No area of tax policy has changed more over the past four decades than corporate income taxation. Since 1980, corporate tax rates have fallen as countries have vied for business investment in an increasingly global economy. More recently, however, lower corporate tax rates have triggered concerns about a “race to the bottom” and, in turn, sparked a multinational effort to create a global minimum tax.
Between 1980 and 2017, the United States fell behind in the race to reduce corporate tax rates and even briefly levied the highest corporate tax rate in the industrialized world. The 2017 Tax Cuts and Jobs Act (TCJA) brought the corporate tax rate down and restored U.S. competitiveness, but the 2022 Inflation Reduction Act (IRA) clawed back some of the benefits by creating two new and untested corporate tax provisions.
As countries continue to work to establish a global minimum tax, economists have demonstrated that the corporate tax is the most harmful tax for economic growth, with much of its burden falling on workers in the form of lower wages.
This is from Scott Hodge, “Corporate Income Taxation,” in David R. Henderson, ed., The Concise Encyclopedia of Economics.
One of the articles in the Encyclopedia most in need of updating was the one on corporate income taxation. So much has changed since the print version of the Encyclopedia was put to bed in 2006. I saw Scott speak at a Stanford Institute for Economic Policy Research (SIEPR) event last October. I was impressed. I thought he would be a good person to write the new version. I was right.
READER COMMENTS
Thomas Hutcheson
Jul 12 2023 at 1:16pm
I guess I agree that the corporate income tax is the most inefficient tax. It has the most potential for distorting investment between one sector and another. But it is also unjust in that it taxes all owners’ incomes at the same rate, whatever the owner’s actual marginal tax rate is. Ideally we would just impute business income to the owners personal incomes and tax that progressively(or the consumption portion of that). We would still need the machinery of business taxation to insure that income was not being under recognized, which would still leave the temptation to distort investment decisions, but it should help.
vince
Jul 12 2023 at 3:09pm
Allowing a deduction or a credit for dividends is a simple fix. Double taxation is eliminated.
Jose Pablo
Jul 14 2023 at 6:32pm
And yet, dividends are taxed, so, a “triple” taxation is created.
steve
Jul 12 2023 at 3:13pm
We should have entirely gotten rid of the corporate income tax years ago.
Steve
Jose Pablo
Jul 14 2023 at 6:37pm
We will never get rid of corporate taxes. A tax that is paid by “legal entities” (which are non-voters) is a public choice optimum
You should expect public choice optimum to increase over time. Actually the “corporate tax rate” is, very likely, the best indicator of populism ever created.
Matthias
Jul 12 2023 at 10:03pm
There’s another problem I didn’t see mentioned, yet:
Companies can avoid parts of their corporate income tax burden by shifting their capital structure from equity to debt.
There’s concern that lots of leverage in the economy makes it brittle. I don’t think a tax system should incentives leverage even more.
Knut P. Heen
Jul 13 2023 at 8:00am
You are correct. There seem to be a tax incentive to lever up at the corporate level, but some of it may be offset by personal taxes on debt financing. In general, US corporations have much lower debt levels than the rest of the world (probably because of more developed equity markets).
My problem with taxing corporations is that it is very unclear who is actually paying those taxes. It is usually sold as a tax on the rich, but it certainly also reduces both wages and number of jobs in the corporate sector (making some new investments unprofitable thus reducing the competition for labor). Moreover, a large fraction of people’s retirement savings is usually invested in equities.
The dividend tax is even worse because it makes dividends less attractive. The result is that dividends and reinvestment by investors in new ventures becomes less attractive compared to just leaving the money in a corporation with few good investment opportunities. It is a recipe for creating big business instead of new innovative profitable business.
vince
Jul 13 2023 at 1:11pm
That’s why I mentioned a dividend deduction or tax credit to the corporation. Debt is no longer favored.
Vivian Darkbloom
Jul 13 2023 at 2:32pm
“Companies can avoid parts of their corporate income tax burden by shifting their capital structure from equity to debt.”
I’m not sure I agree with this or at least how you framed it. By taking on external debt, companies shift income to creditors and, all else equal, report lower book and tax income. Sure, it’s an actual expense, and if your profits are lower, you pay less tax! What a tax dodge! What will they think of next? Outsourcing manufacturing?
Companies often do take on debt with the idea that by doing so they stand to increase their return on equity. Stated differently, those companies believe that the cost of servicing that debt is lower than their expected return on equity. But, this is certainly not a sure thing and I would not exactly call it tax avoidance.
A far more interesting game, and one that I have a more than passing acquaintance with, is using internal group debt to reduce one’s global corporate tax bill. The idea is that a company within the group in a low tax jurisdiction lends money to another group company in a high tax jurisdiction. Deductible at a high rate and included in income at a low rate. The US has “earnings stripping” rules under IRC Section 163(j) that makes this difficult. Alternatively, a company in a jurisdiction that treats an instrument as equity might advance funds to a group company in another jurisdiction that treats the same thing as debt. This is known as a “hybrid instrument”. Hence, deductible in the latter and not reportable in the former as income, usually because dividends are exempt under a “participation exemption.
I can’t really think of any advanced, developed economy that doesn’t have a corporate income tax (for legitimate reasons too difficult to explain here). This will continue to be the case during my lifetime and I’d wager a bet during yours as well.
Jose Pablo
Jul 14 2023 at 6:45pm
Companies often do take on debt with the idea that by doing so they stand to increase their return on equity.
This increase of their “expected” return on equity certainly came with an increase of risk (which is what you refer to in the second part of the paragraph), meaning that this increase in their expected return on equity has no impact on their “market value” (at least under the CAPM framework). This fact is often overlooked.
Comments are closed.