Rather than trying to prop up the corporate income tax against competitive pressures, countries around the world should celebrate its decline and work for its demise… To summarize these arbitrary distinctions, the corporate tax is best described as a tax on saving for the future when that saving is done by holding equity securities in a firm that is either publicly traded or that is locked into the corporate form by its history.
Alan Viard has an excellent essay in the latest Tax Policy Outlook. Viard examines the global trend towards lower corporate taxes — a KPMG survey of 86 countries for 1992-2006 showed that average rates were down by almost 30%. That’s a country size-weighted average I presume.
The downward trend is enhancing labor incomes by enhancing productivity. But politicians are generally more concerned about having bigger budgets to spend rather than citizen welfare. So naturally there is a move afoot to “harmonize” minimum corporate tax rates. The following may seem unbelievable, but it is entirely true:
In May 2004, for example, French and German officials denounced the “unfair competition” posed by new EU members’ low corporate tax rates and urged the EU to set a minimum corporate tax rate for all members, but they were unable to secure the unanimous support required for adoption of their proposal.[10] The idea was not a new one in European discussion. In 1975, the European Commission published a draft directive suggesting harmonization of corporate tax rates in the 45-55 percent range; in 1992, a committee appointed by the commission recommended harmonization in the 30-40 percent range.[11]
Contrast the stunning growth of low-tax Estonia and Slovakia with what would have happened if they had joined the “tax harmonized” EU.
Viard offers a nicely concise explanation of why the corporate tax penalizes savings/investment [as does any tax on capital income]:
The corporate income tax is nonneutral in several important aspects. Like other taxes on capital income, it penalizes saving for future consumption relative to current consumption. It also penalizes corporate firms relative to noncorporate firms and equity securities relative to debt securities.
Current Consumption versus Future Consumption. A corporate income tax is one type of tax on capital income. Taxes on capital income are nonneutral because they impose a heavier tax on those who save to consume in the future than on those who consume today. This nonneutrality is present even if the tax applies uniformly to all capital income and even if capital income is taxed at the same rate as labor income. At first glance, such a tax may seem neutral because it applies whether the capital income is used to buy yachts or other goods. But people choose when–as well as what–to consume, and the capital income tax distorts that choice.
Consider two workers, Patient and Impatient, both of whom earn $1,000 in wages today. Impatient has no desire to consume in the future, and Patient has no desire to consume today. Suppose that savings earn a 100 percent return between today and the (somewhat distant) future. With no taxes, Impatient would consume $1,000 today. Patient would save the $1,000, earn a $1,000 return, and consume $2,000 in the future.
What happens if a uniform 20 percent tax on labor and capital income is introduced? Impatient pays $200 tax on the $1,000 of wages and consumes the remaining $800 today. Compared to the no-tax world, he suffers a 20 percent reduction in consumption. Patient also pays $200 tax on his wages and saves the remaining $800. He earns an $800 return on his savings, on which he pays $160 tax, leaving him with $1,440 to consume in the future. Compared to the no-tax world, he suffers a 28 percent reduction in consumption.
Capital income taxation imposes a heavier burden on Patient–28 rather than 20 percent–solely because he consumes in the future. Just as the yacht tax singled out yachts for heavier taxation than other goods, the capital income tax singles out consumption in the future for heavier taxation than consumption today. The tax therefore interferes with consumer decisions, causing people to consume today rather than save to consume in the future.
The tax penalty on saving has another important implication. Capital income taxes, including the corporate income tax, would burden workers even if investment could not move across international boundaries. By penalizing saving, capital income taxes reduce the volume of investment, making workers less productive and lowering their wages.
The corporate income tax would therefore be non-neutral even if it applied uniformly to all capital income. In actuality, though, the corporate tax is worse because it does not apply uniformly to all capital income.
Another of the many depressing effects of the corporate tax is penalizing equity and rewarding debt financing:
Debt versus Equity. The corporate income tax also arbitrarily distinguishes between different types of financial securities. Not all of the income generated by a corporation is subject to tax. The firm is allowed to deduct interest that it pays on debt but not dividends that it pays on equity. In other words, the corporate tax applies only to the income paid to equity holders, not the income paid to debt holders. Of course, there is no logical justification for taxing the one kind of income but not the other.
Definitely read the whole thing! Viard’s bio:
Professional Experience
-Senior economist, Federal Reserve Bank of Dallas, 1998-2006
-Visiting scholar, Office of Tax Analysis, Treasury Department, 2005
-Senior economist, President’s Council of Economic Advisers, 2003-2004
-Assistant professor of economics, Ohio State University, 1990-1998
-Economist, Joint Committee on Taxation, U.S. Congress, 1992-1993
Education
Ph.D., M.A., economics, Harvard University
B.A., economics, Yale University
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