The exchange I had with Jared Bernstein and subsequent comments by others have led to me do more thinking on the corporate income tax. First, just to respond to various notes and comments, I was not all upset that Jared and I disagreed. Jared is an old friend and a very good economist. I value his views, which is why I write books with him. I learned from his comments and I appreciate his concern for losing revenue even if it doesn't over-ride my my reasons for thinking that eliminating the corporate income tax (CIT) is a good idea.

I think the most useful way to think of the CIT is an optional levy placed on corporate income. We tell corporations that they have to pay 35 percent of their income in taxes to the government. It's optional in the sense that we allow them to cut this amount by two-thirds, if they instead pay one-third of this levy to Wall Street investment banks, accounting firms, and tax lawyers. (Using 2014 numbers  nominal corporate tax liability would be roughly 6 percent of GDP or $1,050 billion, with actual tax collections around 2.0 percent of GDP or $350 billion.) This is roughly how the tax boils down, with the Government Accountability Office estimating that companies pay about 13.0 percent of their income in taxes to the government, compared to the 35 percent nominal tax rate. This means that 22 percentage points of the profits, that in principle are owed as taxes, are escaping taxation by the government.

In fairness, I don't know how much corporate America is actually paying to escape its taxes. (Someone have a good study to send me?) Essentially, I am just assuming that they spend half of their tax savings on avoidance costs. 

These avoidance costs have real economic consequences. We are paying people lots of money to do activities that have zero value to the economy even though they are hugely valuable to their corporate employers. The people working on tax scams at the major accounting firms, or working out inversion mergers at Goldman Sachs, or creating new tax shelters at private equity companies could all be employed doing something productive. This is like giving companies a tax credit to pay people to dig holes and fill them up again. The difference is that these are highly educated people and they are getting paid really big bucks for the pointless hole-digging.

 

If we snapped our fingers and just shutdown the CIT avoidance industry tomorrow, these people would have to get real jobs. Think of the Republican rhetoric about laying off government bureaucrats and forcing them to get real jobs in the private sector. While that line is overwhelmingly nonsense (the vast majority of government employees are doing real work), in this case it is completely accurate since people employed in avoiding the CIT are doing nothing of value for the economy. This means we will have freed up somewhere around $350 billion in real resources to do productive tasks in the economy. (Yes, I know we are facing stagnation so these workers could just end up unemployed. That would be true in today's economy, but if we imagine that at some point in the future we will be close to full employment then it would be an enormous boost to the economy to have these people doing productive work rather than gaming the tax code. And, if we are below full employment we don't really need the taxes anyhow.)

The question that many people raised, including Jared, is why wouldn't a comparable tax avoidance industry arise on the individual side of the economy, especially if we were raising taxes by almost enough to cover the lost revenue? There are two points on this one. First, as a theoretical matter, there are large costs to tax avoidance. It makes sense for a big company to spend $5 billion to save $10 billion in tax liability.

However if we dished out that $10 billion as $10,000 for one million people, it is likely that it would cost each of them much more than $5,000 to find a tax scam to save them this amount of money. In fact, it is likely to cost them much more than $10,000 each. There are big economies in scale in tax avoidance. This means that we would not see anywhere near as much of a tax avoidance industry on the individual side growing up to replace the one we killed on the corporate side.

In fact, we have a pretty good way to assess the size of the tax avoidance industry this would create. We would be increasing personal income tax revenue by roughly 25 percent. As a first approximation it would be reasonable to assume that the tax avoidance industry on the personal income tax side would also increase by 25 percent. I haven't seen any studies on this, but my guess is this increase would be tiny compared to the CIT avoidance industry that we just killed.

Anyhow, if we can pull this one off politically, I don't see anyway around the fact that the potential gains are enormous. It makes no sense to have a government program that gives hundreds of billions of dollars to many of the richest people in the country to do nothing. That is effectively what we are doing with the current CIT. No one should be deluded into thinking this doesn't have a real cost to the rest of us just because it is not a line item in the budget.

One final item, I know this is a political non-starter right now not only with the Republicans but probably also with many Dems. I know who gives them campaign contributions. But that shouldn't keep us from thinking what a better system might look like and then think about how we can get from here to there.

 

 Note: Share of profits esacping taxation has been clarified. Thanks to Robert Salzberg.

 

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