that under my plan the favorite middle-class savings vehicles -- tax-qualified pension and IRA plans -- are not affected by the pass through and still defer their income taxes until they retire!!