TCS Daily


The Grand Tax Illusion

By Tim Worstall - September 12, 2006 12:00 AM

You will have seen, around and about, a lot being said about how the current recovery just isn't feeding through to the average man and woman out there. Wages don't seem to be rising; in fact, Paul Krugman recently made the astonishing claim that they haven't risen for the average man, per hour, since 1973. Rather than rootling around in Census Bureau data to show the inanity of this claim (largely because neither you nor I desire a simple rehash of something I wrote here back in January) I thought I'd try and offer something constructive. A solution if you wish, offered with humility.

Let us put ourselves into the position of those complaining. Wages should rise -- a noble goal. How, exactly, are we to achieve this? By what mechanism are we going to reshuffle the current distribution of income so that more flows into the moth-eaten wallets of the hardworking US citizens? Simple:

Abolish the Corporate Income Tax.

I know, I know, you're aghast at the idea that corporations won't be paying their fair share, that somehow they'll be getting away with something. In fact, they'll be getting away with precisely nothing. For, you see, corporations don't actually pay taxes. Only people pay taxes. This is an idea called "tax incidence". It means that people we think aren't being taxed are in fact coughing up the dough demanded by a specific impost.

Think of it this way. The money withheld from your paycheck for FICA and income taxes is in fact paid over to the IRS by the corporation that cuts your very paycheck, is it not? But no one thinks that it is the corporation actually paying those taxes, despite their name being on said check. Things become a little greyer with the corporations's own FICA payments for the joy and pleasure of employing you. Whether all of this comes from lower wages paid to you or whether at least some of it (but definitely not all of it) comes from the profits of the company depends on a few inelasticities which we'll not trouble ourselves to go into right now.

Yet we have established at least one point: whose name is on the check paying the taxes does not necessarily coincide with who is actually paying the taxes, yes? In the case of the corporate income tax we've also just been told who it is that really pays it and no, it isn't the company. Some of it is paid by the investors in the company, in the form of lower dividends or returns on their investment. But as a working paper from the Congressional Budget Office tells us:

"Burdens are measured in a numerical example by substituting factor shares and output shares that are reasonable for the U.S. economy. Given those values, domestic labor bears slightly more than 70 percent of the burden of the corporate income tax."

Now I do hope I don't have to point out that the CBO is in fact non-partisan, that they are the closest we get to an informed and non-ideologically driven examination of such matters?

There are other very good reasons for abolishing the corporate income tax, as this piece from Jane Galt a few years ago reminds us. One of the best is that it is hugely expensive to actually collect:

"The Corporate Income Tax brought in $204.9 billion in 1998. My tax professor (a Democrat) estimated the cost of corporate compliance in that year to be $300 billion. That's just the direct cost -- what corporations paid tax lawyers and accountants.

This labor is unproductive. It adds no new wealth to the economy; we are paying people simply to transfer money from one place to another, a net economic loss."

There are many alternative ideas about how we should best tax investment returns but the idea of abolshing this specific tax in order to stick it to the tax lawyers and accountants has its features, does it not? Plus, of course, we would be lifting a burden from the backs of the working people, for as our CBO report tells us, they in fact pay 70% of the tax through their receipt of lower wages.

As Wikipedia tells us, the corporate income tax is expected to raise $220.3 billion in fiscal year 2006. Abolition would mean that some $154 billion, 70% of that sum, would feed back in higher wages to the very working stiffs we all claim to be fighting for. Wouldn't that be wonderful? Given that this one tax raises some 10.1% of the federal budget, we would, by making this cut, in fact be returning 7% or so of that budget to precisely the group that our Democratic friends wish to aid: the workers.

It's extraordinarily difficult to see any one other thing in either the expenditure or revenue accounts of the federal budget that would in fact have an impact of anywhere near this sort of magnitude. So no doubt we'll be able to get them all on board to aid in taking this simple and obvious step? What's that? I'm insanely optimistic? Yes, I suppose I am, expecting anyone to be thinking about economic facts just two months before an election.

One final thought, there will be those who wonder how I would fill the revenue gap. No, I'll not make claims about the Laffer Curve, or increased dynamism, nor identify specific programs that should be cut, for after all, it is only 10% of federal revenue.

As O'Rourke's Law of Circumcision points out, you can take 10% off the top of absolutely anything.

Tim Worstall is a TCS Daiy contributing writer living in Europe.

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30 Comments

Re: The Grand Tax Illusion
JFC!

"...the corporate income tax is expected to raise $220.3 billion in fiscal year 2006. Abolition would mean that some $154 billion, 70% of that sum, would feed back in higher wages to the very working stiffs..."

Divided equally, 90%-10%, between bosses and the so-called working stiffs, no doubt, while state pensions and other important benefits would be slashed.

Another shill licking corporate boots for a living. Were Bernie Ebber's and Ken Lay's feet especially tasty, Tim?

The Grand Tax Illusion
Why only the corporate income tax?

The entire tax code (60,000-66,000 pages) is becoming increasingly complex, unwieldy, expensive, out of control and hard to defend. The IRS can't even give correct answers at least half the time.

Since the last overhaul in 1986, the IRS code has been amended around 15,000 times. Each amendment only makes the code more complex, expensive and unmanageable, and we the people don't benefit at all, only the companies that get tax breaks from the legislation.

Continued "fixing" and "tweaking" are just stall tactics from politicians who benefit from votes and campaign contributions courtesy of this chaotic system.

The flat tax idea is no solution either. Support for it has dried up. House bill HR 1040 has gained exactly 5 co-sponsors since it was introduced in January 2005.

The FairTax (www.fairtax.org) seems to be the only realistic tax reform plan out there. It completely replaces the current tax code and renders it inert. That's the only meaningful way to solve our tax mess.


Why not eliminate corporations?
Why not eliminate corporations instead of giving them even more legal protections?

Uh..
First, corporations are creatures of STATE law, so you need to get 50 states, plus DC, Guam and Puerto Rico to sign on. Second, what does this have to do with the article?

The Grand Liberal Delusion -Another Shill Licking Political Boots
If you really must follow your visceral, foaming-at-the-mouth hatred, try disciplining it and directing it properly.

The ugly reality is that because of the tax, just about all corporate expenses are deductible, unlike personal expenses.

Its a cardinal rule of finance that after tax costs = (1- tax rate) * nominal cost, which means that whether Enron bought a notebook or a trip for its executives, it paid 65 cents for everything you pay a dollar to buy.

On the other hand, BILLIONS of hours are wasted on FASB 109, Forms 1120 and Schedule M's and the the constant tinkering with taxes causes corporations to spend money lobbying and influencing people-all because the stupid and envious can't see how the political class manipulates them.

First abolish the corporate person...
...If corporate taxes (I agree that it is way too high but no more so than individual taxes.) are so bad why are corporations not turning into some new kind partnerships that can be sold in the stock markets but where investors are liable and not double taxed. It seems even with high corporate taxes investors and owners value the protection against liability more than the taxes they pay.

An example:

The corporate person makes for the absurd situation that current smokers (presumable the victims) are paying for the damages done (allegedly) by the cigarette corporations. Would in not be better if the management and investors who made the money in the sale of the cigarettes would pay the damages?

We should give some thought to abolishing the corporate person or just keep the tax and see if some low liability corps turn into partnerships to avaoid the tax.




Now that is a good idea. Eliminate the Income tax all together. We call it the billion man hour..
...waste.

As soon as
Some novel legal structure comes along, the IRS (rightly) takes the position if it walks like a duck, quacks like a duck, it gets taxed like a duck.

There are all sorts of organizational novelties today-Subchapter S corp's, LLC's, LLP's, etc. None can incorporate all the advantages of a corporation (free transferability of interest, unlimited life, limited liability)without being subject to the full bore of corporate tax.

The Congress and the IRS are not so stupid as to allow you to create something who's sole purpose is is the avoidance of taxes.

classism on display
Why do you assume that the bosses would get 90% of the released money?
They don't get anywhere close to 90% of the wages now?

Why is it that liberals default assumption is that everyone who disagrees with them does so because they are bought and paid for?

why don't we all just become self employed
that's sarcasm for you liberals.

responsibility
Unless the corporations held them down and forced the cigarettes on them, then the smokers are indeed resposible for the damage they are doing to themselves.

As to making investors liable for all damage done by a company, that's a good way to make sure nobody ever invests in a company again. I sure as heck would keep my money in the mattress, rather than expose myself to all the shyster lawyers out there.

First I agree about the cigarettes. But that is a problem with the award not with who pays it.


Shyster lawyers are a separate problem, I agree that we need tort reform (loser pays maybe) but let’s keep that issue separate. Many people are invested in partnerships/sole proprietorships and they are liable, so the idea that no one would invest is false add to that 40% more income would induce you to invest (no more Corp.. tax). You would have to invest more carefully that is all. Also management would have to assume some if not most of the liability and insurance could cover most things. Barring all that lets work for lower taxes for both corps and individuals.


In a partnership, I have a great deal of input and control over what the company does.
Such a degree of control does not exist with corporations.
Nor is it possible to keep up with what management is doing. Such a requirement would mean that I have to keep all of my investments in a couple of companies. If I were to spread my investments between 100 companies, there's no way I could adequately keep track of what each company was up to.

Passed on to customers?
I always figured, corporate taxes were the cost of doing business and figured into the cost of the product and thus paid by, once again us, the customer. So, the business doesn't really pay them.

Also, if we were to eliminate the corp tax, shouldn't we end corp subsidies? If that were done, it would cover that 10% reduction in gov revenue but it would also eat into the money the article assumes would go back to the workers. If I'm right about the tax being figured into the cost, then the cost should go down, benefiting all consumers and improving American competition.

What?
"Also, if we were to eliminate the corp tax, shouldn't we end corp subsidies?"

What the heck's wrong with you, without those subsidies and politicians getting their pictures taken with giant novelty checks, the world would end! End I tell you.

I doubt corporate subsidies are that high, but by all means, they should be gotten rid of.
...

The Subsidies are hidden, check the studies on sugar and other ag subsidies
That sure as hell don't benefit poor Jeb and Emma, no sir, them programs is fer Archer Danel Midlund and Conagra.

the sugar subsidies (which are real) don't come out of the general budget.
Neither do most other agricultural subsidies.

They restrict supply to keep the price high.

They should be gotten rid of as well, but eliminating these subsidies won't decrease the deficit. (Might even increase it short term, depending on how much farm income dropped.)

Ending corporate taxes won't happen until ...
Ending corporate taxes won't happen until a critical mass of people wise up to the fact that politicians of all parties like indirect taxes because they never get voted out of office for passing them.

Simple malarkey
Tim, I'm starting to wonder about you. You say "the corporate income tax is expected to raise $220.3 billion in fiscal year 2006. Abolition would mean that some $154 billion, 70% of that sum, would feed back in higher wages to the very working stiffs we all claim to be fighting for."

But you haven't described any mechanism that would impel these beneficiaries of nontaxation to put the windfall into wages. Exactly why would we not assume they would put every dime into shareholder profits and executive compensation?

And why 70%? I've looked over your working paper from the CBO, but what it actually says is that the burden of paying taxes is shared by all owners of working capital, per Harberger (1962). There's nothing I can find in there mandating that the company's gain be returned to the workers.

You've got some 'splainin' to do.

A modest proposal
I agree with your thinking. And since the costs corporations must bear are passed along to the consumer anyway, wouldn't it be simplest to abolish the individual income tax instead? Then the corps could pay it all and pass the costs along to us through pricing.

Our tax structure would be much simpler if we wee mortals were altogether out of the loop.

econ 101 roy, try learning some.
...

tax
Lets get rid of all taxes do away with the 16th amendment and go to a consumption tax such as the FairTax. To get further info on the FairTax go to the web site www.fairtax.org sign the petition and get involved..

Backwards
If the costs corporations bear are passed onto consumers, then you eliminate the corporate tax. You need to read up on the proper way to administer taxes when the levy results a different "incidence" of taxation.

If you eliminate the cni, you also remove the distortive effect of corporations bearing a lower cost for things due to the effect of tax deductibility.

Your proposal would guarantee:

1.) More fiscal insanity, since the there'd be no electoral response to ever increasing taxes.

2.) Increased use of partnerships as business organizations reacted to the cost differential.

The tax system would be much simpler if we stopped using the public treasury as a bellum omnium contra omnes, to borrow from Hobbes.

Raise the Corporate Tax
The only excuse for taxation is control over the economy.Raising taxes on Corporations should in the best of all worlds cause weak and badly managed Corporations to fold leaving the stronger Corporation that can maintain high efficiency and better profit margins,which would mean Corporations that would be an asset to our country instead of multitudes of poorly run companies that barely stay afloat and are unable to pay living wages to their employees or offer even the most rudimentary health packages.Lowering or eliminating taxes on the other hand would encourage the proliferation of marginal businesses.

The best way to strengthen corporations is by weakening them????
And just how do these corporations manage to pay their workers more, after the govt takes even more of their money?

The market already does an excellent job of weeding out poorly run companies. We don't need the govt helping to pick the winners and loosers.

Fiscal Darwinism?
Fiscal darwinism? How does raising the corporate income tax eliminate "marginal businesses", when they show smaller income and pay less?

By the way, assuming you had devised an effective scheme, its not your business to cull the herd with corporate eugenics.

Just because a business is marginal today, doesn't mean it doesn't provide useful services or products, or won't be a Fortune magazine centerfold a couple years from now.

Not at all
Your comments seem like carefully crafted gobbledigook. I really don't care whether corporations can deduct their expenses. They must-- there's no other way to calculate their profits. This business about a "cni" and the (minor) effect of tax deductibility is a red herring.

And your comment "If the costs corporations bear are passed onto consumers, then you eliminate the corporate tax" makes no sense. Corporate costs are always passed on to consumers. If they aren't, the corps make no profit. This is the case whether they pay all our taxes, some of our taxes or none of our taxes.

Finally, I assure you that if personal income taxes were abolished and we only paid the higher prices that would result from corporate taxation, the voting public would still be exquisitely sensitive to alterations in the corporate tax rate-- as it would affect their consumer prices directly.

Furthermore corps under my plan would be able to continue to profit as they did before, merely by adjusting their prices appropriately upward. However my suggestion was tongue in cheek. Everyone knows it ain't going to happen like that. Not under this Congress, at any rate.

Hey Roy, we agree on something !!
Eliminate the income tax, and make up the shortfall through higher corporate taxes which the corps then pass on to us.

I like it!

The part I like best is that this tax is regressive, meaning the poor pay a higher % of their cash as tax. Just like a consumption tax. Which is great. Seriously, it really is great, because it encourages the most productive people (the rich) to produce even more, because they are taxed on consumption rather than on the fruits of production.

Who'd have thunk a liberal looney like Roy would propose such a thing? Three cheers for Roy the reformed libertarian! Hip hip...

FairTax
I agree wholeheartedly with the author's line of reasoning here - in fact, as a passionate supporter of the FairTax bill (H.R./S.R. 25), I'd like to see an end to an end to taxes on income across the board. As a Libertarian, I'm not of the opinion that the Federal Government should be taking as large a bite out of this county's economy as it currently does; but as a realist, I know that the best we can hope for at this point is a switch to a taxation system (such as a national sales tax) that at least makes the true size of that bite visible to every citizen on a daily basis. The average Joe doesn't realize he's paying corporate taxes (also corporations' payroll taxes, regulatory compliance costs, lost opportunity costs, etc., etc.), as they are hidden in the price of everything he buys. Visit www.fairtax.org to see how a consumption tax would (among other benefits) educate everyone about the true cost of our federal government! It might result in some meaningful changes to our choices in the ballot box!

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