Time to reform corporate taxes?

April 15, 2013

I am unfortunately skeptical of the current corporate tax reform process in Washington. At minimum, we should end up with a statutory rate at the OECD average of 25% with fewer tax loopholes/breaks/deductions.

But congressional tax writers are having a hard time getting anywhere close to that number without harmful gambits such as “paying” for the rate reduction by a slowdown in depreciation deductions. Not only does such a plan take with one hand what it gives with the other, but it penalizes new investment in favor of old. And if the rate can’t be lowered close to the OECD average, the whole process is likely to collapse anyway as Corporate America passes.

So maybe it’s time to give up on tinkering. Maybe it’s time to just scrap the corporate income tax. Matthew Yglesias:

Rather than trying to mend the tax, we ought to end it and replace it with something else. My preference would be to structure its replacement to ensure that the costs are born by rich executives and wealthy shareholders rather than middle-class workers. That suggests curbing the current tax preference for dividend income over labor income. That way corporate profits that are paid out to firm owners would end up being taxed about as much as they are today, but profits reinvested in hiring new workers and expanded capacity wouldn’t be.

The corporate income tax is a lousy way to raise revenue.

1. An OECD study concluded: “Corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxes.”

2. AEI economists Kevin Hassett and Aparna Mathur have found that “corporate tax rates affect wage levels across countries. Higher corporate taxes lead to lower wages. A 1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates.”

3. While estimates certainly vary — with one study finding workers bear 60% of the burden, another finding capital bears 80% — certainly corporate taxes do fall on workers, at least to some significant extent.

Yglesias offers several ways to make up the lost revenue, about $236 billion last year. But there is evidence that the current corporate tax code is so inefficient and the rate so out of whack that you could lower the rate substantially — maybe all the way to 26% — without losing revenue. Something to keep in mind.

Another pro-growth reform option is to transform the current business income tax into a consumption tax, as proposed by AEI’s Alan Viard. Businesses, corporations, partnerships, and sole proprietorships would be taxed on their business cash flow at a flat rate equal to the tax rate paid by the highest-wage workers. Firms would be allowed to immediately deduct all business expenditures, including purchases of equipment and buildings, rather than depreciating them over a period of years. Firms would not deduct interest expense or any other financial outlays. Rep. Devin Nunez has proposed just such a plan, though his 25% rate is probably too low.


This is a cross-post from the AEIdeas Blog. To read more from James Pethokoukis, click here