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Home Publications Blogs Beat the Press Subverting the Inversions: More Thoughts on Ending the Corporate Income Tax

Subverting the Inversions: More Thoughts on Ending the Corporate Income Tax

Tuesday, 26 August 2014 20:08

I see that my friend Jared Bernstein has some more thoughtful (if mistaken) arguments on ending the corporate income tax. I recognize his concerns about giving more money to the people who have the most (hey, it’s the American Way), but I still think this is a policy that could be a big winner in the battle against the enemies of the people.

I will quickly address two issues Jared raised, the extent to which any of the savings will be passed on in wages and the ability to replace the revenue. However my main focus is the nature of the corporate tax avoidance industry. This is a pernicious drain of economic resources. It is also a major source of upward redistribution. I consider its elimination an enormous benefit – even if on net we give up some government revenue to do it.

First, I followed the Tax Policy Center in assuming that 20 percent of the benefits would go to workers in higher wages. Jared rightly pointed out that this will depend on workers bargaining power. However, it is worth noting that even in the worst of times workers have gotten some fraction of productivity gains. And if we look at the last year, the data show that average real hourly compensation increased almost as much as productivity growth (1.0 percent rise in real compensation versus a 1.2 percent increase in productivity). So the Tax Policy Center’s 20 percent pass back to wages hardly seems out of line.

The second question is how we would make up the lost revenue. The Congressional Budget Office (CBO) projects we will get $351 billion or 2.0 percent of GDP from the corporate income tax in 2014 (Table 4-1). This is the average for the next decade as well. Much of this can be gotten back from eliminating the special treatment of dividend and capital gains income. The major rationale for their special treatment was the argument that it amounted to double taxation since profits were already taxed at the corporate level. Since the corporate income tax will have been eliminated, there is no rationale for special treatment.

In 2012, the most recent year for which data is available, the Internal Revenue Service reported $260.4 billion in taxable dividend income and $2.217 trillion in capital gains distributions. If we assume an average increase of 10 percentage points in the tax rate on dividends and 5 percentage points in the effective tax rate on realized capital gains, this gets us $137 billion in tax revenue (26.0 billion from dividends and $111 billion from taxing capital gains). If we adjust this figure up by 10 percent to account for nominal growth from 2012 to 2014 we are up to $151 billion.

In addition, eliminating the corporate income tax will cause both sources of income to increase, which would imply a further increase in revenue. If half of profits are paid out in dividends (a bit less than the historic average) then we would see dividends increase by $175 billion (using the 2014 numbers), which at a 30 percent average tax rate gets us $53 billion in tax revenue.

The ending of the corporate income tax would increase after tax profits by around 25 percent, which presumably would lead to a corresponding increase in stock prices. That would lead to a one-time windfall for both stockholders and also the government in the form of capital gains tax revenue. However going forward stock prices should rise on average at the same pace but at base that is roughly 25 percent higher. In 2011 (sorry, most recent year I could find) the CBO projected capital gains income for 2014 of $103 billion. If we up that by 25 percent, it gets $26 billion.

This brings the total from additional capital income to $79 billion. Adding that to $151 billion from raising the tax rate, get us to $230 billion. Suppose we raise the top marginal rate by three percentage points. CBO projected that the ending of the Bush tax cut for high end individuals would raise $109 billion in 2014 (Table 3), so a three percentage point hike should get around half that, or $55 billion. That gets us to $285 billion, still a bit short of the $351 billion in lost corporate tax revenue, but it is within spitting distance.

I know all the tax increases mentioned here and others that could be added to the mix would arouse intense political opposition. I’ll come back to that point at the end.

Now let’s turn to the tax avoidance industry. There are two points to be made. First, this is a horrible entity that all right thinking people should want to see killed. Second, we would see a huge reduction in the size of the industry if we eliminated the corporate income tax.

On the first point, it is important to recognize that many of the highest income earners in the country make their money from gaming the tax system. As I noted before, the private equity industry, which currently has over $2 trillion in assets under management, is largely about gaming the tax code as shown in the new book by my colleague Eileen Appelbaum and Rose Batt. The people who design complex accounting schemes are often high end lawyers or accountants who can earn $500 an hour or more.

General Electric has a huge accounting department that exists to ensure that one of the most profitable companies in the history of the world consistently pays little or no taxes. Naturally these people are well-compensated. And when Burger King or some other major corporation is planning an inversion to end its U.S. tax liability altogether, Goldman Sachs or some other investment bank will make hundreds of millions in fees off the deal.

The tax avoidance industry employs many of the highest earners in the country. The M.I.T. economists call this explosion in job opportunities “skills-biased technical change” and tell everyone left behind that technology has made their skills obsolete. The reality has nothing to do with the skills bias of technology. It is about creating a Swiss cheese tax code that richly rewards the people who are best at finding the holes.

To get an idea of the money at stake, CBO projected corporate profits at 9.5 percent of GDP in 2014 (Table 2-1). If we actually collected the 35 percent corporate tax rate then the corporate income tax would be 3.3 percent of GDP. The 1.3 percentage points of GDP difference between this simple book rate and the 2.0 percent actually collected amounts to $230 billion of potential income for the tax avoidance industry. If half of savings to the tax avoiders and half is payments to the industry in various forms, they are pocketing $115 billion a year (0.65 percent of GDP) to game the tax code. This is a huge deal.

In response to this argument, Jared is concerned about the gaming system becoming even larger if we allow corporate income to go untaxed. He worries that people will shift their personal income to being corporate income and thereby escape taxation. He cites the evidence that small businesses are among the biggest tax evaders/avoiders.

There are two points to be made on this. First, there has been a conscious political decision to allow small business owners to cheat the tax code with impunity. It is a standard practice for small businesses to do things like depreciate the family SUV as a business expense. The I.R.S. could crack down on this, but there would be screams of bloody murder in Congress. (Very modest crackdowns in the Clinton years produced a Congressional inquisition that at one point led the I.R.S. to adopt a plan to audit auditors to ensure they weren’t abusing people.)

Whether this tax evasion is good or not, it is qualitatively different from the issues raised by allowing corporate income to go tax free. If the concern is that every Jared or Dean will incorporate as Jared.Inc or Dean.Inc, that could be easily prevented. It would be a simple matter to set some fee (e.g. $1 million a year) that would need to be paid to get tax exempt corporate status. This would be trivial to any major or even mid-size corporation, but it would prevent Jared or me and millions of other upper middle income people from trying to scam the system by incorporating.

The other side of this question is whether people will spend more on tax shelters now that they have more individual taxes to pay. The answer to this is almost certainly yes, but it is difficult to see this outcome creating a tax avoidance industry to rival the one being eliminated.

The very high end earners (say $20 million a year and above) are already paying clever accountants and tax lawyers to minimize their bills. Maybe they will blow a bit more money on this effort, but the increment is hardly going to be a hundred billion dollar industry.

We also have the little bit rich crowd, people who make $1-$2 million a year. These people will also spend a bit more avoiding taxes, but none of them have enough at stake to be paying millions of dollars a year to Goldman Sachs or Mitt Romney to devise clever schemes. To see this point, remember that someone earning $1 million a year now would probably face a comparable tax liability to someone currently earning $1.3 or $1.4 million. This latter group does not have qualitatively different behavior than the former group. In short, it seems like a safe bet that with some simple precautions a wholesale shift from personal income to corporate income can be prevented.

This brings us back to the politics question. Would the Republicans in Congress ever agree to a set of tax changes that were roughly revenue neutral and wiped out their friends in the tax avoidance industry? The answer is of course “hell no!” This is a political party that has as its guiding principle taking money from the rest of us and giving it to the rich.

However that is not a reason to not put forward what should be a very reasonable tax proposal that would sharply curtail waste while maintaining the progressivity of the tax code. We can certainly do better than the system we have now and highlighting what a better system might look like is an important step toward getting us there.


Addendum: I know these posts are supposed to get shorter as the exchange goes on. I promise the next one will follow the script.

Comments (17)Add Comment
State Taxes
written by Ted, August 26, 2014 8:26
Are you worried that states would abolish their corporate income taxes, which would lead to more regressivity and less revenue? It could produce a race to the bottom. I think you make a good case, but not a great case, for getting rid of the corporate income tax.
I've been saying this for years.
written by Doug Rife, August 26, 2014 10:31
Dean has the right idea. I would add that much tax avoidance involves converting ordinary income into long term capital gains. One example is the so-called carried interest loophole. It and all other such tax avoidance schemes would disappear overnight if capital gains and dividends were taxed as ordinary income. In fact, dividends had long been taxed as ordinary income until the W. Bush tax cuts. And the 1986 tax reform act signed by Reagan taxed capital gains and dividends as ordinary income and the world economy did not implode if I recall.

The point is we've done this kind of tax reform before and there were no negative effects on economic growth or stock returns. The only people upset were the very wealthy who live entirely off of their stock dividend and capital gains income. W. Bush paid back his rich donors by cutting their taxes. His dividend and capital gains tax cuts were not about sound policymaking but simply political payback for his rich donors helping him get elected.

Jared is correct that without a corporate income tax corporations could become tax shelters. But that could easily be handled by requiring retained profits be distributed to shareholders or invested to avoid being subject to federal taxes. In other words, the corporate income tax would still exist on the books as it is today but with the additional proviso that it can be avoided by either investing profits or paying them out to shareholders. That would keep corporations from hoarding cash and stimulate demand either via new business investment or by spending of the dividends paid to shareholders.

If corporations need funds for new investment after having paid out profits to shareholders they can always tap the capital markets either by issuing new shares of common stock or new bonds. That is after all why the capital markets exist in the first place. Therefore, there are no good business reasons for corporations to hoard profits, only tax avoidance reasons.
written by JayR, August 27, 2014 12:08
There is good reason to think that not even a slightly measurable amount of this money would hit employees. Companies for the most part pay the lowest wage they can get away with for the talent that they desire. That sort of is how supply and demand are supposed to work. Demand in this cases is companies hiring and par of the supply is the massive amount of works who are unemployed or under employed. Isn't middle class incomes actually shrinking? Wouldn't you have to get the labor market somewhat back to normal before workers would have any real bargaining power? Hasn't Dean made various remarks about how at the rate we are "recovering" we should be back to normal by the year three thousand?(I exaggerated slightly on that last point).
Radical tax reform
written by Robert Salzberg, August 27, 2014 12:35
If we combined the corporate tax reform described above with the elimination of all individual tax expenditures, (replacing the good ones with stand-alone spending programs), then we could take a bigger bite out of the tax avoidance industry and reduce the tax revenue losses on the individual side.

If we also added a VAT, we could recoup the lost corporate tax revenue. In addition, a well designed VAT could have a built in carbon tax component.
Eliminate the corporate tax...
written by LSTB, August 27, 2014 6:37
...And shift it onto land values. (Like all taxes.)

No VAT, no consumption taxes, no national sales taxes or similar taxes that dishonestly treat speculating on real estate as "saving." A sizeable chunk of market capitalization is the land corporations own anyway.

Put it this way, when corporations invert in a foreign country, it's good business, but when they invert their land titles to a foreign country it's treason.
Sock Puppets Beware: Careful What You Wish For, You May Get It
written by Last Mover, August 27, 2014 7:12

Two interesting questions raised in comments above relate to how elimination of corporate tax affects collection of monopoly profit (economic rent) which does not add economic output value.

When this is taxed away in current form or new ways to replace it, it does not reduce additional productivity, job creation or new investment in any way (other than more rent seeking investment).

Whether those taxes work in the opposite direction depends on who gets the revenue. For example if retained profits are required to be distributed to stockholders who themselves can be concentrated among the rich, the reduction of value added from market power may continue albeit more diluted.

As for the tax avoidance industry, wait for it. The new propaganda line will be this is a liberal conspiracy to defang the last bastion of defense by free Americans against big government who only want to protect the little guy from paying through the nose with more exploitive taxes, by taking jobs away in the tax avoidance industry - and highly skilled ones at that.

If elimination of the corporate tax could be designed to eliminate economic rent by redistributing it to labor as competitive pay deserved in a competitive market absent rents, and redistributing it to consumers as competitive prices deserved in a competitive market absent rents ...

... Well then, free markets might actually start to work like they are supposed to. And that's exactly the problem isn't it. They're only supposed to work for the 1%, not the 99% in the message preached to a gullible choir by sock puppets, the anti-tax anti-government message of redemption cloaked in the ridiculous name of "free markets".

It's time for come uppence of the sock puppets. Make them squirm. Give them what they wish for and watch them run for the hills at the hideous prospect of facing the gale winds of free market competition they preach to the 99% at the behest of their masters in the 1%.
Better idea to clear out the tax avoidance industry
written by Matt, August 27, 2014 7:18
Close the loopholes. Anybody who doesn't get the message can enjoy their stay in jail.
Shift the tax, shift the tax avoidance
written by kea, August 27, 2014 10:16
If you shift the tax burden to (rich) individuals, why do you think those individuals will be any less active in tax avoidance than the corporations? The solution is to produce an avoidance-proof tax code, and strictly enforce it.
written by skeptonomist, August 27, 2014 10:35
Capital gains should be taxed as ordinary income, but they should be indexed to inflation. The lack of indexing is one reason that rich people want to see interest rates raised, to forestall inflation (as they think). Stockholders are taxed for inflation as long as prices keep up with inflation (which may or may not happen, depending on what the Fed does. Paradoxically, the raising of rates by the Fed in the 70's probably caused money to flow out of the market and into bonds, sending stock prices down).

The way to eliminate the waste of tax avoidance is to eliminate the loopholes, whatever kind of tax is involved. And rich people will continue to spend money on lobbying to get loopholes and then on schemes to take advantage of them. When the individual rates were very high there were all kinds of dodges, involving fake businesses and dubious donations for example. With lower rates these were no longer worthwhile. But probably the simpler the law and the fewer the different kinds of rates the easier it will be to quash loopholes.
how about...taxing rich people
written by nick bradley, August 27, 2014 11:30
based on IRS data, we can pay for that $110bn by adding in a 52% tax bracket for people that make $1m or more.
written by Tom Mullaney, August 27, 2014 2:20
Why not chuck the entire Internal Revenue Code (certainly an abomination) and replace it with a PROGRESSIVE CONSUMPTION TAX? KISS!
Some problems
written by Benjamin Levy, August 27, 2014 3:44
"Whether this tax evasion is good or not, it is qualitatively different from the issues raised by allowing corporate income to go tax free. If the concern is that every Jared or Dean will incorporate as Jared.Inc or Dean.Inc, that could be easily prevented. It would be a simple matter to set some fee (e.g. $1 million a year) that would need to be paid to get tax exempt corporate status. This would be trivial to any major or even mid-size corporation, but it would prevent Jared or me and millions of other upper middle income people from trying to scam the system by incorporating."

However, it would be a huge deal for small businesses and give the big ones a massive advantage.

"This brings us back to the politics question. Would the Republicans in Congress ever agree to a set of tax changes that were roughly revenue neutral and wiped out their friends in the tax avoidance industry? The answer is of course “hell no!” This is a political party that has as its guiding principle taking money from the rest of us and giving it to the rich."

I agree with the point about the Republicans. But, to be fair, if you think Democrats would agree to abolish the corporate tax rate (even with more taxes on the rich), you're dreaming. The unions (who run the Democratic party) would never allow it. They would demand the new taxes along with the current (or higher!) corporate tax.
call me crazy
written by jim, August 27, 2014 4:03
but I'm pretty sure capital gains fluctuate wildly, and 2.2 trillion during a year the market goes up 32% has very little shot of being repeated
Sorry, Charlie
written by Incubus, succubus, gog and agog, August 27, 2014 7:31
Ideas that should have been fulfilled and enacted years ago are the same ideas that never get enacted. Taxes are an ongoing scam and just pointing out the scam doesn't deter those that benefit from the scam to continue their imposition of the scam.
Other effects
written by Jon, August 28, 2014 4:25
Theoretically, we're removing a large burden on corporations. We'll still have payroll taxes, etc. Doesn't this also remove a lever from the legislative branch for certain behavior i.e. R&D, equipment depreciation, healthcare, and other subsidies? Or are we removing one stick, but leaving the carrot. We'd have higher outflows from the Treasury.
one more thing..
written by PhilTheCapitalistPig, August 28, 2014 4:00
He also mistakenly assumes that the labor market would remain static in rebutting your argument that some of the tax cut would go towards wages. Employers would have no choice but to pay more in wages since the demand for labor would increase substantially if the US became competitive in the global tax environment.
written by PhilTheCapitalistPig, August 28, 2014 4:11
Capital gains tax is a tax on investment, and its not just the rich paying that tax. Its anyone with a 401k or IRA. Ultimately the best answer is the fair tax. Eliminating corporate tax will lower the cost of goods for consumers and raise their wages. All taxes are paid by consumers anyway. Any tax avoidance measures are done in a effort to compete in the marketplace on price. If Burger King needs to go to Canada to offer a whopper at the same price as a big mac, then that's what they do. And by eliminating corporate tax, the benefits will go to the consumer and the worker in the form of lower prices and higher wages. Corporations don't just avoid taxes, they don't pay them at all! All tax is added to cost of goods manufactured and paid for at the cash register!

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.