Wednesday, April 17, 2013

Eliminating the Corporate Income Tax

Megan McArdle, my favorite blogger, came out with a brilliant piece advocating the elimination of the corporate income tax.

Reducing or eliminating the corporate income tax has been the province of libertarian-leaning economists for a long time. But there was another dimension I hadn't considered along with eliminating the corporate income tax: treat all individual income equally regardless of source. Which means eliminating the reduced rates on qualified dividends and long term capital gains.

From a tax "fairness" standpoint, the vast majority of Americans support a somewhat progressive tax code. But given the complexity of the tax code, many of them have the sneaking suspicion that many rich people pay less in taxes (relative to their income). The two biggest contributions to this suspicion are the dividend/gains tax rates and the hideously bloated deductions and subsidies found within the Internal Revenue Code.

If you eliminate the corporate income tax and instead tax the individuals who receive the profits of the corporations, it makes it impossible for a person like Mitt Romney (with his notorious 14% effective Federal tax rate) to pay less than a middle income worker like me (with an effective Federal tax rate of 20.54%). And because we've gotten rid of the corporate income tax, we also eliminate the double-taxation that occurs when a corporation pays taxes on its profits and then also having the individual pay taxes on the after-tax dividends that the corporation then issues.

We also make it more economically efficient for firms to raise capital, eliminating the relative disadvantage companies experience when they seek to raise capital via the stock market. Because interest on capital loans are tax deductible, it usually makes it more attractive for companies to raise money on the bond market. Since there isn't a compelling economic argument in favor of companies taking on debt to raise capital instead of selling equity, eliminating corporate income taxes (and thus the capacity to deduct interest costs from the firm's tax liability) also makes a firm's capital structure less dependent on government regulation.

This also eliminates a vast portion of corporate lobbying at the Federal government. Much of the lobbying done is to carve yet another deduction or subsidy in our brobdingnagian tax code, which is currently over 3.4 million words long (about 6 times the length of Tolstoy's War and Peace). Now the only thing corporations can lobby for are changes to the Federal Register (economic regulation) and the US Code.

From a long term view, there is no significant downside to eliminating the corporate income tax. In the short run, the progressive bloggers at Slate, TNR, The Atlantic, and other assorted periodicals might have an aneurysm at the sudden increase in net worth of households who already have significant stock holdings (an all stock portfolio would see an average increase of about 25% in nominal net worth), but this is offset in the long run by making it relatively cheaper for lower income households to own stock (currently, depending on the tax bracket, it's either as cheap or significantly more expensive for middle income households to own stock).

That collective aneurysm would be fun to watch, though.

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