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Abolish the Corporate Income Tax; Tax Corporations Like Partnerships
Raymond Richman, 8/12/2013

Both the Democrats and Republicans have proposed tax reforms. By and large, the Democratic proposals simply deny the rich deductions the remaining taxpayers can take. Republicans on the other hand appear to be opposed to any but consumption taxes. Neither party seems to be aware that over the centuries economists have developed a set of principles of taxation to aid in determining what tax is best to finance a given set and level of expenditures.

Some accepted principles of taxation are the following:

  1. In selecting a tax, the cost of administration and compliance should be taken into account.
  2. Classes of taxpayers who receive specific benefits from government expenditures should ordinarily be charged for such services, e.g., this justifies registration fees for real estate and motor vehicles, and court costs of private litigation, taxes on motor fuels to pay the cost of building and maintaining roads and bridges, etc.
  3. Taxpayers in equal circumstances should be taxed equally.
  4. The economic effects of a tax must be taken into consideration, with the negative effects of taxes minimized.
  5. The tax burden should be distributed progressively subject to the qualification that the social benefits of reduced inequality of income should at the margin never exceed the costs of diminished incentives to save and invest.

Here is what the Democratic proposals look like. According to the Center for American Progress, a self-described progressive group, the President has proposed that the 2014 federal budget include:  

1. Limit the deductions that can be taken by the rich while preserving them for lower income groups. (One rule for some taxpayers but a different rule for others, violating the rule that laws should apply equally to all citizens.)

2. Adopt a rule (credited to Warren Buffett) that the rich pay at least 30 percent of their incomes after charitable contributions and denying them the benefit of lower rates on capital gains and corporate dividends. (What happened to equal treatment under the law?) 

3. Place a ceiling on the total amount that can be accrued in tax-preferred retirement accounts.

4. Eliminate the unfair tax classification that allows hedge-fund managers to pay tax rates lower than middle-class Americans.

5. End the special depreciation allowance given to corporate jets.

To say that this represents intellectual bankruptcy is charitable. 

Annette Nellen, CPA, writing on the American Institute of CPA’s website on November 10, 2011, lists the following proposals of candidates for the Republican presidential nomination:

Congresswoman Michele Bachmann proposed a one-time dividend repatriation holiday for American firms reluctant to repatriate their foreign earnings not subject to tax until repatriated, repeal of taxes included in the 2010 health care legislation, repealing the AMT, repeal of estate taxes and a "simpler and fairer" unspecified corporate income tax.

Herman Cain calls for replacing all current taxes other than excise taxes (as though all  excise taxes are good!) with a 9% tax on gross revenue less purchased inputs, a 9% personal tax on gross income less charitable contributions, with no tax on capital gains, and special treatment of those who living or work in so-called “Empowerment Zones”, and a 9% national sales tax. The suggestions are so silly that it would be a waste of time to consider them.

Sen. Jon Huntsman’s plan calls for eliminating all deductions and credits.  Rates would drop to eight percent, 14 percent and 23 percent. The AMT would be repealed. Capital gains and dividends would not be taxed. The top corporate rate would be 25 percent. A territorial system would be implemented with a repatriation holiday.

Gov. Rick Perry proposed a taxpayer option for a 20% flat rate with a standard exemption of $12,500 and deductions for mortgage interest, charitable contributions and state and local taxes for families earning less than $500,000. There would be no tax on social security benefits or capital gains. The estate tax would be repealed. The corporate rate would be 20 percent. The system would move to a territorial basis.

Pres. candidate Mitt Romney proposed lower individual tax rates, no tax on capital gains, repeal of the estate tax, and a 25% maximum corporate tax rate and a territorial basis for taxing foreign income.

The only way to describe both the Democratic and Republican proposals is that they are worse than what we have now. What all the candidates, Democrat and Republican, demonstrate is that they know nothing of the economics of different taxes nor their history.

We won’t go into Republican opposition to the estate tax here. We’ll write about it separately.   In the lexicon of federal, state, and local government taxes, it is the best tax from the standpoint of all the criteria of a good tax. It is economical to administer and comply with; it has virtually no bad economic effects, and it is progressive. Why Republicans oppose it is a mystery. Its opponents complain that it is anti-small business which our analysis shows is nonsense.   

Except for its high cost of compliance, the personal income tax gets high ratings from economists. However, economists have called attention to some negative economic effects, for example seeking and finding ways to avoid high rate of tax. Because capital gains are taxed at lower rates than ordinary income, corporations, instead of paying dividends, buy back outstanding shares which, other things equal, raises the prices of the outstanding shares enabling shareholders to realize lower-taxed capital gains. This is the principal cause of corporations buying back their shares to raise the price of the remaining outstanding shares instead of simply paying dividends which are normally taxed at standard rates. But as we have shown elsewhere this can be easily corrected by appropriate treatment of capital gains. For example, untaxing capital gains that are rolled over, i.e., reinvested (the treatment accorded to homes) and taxing consumed gains at the same rates as ordinary income.

On the other hand, the U.S. corporate income tax violates nearly every criterion of a good tax. It is believed to be progressive because corporate ownership is distributed unequally But the incidence of the tax is in doubt. Prof. Harberger argues that corporations that export much of what they produce cannot pass the tax forward to consumers because of international competition. But corporations that sell their products domestically may be able to pass the tax forward to consumers or backward to their employees. Moreover, a great deal of corporate securities are owned by mutual funds, pension funds, and is very burdensome on workers whose savings are invested in pension funds that are heavily invested in corporate securities. We have a solution to make the corporate income tax more onerous for millionaires and less onerous for those in lower personal income tax brackets.

Then there is the criterion of equal treatment of equals. The corporation is an association of individuals who are currently taxed twice on the income they derive from the corporations they own. The British t axed corporations until the end of WWII as part of the personal income tax not as an entity separate from its owners but as taxation at the source of personal income derived from corporations. Corporations paid the basic rate of income taxation on their earnings and shareholders were credited with the basic rate of income tax on income earned by the corporation. (That lunacy is contagious is illustrated by the fact that after labor took power in the 1940s, the British imitated the worst characteristics of the U.S. income tax system including high rates (up to 98%), imposing a separate corporate income tax, and imposing a capital gains tax separate from the income tax.

Progressive income taxes do little to equalize incomes. Progressive expenditures like free public education, Medicaid, food stamps,  public libraries, public parks and recreational facilities, welfare, public safety, public entertainment, et.al. are the great equalizers of income.

While the progressive personal income tax is highly regarded by economists, their acceptance of the corporate income tax is hard to justify. It violates almost all of the principles of taxation. The corporate income tax is a product of the economic lunacy that afflicted the economically illiterate U.S. citizens and their elected representatives and economists! during the last decades of the 19th century. As is typical of democracies, bad laws which have a constituency are never repealed. Other examples come to mind: the creation of the unconstitutional and monumental failure, the Department of Urban Development, the promotion of wind and solar energy, and biofuels.

Then there is the problems of double taxation and the problem of utilizing the corporation as a device to escape the high rates of personal income taxation. Corporations pay income tax on their earnings and then their earnings distributed as dividends are taxed as the personal income of their shareholders. The millionaires who control most corporations are reluctant to pay dividends which would be subject to high rates of personal income tax. So instead of paying dividends, they accumulate earnings without paying dividends. Share prices rise and the owners sell shares realizing capital gains which are taxed at much lower rates than dividend income..

But there is also an equity argument against the corporate income tax. The corporation is an association of individuals, its shareholders. Those who do business as a partnership are taxed on their individual shares of the partnership as personal income. The partnership is not taxed as such. The partners must declare under the personal income tax their share of the partnership’s net income. While the corporation can be used as a device to lower the tax burdens on the upper-income shareholders simply by retaining earnings or by converting earnings into capital gains as we’ve shown, partnerships cannot be used to play such gains. High income partners pay high personal income tax sive on their partnership income and low income partners pay lower rates of personal income tax on their income from partnerships.    

Why should the corporation be considered an entity different from its shareholders? Why should corporate earnings not be taxed to the shareholders when earned just as partnership earnings are taxed to the partners.

Republicans think all taxes as bad and most are. But government needs to raise revenue to finance legitimate expenditures. Some taxes are better than others. Why not choose the right tax?

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    Wikipedia:

  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]