The Costly Lie Called the Corporate Income Tax

You now know, or will soon know, what your individual (or joint) tax liability was for last year. However, you’re paying considerably more income taxes than you probably realize. How much more? That’s impossible to say, and that is a major flaw in our tax system. What you don’t know can hurt you and, in fact, is hurting us all in numerous ways.

The revenue collected for 2014 from federal personal income taxes will be roughly $1.4 trillion. The federal corporate income tax will generate an estimated $.32 trillion for the same period. Politicians would like for to believe that corporations bear the burden of that tax.

Economists, however, absolutely agree on one thing regarding corporate taxes—corporations don’t pay them. Corporations write the checks, but that means next to nothing. The tax in no way allows humans to avoid taxes any more than taxing cows would. In this context, corporations are really nothing more than the treasury’s collection agency. The corporate income tax is a public policy lie, pure and simple.

Corporate taxes are paid by some combination of three groups—shareholders in the form of lower returns, customers in the form of higher-priced products (a kind of “value-added tax”), or employees and other input suppliers in the form of reduced wages and prices. The distribution of the tax burden among these groups depends on numerous variables such as competition, elasticity of supply, and elasticity of demand. A study by William C. Randolph of the Congressional Budget Office estimated that “Domestic labor bears slightly more than 70 percent of burden of the corporate income tax.”

We have no idea if the corporate tax burden is progressive, regressive, or proportional. The corporate tax is by far the most opaque of all major tax categories. It is both a stealth tax and, essentially, a random tax. It is public policy flying blind.

The fundamental point is that humans, not corporations, are the ones who experience reductions in their real incomes because of the money collected from what we call the corporate income tax.

This duplicitous tax allows politicians to play the game Milton Friedman described as, “Don’t tax me, don’t tax thee, tax that fellow behind the tree.” The corporate income tax is the world’s biggest tree. The sad reality, however, is there’s no one behind that tree.

We know that for the federal personal income tax the top one percent of taxpayers pay 36 percent of individual income taxes. We haven’t the earthliest idea what the allocation among income groups is for the corporate tax.

The very thing that makes the corporate income tax bad for the economy and bad for rational policy making is the thing that makes it so attractive to politicians. The corporate tax is a demagogue’s Disneyland. As Jonathan Gruber revealed in regard to the passage of Obamacare, in the political world, lack of transparency can be a tremendous advantage. Politicians generally do not like transparency. They’re as afraid of sunlight as vampires are.

Not only do we not know who’s paying corporate income taxes, we also do not know what those taxes are costing the economy. You can be certain that they are costing a lot more than the $.32 trillion received by the treasury.

For the federal government to collect a billion dollars in taxes, it’s not a simple matter of transferring that amount from a checking account in the private sector to a government checking account. “Compliance costs” are a big part of the problem.

A 2013 study by the Mercatus Center at George Mason University found that “Americans face up to $1 trillion annually in hidden tax-compliance costs.” These costs include the fact that “Americans spent more than 6 billion hours (2011) complying with the tax code. This represents an annual workforce of 3.4 million — a population that could be the third largest city in the United States… and larger than the population of 21 states.” The deadweight cost to the economy is equal to over half of the amount collected by the Treasury.

The subjective burden of those billions of hours is multiplied by the fact that virtually everyone positively hates the time they’re forced to spend filing taxes. It is essentially a form of involuntary servitude.

Recently Bloomberg News reported that U.S. corporations are keeping $2.1 trillion of profits overseas. Bloomberg reviewed the securities filings of 304 corporations having both domestic and foreign operations. There isn’t just one reason for doing this, but by far the most obvious is that repatriating those profits would subject the corporations to the U.S. corporate income tax rate of 35 percent.

How much damage is done to the U.S. economy because that enormous amount of money is out of reach? What would be the impact on the U.S. economy if those two trillion dollars were brought to the U.S.? It’s impossible to say with any precision, but it’s reasonable to assume that it would be significantly stimulative.

When profits are sequestered overseas the U.S. treasury doesn’t get a dime of revenue. Our 35 percent corporate income tax generates zero percent revenue on those profits. The world’s highest corporate tax rate generates no tax revenue on that money but it does significant damage to the economy.

If the corporate income tax were repealed entirely, if the $.32 trillion were left in the private economy, what would happen then? There would be more investment and more consumption. More investment would mean more economic growth, more demand for workers. Rising demand for workers would put upward pressure on wages and salaries. More employment and higher incomes means more individual income tax revenue. More investment would increase the capital-labor ratio which would increase labor productivity which would eventually translate to higher wages. Any tax on income is essentially a tax on production. Whenever you tax something you always get less of it.

When investment returns increase, share prices increase. In other words, not only would incomes rise, so too would wealth. Anyone with a 401(k), for example, would see a significant increase in his or her account value.

A 2013 study by the Tax Foundation titled “Growth Dividend from a Lower Corporate Tax Rate” concluded that “When the full economic effects of cutting the corporate income tax rate are taken into account, the federal treasury would collect more in total revenue than it would lose from a lower rate.” The corporate income tax is doing serious damage to the economy and all its participants and it isn’t even benefiting the Treasury (to say nothing to all the state treasuries). We are shooting ourselves in the foot and getting nothing for it.

The Tax Foundation’s study conclusions were opposite to what Congress’s Joint Committee on Taxation (JCT) concluded in a similar report. The contrary conclusions resulted from a simple difference — the JCT used static analysis in making predictions, the Tax Foundation used dynamic analysis. The JCT, in other words, made the absurd assumption that cutting the corporate income tax rate would have zero stimulative impact on the economy. That long-standing methodology used by the JCT has been repeatedly condemned by the Wall Street Journal, among countless others. Requiring the JCT to switch to dynamic analysis in its reports would have profound implications.

The damage done to the U.S. economy by our high corporate income tax rates is magnified by how it compares to the rates in other countries. When state corporate income taxes are included the top rate in the U.S. is 39.1 percent. Only Chad and the United Arab Emirates have higher rates. According to the Tax Foundation, the worldwide average top rate is 22.6 percent. Also, according to the Foundation, “Every region in the world has seen a decline in their average corporate tax rate in the past decade.” The U.S. is suffering from a large and growing disadvantage relative to the rest of the world. Reducing our corporate income tax rates would be beneficial, but only total elimination would allow the avoidance of the enormous compliance costs of the tax.

The fact that most other countries in the world have cut their corporate tax rates shows that it can be done. Other countries have the same kinds of charlatan politicians we have here, but they’ve somehow managed to take steps in the right direction.

If we were ever to eliminate corporate income taxes, one of the greatest benefits would be a major increase in the honesty quotient of our tax system. Wouldn’t it be nice if, for once, we stopped lying to ourselves?

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◼ The Costly Lie Called the Corporate Income Tax April 10, 2015

Ron Ross Ph.D. is a former economics professor and author of The Unbeatable Market. Ron resides in Arcata, California and is a founder of Premier Financial Group, a wealth management firm located in Eureka, California. He is a native of Tulsa, Oklahoma and can be reached at rossecon@gmail.com.

Don't Blame Reagan

Today's California seems to hate the private sector. And vice versa.

◼ Don't Blame Reagan - Ron Ross/North Coast Journal

We can all agree that California is a fiscal mess. As I have traveled around the country over the past few months, people I talk with seem to essentially view our state with a sense of pity. They ask, "What are you guys going to do out there?"

The fact that this state, with all its natural beauty, delightful climate and creative population, has gotten itself into such dire straits raises the obvious question -- why? How, exactly, did this come to pass?

Two Bay Guardian journalists, Steven Jones and Tim Redmond, present the rather implausible hypothesis that the true sources of our problems are rooted in the long-ago administration of Ronald Reagan and the free market philosophy that he espoused. More specifically, they blame the 1978 passage of Proposition 13, which limited property tax increases in the state. Attributing our problems to Prop 13 is an argument I've seen presented many times over the past few years.

Jones and Redmond assert that "opposition to taxes is now deeply embedded in the California electorate." Their lament, essentially, is that we are in this predicament because taxes aren't high enough. Granted, primarily because of Prop 13, California's property tax rate is below the national average. That, however, is only part of the picture.

California has the highest state income tax rates and the highest sales tax rates in the nation. We are first out of 50 in those rather dubious achievements. (Our top income tax rate, 10.55 percent, is almost twice the average of the other 49 states.) I shudder to think how high our tax rates would be if the electorate were not under the spells of Ronald Reagan, Howard Jarvis (described by the authors as "a Republican landlord lobbyist") and Milton Friedman. In spite of Prop 13, state government expenditures have increased more than 7 percent per year since its passage.

Jones and Redmond seem to believe that advocacy of free market economics and opposition to government growth started in California 40 years ago. They also believe that California is such a trendsetter that the philosophy contaminated the rest of the country, and the whole world as well.

Argument for the benefits of free market economics has been around for well over 200 years and was first elaborated by a Scotsman, Adam Smith, with the publication of "The Wealth of Nations" in 1776. The most famous tax revolt, the Boston Tea Party, occurred in 1773.

It apparently doesn't occur to the authors that the kinds of liberal and progressive policies they advocate might have played in California's decline. Because they refuse to look inward or take any accountability, they can only conjure up strained explanations as to why someone else must be to blame. All the state's problems are caused by the ghosts of three dead white guys (Reagan, Jarvis and Friedman).

California's fundamental problem is its anemic economic growth rate. Our state has the fourth highest unemployment rate (12.2 percent) and the second highest home foreclosure rate. Is California in such relatively bad shape because its citizens are not taxed enough? That doesn't make sense.

The opposite is much closer to the truth. Because of high taxes and irrationally burdensome regulations, California is near the top of the list in regard to hostility toward business. According to a ranking by the Small Business and Entrepreneurship Council, only New Jersey has a more business-unfriendly environment. Californians can, if they choose, burden businesses with ever more demands and regulations. They pay a high price, however. Choices have consequences. Intel Corporation, the chip manufacturer that started in California, announced earlier this year that it would be investing $7 billion in new manufacturing facilities over the next two years -- in Oregon, Arizona and New Mexico. There's a pattern there. Are they avoiding California because our taxes are too low?

Jones and Redmond recognize the negative effects of the kinds of policies they espouse. "Certainly, turning over more public resources to free market capitalists, cutting taxes and slashing government regulation will spur private sector economic growth, just as advocates claim. But that growth has a cost. The wealth won't be shared by everyone." Their argument essentially says there's no point in creating wealth if it's not equally distributed.

In other words, if the beneficial impacts of some policy are not equally shared by everyone, they must be rejected. Such a standard creates an absolutely impossible hurdle for any human action. For Redmond and Jones, income equality is more important than economic growth. I have never understood those kinds of priorities. The damage done by unemployment is a real and unrecoverable loss. Ironically, it also hurts government revenues and, in the end, those citizens who depend on government-funded programs. If Redmond and Jones really want more money flowing into state coffers they should be welcoming policies that encourage economic vitality.

Jones and Redmond regret that corporations don't pay as much taxes as they should, partly because of Prop 13. The fantasy that corporations are capable of paying taxes is one of the most naïve beliefs of the left. In the real world, the world all of us actually live in, only humans are capable of paying taxes. Corporations are only intermediaries. They can write the checks to the IRS or the Franchise Tax Board, but they can't bear the "burden" of taxes any more than cows or real estate can.

Corporations connect with humans in three ways -- owners, employees and customers. The burden of corporate taxes falls on some combination of those three groups. Corporate taxes result in some combination of reduced profits for shareholders, higher prices for customers and lower wages for employees. The actual distribution of the effects varies from industry to industry, case to case. The conclusion of most recent research indicates that the principal burden falls on the employees of corporations. If your objective is to soak the rich, the corporate tax is an extremely crude and counterproductive means for doing so. Many on the left despise corporations and have no interest in actually analyzing their policies, so the corporate tax is one of their favorite weapons of choice.

California will survive and we will muddle through somehow. Unfortunately, we are squandering our vast potential by misreading the fundamental sources of our chronic problems.

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This article originally ran in the North Coast Journal. October 29, 2009