Everyone Who Calls for Repealing the Corporate Tax Is Wrong

Every now and then something happens — a Senate investigation into Apple’s tax dodging, Burger King’s plan to become Canadian — that demonstrates that our corporate income tax is very ill. Every time, pundits debate how to cure this disease, offering various tax reform proposals. And every time, a few suggest we shoot the patient, that is, repeal the corporate income tax, which is expected to raise $4.6 trillion over the coming decade.

The idea of repealing the corporate tax seems to have just one virtue, which is that it’s simplistic enough to fit into a blog post or op-ed. In every other way this idea is terrible.

The argument made is usually some variation of the idea that corporate profits are eventually paid out as stock dividends to shareholders who pay personal income taxes on them, so there is no need to also subject these profits to a corporate income tax. But in real life that’s not how things usually work.

CTJ published a fact sheet last summer that explained three very important reasons why we need the federal corporate income tax.

First, a corporation can hold onto its profits for years before paying them to shareholders. This means that if the personal income tax is the only tax on these profits, tax could be deferred indefinitely. It also means that people with large salaries could probably create shell corporations that would sell their services. Their income would then be transformed into corporate income and any tax would be deferred until they decide to spend the money, which could be decades later, if ever.

Second, even when corporate profits are paid out as stock dividends to shareholders, under our current system about two-thirds of those stock dividends are paid to tax-exempt entitles, such as pensions and university endowments which are not subject to the personal income tax. In other words, a lot of corporate profits would never be taxed if there was no corporate income tax.

Third, our tax system overall is just barely progressive and it would be a lot less progressive if the corporate income tax were repealed. The corporate income tax is a progressive tax because it is mostly paid by the owners of capital — people who own corporate stocks (which pay smaller dividends because of the tax) and other business assets.

Some have tried to argue that the corporate tax is mostly borne by labor because it chases investment out of the United States, leaving working people with fewer jobs and/or lower wages. But corporate investment is not perfectly mobile and, as a result, the Treasury Department has concluded that 82 percent of the corporate income tax is paid by owners of capital, and consequently, 58 percent of the tax is paid by the richest 5 percent of Americans and 43 percent is paid by the richest one percent of Americans. Congress’s Joint Committee on Taxation has reached similar conclusions.

There are various ways Congress could conceivably repeal the corporate income tax and get around these problems but each presents so many complications and uncertainties that one wonders what could possibly be gained in the effort. One proposal that has received attention would partly offset the cost of repealing the corporate income tax by taxing dividends and capital gains as ordinary income (repealing the lower rates for those types of income) and taxing the gains on corporate stocks each year rather than only when they are realized when the stocks are sold. Those are all fine ideas in themselves, but they don’t make up the revenue loss from repealing the corporate income tax. The net effect of the proposal, as its proponents acknowledge, would be to lose about half the revenue raised by the corporate income tax.

Congress could make additional changes, for example, ending the tax-exempt status of those pensions and university endowments that receive so many stock dividends without paying any tax on them, but that seems politically unrealistic to say the least.

Moreover, repealing the corporate tax could create worrisome problems of tax compliance. For example, Jared Bernstein has noted that we do, of course, have many businesses structured as “pass-through” entities whose profits are subject only to the personal income tax and not the corporate income tax, but these businesses are linked to even greater tax compliance problems.

“One study found that the tax gap — the share of taxes owed but not collected — was 17 percent for corporations and 43 percent for business income reported by individuals. That research is over a decade old, but more recent tax gap research found that business income taxed at the individual level was the single largest source of the gap, and that sole proprietors report less than half of their income to the I.R.S.”

The bottom line is that repealing the corporate income tax is a seemingly simple answer that would create far more problems than it would solve and would almost surely result in less revenue, a more regressive tax system, and even more complexity and compliance problems than we have now.