Why Aren't We All Corporations?

In the course of musing about the incidence of the corporate income tax, Matt Yglesias makes a point that's pretty widely believed: "One of the main "real world" elements of the case for the corporate income tax, as I understand it, is that failure to impose such a tax would simply create an inviting method for evasion of individual income taxes."


The question I always have about this is: "Well, why don't more people do this now?"

Say you own a corporation now.  You could have the corporation pay you wages . . . or you could have the corporation buy your house, your car, and everything else you own. Instead of taxable wages, you'd get tax free stuff.

So why don't they do it?  Well, part of the answer is that some people do: there's an enormous amount of chiseling on minor business expenses, which is why so many legitimate conferences and trade expos are held in awesome resort areas and not cheap, friendly Peoria.

However, my understanding is that the chiseling remains pretty minor--mostly stuff that you could at least argue are sort of vaguely related to business.  And the reason that it's mostly pretty minor is that if you are obviously using a corporation to fund your lifestyle, then the IRS will descend upon you like a plague of deranged cicadas.

The issue, as I understand it, is not really about evasion of individual income taxes.  Rather, it's that corporate income would accrue tax free until it was distributed through wages, dividends, or capital gains.  Don't get me wrong--this is a sizeable benefit--but it's not quite what I think most people who bring this up are envisioning.  The costs of tax deferral are real, but they are not as large as the immediate tax cost to the treasury generally suggests.  And it's not one I find particularly worrying, for the same reason that I don't find 401(k)s particularly worrying.  If people can't touch the money, it doesn't bother me that they don't have to pay taxes on it.

The real worry is that people will use corporations as their own personal hog wallow: consuming things that *are* legitimate business expenses, like fancy offices with super-comfy chairs and fantastic televisions; extracting various personal benefits from other people on the basis of the fact that they control a business that buys products.  But I'm not sure how much further the corporate income tax would incentivize this.


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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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