End Corporate Income Tax? #1

Occasionally I read or hear there should be no corporate income tax, “corporations don’t pay taxes, people do”, and similar assertions. Examples:

“As most good economists and knowledgeable others understand, the world would experience a better allocation of resources and more job creation if the corporate income tax was abolished. … The so-called revenue loss would be made up by taxes on the dividend and capital gains increases, and by the extra economic growth and employment that would result from ending the corporate tax.” Link #1.

“Rather, the corporate income tax is actually “paid” by workers in the form of lower wages, and consumers in the form of higher prices. Cut this tax, and workers will both earn and spend more.” Link #2.

Neither source recognizes what would likely happen if the corporate income tax were abolished. With no other changes, it would be foolish to not incorporate and corporations would become tax havens. The corporation could spend its earnings on actual capital investment, pay higher wages, etc., very soon or it could retain the money for any indeterminate use for years. The last one would make an attractive tax haven.  A pass-through entity would not have the last alternative -- the ability to retain earnings. All earnings pass through to the owners, and they pay the income tax on them at whatever rates apply. Profits being retrospective and investment spending plans being prospective compounds the problem.

Under current tax law it’s important that amounts passed through to owners be categorized as dividends, capital gains, ordinary investment income, or compensation (wages or bonuses) because the tax treatment for each is different. For example, capital gains tax rates are lower, and compensation is subject to FICA taxes for Social Security and Medicare, whereas the others are not. (There is some extra income tax that goes to Medicare when income exceeds $200,000 for single filers or $250,000 for married filing jointly.)

The current proposal to reduce the corporate tax rate from 35% to 20% is likely why proposals to change the taxation of pass-through entities have become a significant part of tax reform. I will say more about this in my next post.

By the way, the corporate income tax is not a huge revenue source for the federal government. In 2016 the federal government’s income tax revenue was about 16% corporate and 84% personal. Link #3.