The corporate income tax is a really terrible way to raise revenue. As Aparna Mathur has argued on a number of occasions, high corporate income taxes tend to reduce productivity and wages, and so they harm more than just the owners of capital. Earlier this week, Evan Soltas of Bloomberg View described the many distortions caused by the corporate income tax, and he made the case for its abolition. The challenge, as virtually all critics of the corporate income tax acknowledge, is that the corporate income tax raises a substantial amount of revenue. The Joint Committee on Taxation projects that it will raise $455 billion in 2015, or more than a tenth of the $3.373 trillion the CBO projects the federal government will raise in revenue that year. A number of economists, like Alan Viard of the American Enterprise Institute, have suggested that shifting from firm-level income taxation to residence-based individual income taxation is a strategy worth pursuing:
On the whole, however, it appears that American well-being would be promoted by the imposition of individual portfolio income taxes on a residence basis and (at least in the long run) the imposition of any corporate income taxes on a territorial basis. An extension of the above analysis suggests that the appropriate corporate income tax rate may be close to zero because source-based investment taxation prompts the relocation of investment abroad and transfer pricing schemes. In short, the best way to tax investment income is likely to be at the individual level on a residence basis, an approach that avoids both the capital flight triggered by source-based taxation and the migration away from domestic corporate charters triggered by charter-based taxation.
But the JCT projects that reduced rates on dividends and long-term capital gains will be worth $114.9 billion, an amount that would presumably be even smaller if corporate income taxes were abolished, as firms would be less inclined to offer dividends and owners of capital assets might be more reluctant to sell them. One way to mitigate this behavioral response would be to shift from a realization rule (you only pay taxes when you actually sell an asset) to accrual taxation (annual increases and decreases in the value of a given asset are included in the tax base, whether or not the asset is sold). This shift will, however, spark resistance, as it implies that cash-poor owners of valuable assets will have to find some way of scaring up enough money to afford large tax payments. At the same time, accrual taxation would greatly simplify the tax code and limit certain tax avoidance strategies.
Rather than completely eliminate the corporate income tax, Rosanne Altshuler, Benjamin H. Harris, and Eric Toder have proposed taxing capital gains and dividends at the same rate as ordinary income to finance a cut in the corporate income tax rate from 35 percent to 26 percent. Harris observes that this approach would prove more progressive than the current code:
[T]rading a lower corporate tax for higher taxes on investors in the U.S. would be progressive. My TPC colleagues and I analyzed a revenue-neutral plan to tax capital gains and dividends as ordinary income while simultaneously lowering the corporate tax rate from 35 percent to about 26 percent; we found the plan would lower the average tax burden for the bottom 99 percent of taxpayers.
One wonders if there might be some way to combine the proposals of Altshuler et al. with Robert Pozen and Lucas Goodman’s call for financing a deep cut in the corporate income tax rate — from 35 percent to 25 percent — by capping the deductibility of corporate interest expense. Of course, the Pozen and Goodman proposal only raises revenue if the corporate income tax is still on the books. This raises the question of whether it might make sense to introduce an entirely new revenue source to finance a reduction in the corporate income tax. Greg Mankiw, for example, has called for increasing the gasoline tax or imposing a carbon tax to finance such a cut. In 2011, the CBO estimated that a $20 per ton fee on carbon emissions would yield $1.2 trillion over a decade. There are a number of reasons why one might oppose a carbon tax, e.g., imposing a domestic carbon price might encourage the “leakage” of carbon-intensive economic activity to jurisdictions with lighter regulations. If carbon tax revenue is used to finance a much lower corporate income tax rate, or for that matter to partially finance the abolition of the corporate income tax, it is at least possible that the net effect on investment and job growth would be positive.
Republican resistance to carbon pricing is deeply-rooted, in part because its consequences would be very uneven. Some regions and sectors would benefit much more than others. And measures designed to contain these disparate impacts would introduce new complexities that would give enormous power to the federal government, power that might not be used wisely. Yet the case for abolishing the corporate income tax is sufficiently strong that I wonder if linking the two issues might change the political dynamic.