Future Evolution of The Corporate Income Tax – Maybe Its Time Has Gone - Rethinking the Unthinkable

'When the facts change, I change my mind. What do you do, sir?' (attributed to John Maynard Keynes)

The Dismal Political Economist has always been a strong supporter of the Corporate Income Tax.  Corporations are mostly large, highly profitable organizations that enjoy immense benefits from government services, and so deserve to be taxed.  Furthermore, taxing corporations gives a perception of fairness to the tax system, and that increases the support and voluntary compliance of the tax system that is so necessary for it to function.

Furthermore, despite Conservatives statements to the contrary, the economic burden of the Corporate Income Tax does fall at least partly on the shareholders, and is not passed completely on to consumers in the form of higher prices.  If the Corporate Income Tax were passed on completely, then corporations would be indifferent as to its imposition, meaning that if it goes up their revenues go up the same amount to cover it, and if it goes down there revenues go down by the same amount.  Obviously this is not the situation and will never be as long as Demand Curves are downward sloping

It is becoming clear, however, that termination of the Corporate Income Tax regime is something that must be seriously considered and probably enacted.  The situation is similar to de-regulation of the telephone industry.  For much of the 20^th century, that industry was a “natural monopoly” and unlike most countries, where government ownership was the choice for dealing with the monopoly, the solution to the monopolistic characteristic in the U. S. was to allow private ownership with strict regulation.  The result was low prices, universal service and a good, but not great return on investment for shareholders of telephone companies.

The reason that this system collapsed was that technology rendered the “natural monopoly” status of the telephone industry obsolete.  Competition could then replace regulation, which it did.  The transition was messy and the industry is still somewhat disorganized today, but there is absolutely no rationale, reason or even consideration to going back to a regulated industry.  Economic evolution is a one way street.

The same thing appears to be happening with the corporate income tax.  Consider this passage from an excellent Financial Times commentary by John Kay.

When corporations’ main assets are intangible, the location of their profit is still more difficult to pin down. A Swiss corporation discovers a drug at its research lab in England, manufactures it in Belgium and sells it in the US. The difference between production cost and selling price is large but where does the profit arise? Surely not in the Netherland Antilles, where the company that owns the patent is resident.

Mr. Kay’s point, which The Dismal Political Economist is coming to believe is correct, is that modern economics and finance means that the concept of corporate income, its geographic origin, and the ability to properly tax it has become so complex in the world economy of the early 21^st century that the attempt to tax it is no longer feasible.  Furthermore, competition between various regimes to attract corporations by lowering the rate is creating a drive to the bottom. Corporations are repealing the Corporate Income Tax all by themselves, with creative accounting, geographic income manipulation and playing off competing nations for the lowest rates.

Company tax departments are becoming profit centers, employing experts who will develop legal tax strategies to minimize the tax liability.  The top tax group in the country is now considered the tax department of GE. (Disclosure alert:  The Dismal Political Economist has investments in GE equity and debt.  The Dismal Political Economist is not stupid.)  There is simply no way that the uncoordinated activities of various nations’s tax administration departments can keep pace.

Unlike some Conservatives who want to simply abolish the corporate income tax, the tax must be replaced with a feasible regime. A VAT is not possible in the U.S., too complex and too European.  A gross receipts tax is unfair and a high dividend tax would distort the dividend/retained earning decision.

The most likely candidate for replacing the corporate income tax would be to adopt a modified version of the method Partnerships, LLC’s and S corporations are taxed.  For those entities, the income is allocated to the owners, who report that income on their personal returns and pay tax on that income, whether received or not. 

A corporate version of this, allocating, say Earnings Before Interest, Taxes, Depreciation and Amortization, the EBITDA that business and investors are already familiar with might be a good solution.  There are technical difficulties, but solving those is why there is information technology.  There are political difficulties, but that’s what politicians are for.  Evolution, whether biological or societal does not bother with those constraints, it just happens.