Let's Get Rid Of The Corporate Income Tax

Politicians talk boastfully about taxing wealthy corporations, when they are really just using smoke and mirrors to obfuscate the issue.

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It may be time to hold another Boston Tea Party, this time to rid ourselves of America's most popular and yet most inefficient source of revenue -- the corporate income tax. Whenever the revenue needs of the federal treasury grow acute, Congress turns to corporate income taxes. Almost every deficit-reduction package proposed last year included a corporate surtax, and you can be sure that any tax bill we see this year will also include higher taxes on corporate earnings.

The people who make these proposals frequently attempt to justify them by pointing out that corporate income taxes have declined as a percent of overall federal taxes. In the last 25 years, corporate income taxes have declined from 23% of total federal receipts to 6%. A Washington Post editorial recently stated that "the corporate income tax has almost withered away as a revenue source." Unfortunately that is not true -- the corporate income tax will raise at least $64 billion this year, 3.5 times what it raised in 1958, and many companies still pay high taxes. It is unfortunate that we have a corporate income tax at all, since it is one of the least efficient ways of raising revenue, and a surtax would only serve to make a bad situation worse.

First, the corporate income tax is not paid by corporations. That is a fact that its supporters don't like to talk about much. The corporate income tax is really paid by consumers, shareholders, and workers. Imagine what corporations could do with their profits if they did not pay taxes:

* They could lower prices.

* They could raise dividends.

* They could increase retained earnings and, consequently, increase the net worth of the corporations.

* They could increase wages.

What this means is that consumers, stockholders, and workers are paying a hidden tax. Some labor unions support higher corporate taxes, unaware that it is their members who actually pay it. Politicians talk boastfully about taxing wealthy corporations, when they are really just using smoke and mirrors to obfuscate the issue.

There is a second reason why the corporate income tax is poor economic policy. The consensus of tax economists is that most of the corporate tax is shifted backward -- it is paid by workers through lower wages and by stockholders through lower dividends and lower corporate net worth. Because it penalizes labor and capital, it is really a tax on production, and it slows the growth of American industry. The corporate income tax makes our most distressing economic problems -- expensive capital and low productivity -- much worse. It is a barrier to economic growth. The burden of the corporate tax should be shifted away from workers and investors, because they are what this economy needs most of all.

The third and final fault with the corporate tax is that it is not symmetrical. All companies do not pay the same rate. Generally, large, established, capital-intensive corporations pay much lower tax rates than smaller, rapidly growing companies. The American Business Conference -- a coalition of 100 businesses that have annual revenues of $25 million to $1 billion and that have doubled in size over the past five years -- studied this issue. It found that the highly successful ABC companies paid effective tax rates that were nearly double those of the Fortune 100. The tax rate for ABC companies was about 30%, while the Fortune 100 paid only a 16% rate.

Moreover, the American Business Conference has sponsored research showing that in virtually every sector of the economy, medium-size companies pay higher tax rates than large companies. This may be because large companies can expend more resources for tax planning and lobbying. Yet there is no philosophical or economic reason why different-size businesses should pay different effective tax rates.

The so-called Pease-Dorgan Study, recently completed by the Joint Committee on Taxation of the U.S. Congress, confirms the wide variations in effective tax rates. The trucking industry paid effective rates averaging 40.3% over the 1980 -- 82 period, while the chemical industry paid only 4.3%. The computer industry paid 25.6%, while the paper industry enjoyed negative taxes in the same time period.

This lack of symmetry causes a misallocation of resources. If, taxes aside, you could make a $10,000 investment having the same payoff in either computers or paper, the tax code would force you to put your money in paper. The existence of the corporate tax thwarts the efficient allocation of resources. It shews resources away from high-tax industries (often new, rapidly growing sectors) and toward low-tax industries (frequently older, declining sectors). Our resources would be allocated much more efficiently, and our nation's output would be higher, in the absence of a corporate income tax.

Proposals to impose a corporate surtax would only exacerbate the asymmetry problems associated with the corporate tax. A surtax would make the allocation of America's resources even less efficient. Those companies already paying the highest tax rates would pay more -- and to the extent that these highly taxed businesses tend to be in the newer, fast-growth industries, we would be inhibiting the continued growth of the very companies most likely to keep the U.S. economy moving briskly. A surtax is from the "shoot yourself in the foot" school of economic policy. It is certainly not consistent with long-term economic growth.

Good economic policy strives to increase national output and make our economy more competitive. To me, this means that we should try to reduce marginal corporate tax rates and oppose efforts to impose a corporate surtax. We should work toward the overall abolition of the corporate income tax and replace the lost revenue with taxes that do not penalize savings and investment.

It is time for a revolution in tax policy. The tax policy of the last 30 years encouraged Americans to spend rather than save, to borrow rather than invest. Now, after years of underinvestment, all of our industries need to modernize in order to regain and maintain our competitive dominance in world markets. Our tax systems should offer incentives that will strengthen, rather than weaken, our economy. It is time for a high-growth strategy in which we turn away from corporate taxes and toward consumption taxes, away from taxes that impede production and toward taxes that encourage savings and investment.