Ideas: Fixing the World July/August 2009

End the Corporate Income Tax

The corporate income tax may be the stupidest tax we have. At 35 percent, America’s levy on corporate income is one of the highest in the developed world. In 2007, about 2.5 million companies prepared lengthy returns at great expense, yet the tax generated only about 15 percent of total federal tax revenue. The tax on corporate profits discourages capital formation, targets shareholders regardless of their wealth, and fuels frantic, and costly, business efforts to dodge it. Among experts who study its effects, support for the tax is at best sort of sheepish. Yet as taxes go, it is relatively popular.

When confronted with all the economic costs of the tax, and its anemic contribution to federal coffers (even though in 2007, it accounted for a higher proportion of tax revenue than it did in 1985), its supporters generally call for “closing the loopholes.” But such efforts have historically only made the tax code more complex, raising compliance costs and creating new opportunities for avoidance.

By one estimate, what companies spend in complying with the tax equals almost 13 percent of the tax bill they owe—and that’s the smallest drawback. Corporations go to extraordinary lengths to avoid taxes. Entire investment-banking firms and law practices have been built solely for the purpose of creating valuable tax deductions, and they employ highly educated and skilled people who could make a greater contribution to society by … well, doing almost anything else, really.

But the most compelling reason to eliminate the corporate income tax is that it doesn’t target those with the most ability (or obligation) to pay. A company’s owners won’t necessarily be the ones who bear the tax—corporations might decide, for example, to pass on the cost of the tax to employees in the form of smaller bonuses. And even if you could guarantee that the fat-cat managers and the owners bear the brunt of the tax, those “owners” aren’t necessarily rich—they could be retirees invested in pension funds, or small shareholders.

Democrats are looking at ways to lower the rate and “close loopholes” so that more corporate revenue, particularly profits earned abroad, gets hit by the tax. But Uncle Sam could collect at least as much revenue in a more progressive and less distorting manner by eliminating the thing entirely, and raising taxes on capital-gains and dividend income (which were previously kept low to ease the negative impact of “double taxation”—taxing corporate profits first as corporate income, and then again as shareholder income). That might not provide the moral thrill of demanding that corporations cough up their “fair share.” But with so many real advantages, it’s an idea that both left and right ought to be able to get behind.

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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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