Abolish the Corporate Tax

by Kevin D. Williamson
It’s dumb, corrupt, onerous, and pointless.

The nominal corporate-income-tax rate in the United States is 35 percent, the highest in the developed world. That’s the on-paper rate. The effective corporate-income-tax rate — i.e., the actual rate — is . . . a matter of some dispute, but Martin A. Sullivan, a highly regarded economist specializing in taxation, puts it around 28 percent. Others have estimated the rate to be much lower: A Government Accountability (ha!) Office study put the figure at about 13 percent.

Let’s put it at 0.00 percent.

In reality, the effective corporate tax rate varies substantially from firm to firm and from industry to industry. As Sullivan points out, corporations that operate exclusively within the United States pay an effective tax rate very close to that 35 percent statutory rate, and energy and mining companies generally pay a relatively high rate. On the other hand, multinationals doing most of their business abroad often pay much lower rates, as do many technology and pharmaceutical companies. For example, in 2013 Chevron, ConocoPhillips, and ExxonMobil all had effective tax rates higher than the U.S. statutory rate, but most of their taxes were owed to foreign governments. Microsoft paid about 19 percent. According to S&P Capital IQ, neither Merck nor General Motors paid any corporate income taxes for the second quarter of this year, even though both brought tons of money. (About 22 and a half tons of money in Merck’s case, if you stacked it up in hundred-dollar bills.) Total federal revenue from corporate income taxes in 2013 was $274 billion, or 9.8 percent of total receipts.

When you point out to your average soy-milk-’n’-class-warfare type that the United States has the highest corporate tax rate in the world, and is alone among non-batzoid countries (looking at you, Zimbabwe and North Korea) in imposing that rate on the worldwide operations of domestic firms rather than only on business done in the United States, Moonbeam will reliably point to those lower effective rates as evidence that everything is hunky-dory. But the enormous variability in real tax rates between politically favored companies (Hello, First Solar!) and those lacking in political tax patronage is not an argument against reforming the corporate tax system — it’s an argument for abolishing it altogether.

At the risk of engaging in some absurd oversimplification, we do not really tax corporate income, meaning revenue, but corporate profits, meaning revenue minus everything that can be counted as a business expense — salaries, materials and supplies, inventory, maintenance, etc. (Ordinary operating costs are 100 percent deductible in the year in which the purchase is made, while capital expenses — investments in assets that have a useful lifespan of more than one year — are deducted over time.) A corporation could, in theory, reduce its taxable income to zero every year simply by giving its CEO a cash bonus equal to what would otherwise be its taxable income.

But in that case, the CEO would have to pay taxes on that money as personal income, presumably at the top rate of 39.6 percent, which is higher than the top corporate rate. And that is why it makes sense to scrap the corporate income tax entirely.

Corporations can do a few different things with their profits: They can pay them out to shareholders as dividends; they can keep them on hand to use as working capital, which is fairly common in highly cyclical industries; they can reinvest them in the company in the hopes of making it more productive; they can use them for other business purposes such as acquisitions and stock buybacks. Each of those uses of profit will, if successful, produce taxable income for individuals. Dividends are taxed at the capital-gains rate. Reinvesting in the firm or expanding it is intended to raise the company’s value, and thus the value of its shares, also producing taxable capital gains for shareholders. Stock buybacks are intended to raise share prices (companies generally buy back their stock when they believe it to be underpriced), which also would produce a taxable capital gain. At 15 percent, the capital-gains rate is lower than the corporate tax rate, but profits would nonetheless be taxed — once, as opposed to the double taxation of the current regime, under which the IRS dings the same money twice, as corporate income and as capital gains.

While it seems to me likely that eliminating the corporate income tax would produce some supply-side revenue effects, I am generally skeptical of the idea of self-financing tax cuts and believe that we should take a conservative, pessimistic approach to accounting for them, which means that we’d need either to cut some spending (Yes, please!), raise other taxes (No, thanks!) or increase the deficit (Pass!).

But without going the full Pollyanna, let’s consider what the non-revenue consequences of eliminating the corporate tax might look like.

First, there would be a sharp, ugly increase in unemployment — among corporate tax lawyers, whose financial well-being is of about as much interest to thinking people as that of the fungus that causes athlete’s foot. They are a both a symptom and a cause of the disease that is the tax code.

Second, U.S.-based businesses would immediately save billions of dollars and countless man-hours otherwise diverted to tax-compliance work. General Electric could go back to being the “Imagination at Work” guys instead of a gigantic tax-law firm with a manufacturing subsidiary.

Third, that corporate cash hoard that so incenses the Left could come home. U.S. businesses are holding trillions of dollars in cash overseas — estimates of how much run from about $2 trillion to nearly $8 trillion. They do this mostly to avoid the U.S. corporate income tax. Shareholders would like for that money to end up in their bank accounts — they are, after all, the owners of those profits. Businesses might also like to use it to invest in making their enterprises more profitable. Where might they invest it? There are many things that go into that calculation, but if the world’s largest national economy happened to be attached to a country with a corporate tax rate of 0.00 percent, that would offer some real attraction.

Fourth, we should expect a great deal of investment in U.S. companies and U.S. assets. If we’re so all-fired worried about tax inversions, why not invert the incentives? If the relatively low taxes of Canada or Switzerland are enough to lure U.S. firms overseas, then a zero tax rate, combined with zero tax-compliance costs, ought to lure some investors here. Don’t bemoan the corporate tax haven; be the corporate tax haven.

Capital just wants to be loved.

We do corporate welfare in two ways, mostly through distortions and preferences in the tax code, but also through direct spending — Cato puts that latter figure at around $100 billion a year. Beyond the economic considerations, this is also an affront to the fundamental American ideal that all of us are equal before our government. By scrapping the corporate tax code, we scrap the preferences. And we could cut that $100 billion in corporate welfare spending to $0.00, too, to help offset some of the lost revenue.

Harvard economist Greg Mankiw thinks eliminating the corporate tax is a good idea. So does Boston University’s Laurence Kotlikoff. Megan McArdle makes a persuasive case for it, and points out the less obvious but not insignificant fact that because interest payments are deductible business expenses, the tax creates incentives for corporations to take on debt and risk rather than raise money through offering equity. A little less corporate debt and a few structured-finance types take it in the shorts — not the worst tradeoff in the world.

We need a better, simpler, more predictable environment for businesses and investors to operate in — and, as citizens, we should demand that our government not play favorites in the marketplace. Instead, we have a grotesque swamp of legalized corruption that doesn’t even do a particularly good job of raising tax revenue. If this is how our so-called leaders are going to treat their corporate tax code, they don’t deserve to have one.

— Kevin D. Williamson is roving correspondent at National Review.