Ed Dolan's Econ Blog

The Progressive Case for Abolishing the Corporate Income Tax

Reform of the corporate income tax is shaping up to be one of the big issues facing Congress in 2017. Republicans are pushing for big cuts in the corporate tax rate. Most observers seem to assume that conservatives and progressives will be at swords points over those cuts, but they should not be. There is a strong progressive case for sharply lowering the corporate income tax, or better still, abolishing it altogether.

On the Republican side, President Elect Donald Trump has proposed lowering the top corporate tax rate from its current 35 percent to 15 percent while eliminating most loopholes. House Republicans have proposed a 20 percent top rate, also eliminating some important deductions and preferences.

In the Senate, many Democrats, who retain the power to filibuster tax reform legislation, are digging in their heels against the corporate cuts. Progressive superstar Senator Elizabeth Warren of Massachusetts  is leading the fight. In a recent New York Times op-ed, she wrote, “Congress should increase the share of government revenue generated from taxes on big corporations—permanently.” She points out that in the 1950s, the corporate tax accounted for more than 30 percent of all federal revenue, compared to less than 10 percent today (see chart).


She is wrong. Progressives should stop trying to recreate the glory days of the corporate tax. Instead, they should join forces with conservatives to implement a comprehensive tax reform program that includes deep cuts in the corporate tax, or even its entire elimination. Here are three reasons why.

The corporate tax is not a tax on corporations

The name itself is one reason progressives like the corporate tax, but it is not really a tax on corporations. Although corporations as such bear the legal obligation to comply with the tax, they do not, and cannot bear the economic burden because they are not real people. That is a point progressives are quick to agree with in other contexts, such as campaign contributions and corporate free speech. The organization Reclaim Democracy, dedicated to “restoring citizen authority over corporations,” puts it bluntly: “We believe that corporations are not persons and possess only the privileges we willfully grant them.”

True, corporations as legal entities have been  granted the right to enter into contracts and the obligation to make tax payments to the Treasury. Legal forms aside, however, the economic burden of the tax (the incidence of the tax, as economists put it) must ultimately fall on corporate stakeholders, principally shareholders and workers.

Allocating the economic burden of the corporate income tax has proven to be a difficult and controversial exercise, as a report available from the Urban Institute and Brookings Tax Policy Center details. Economists trying to quantify the distribution of the tax burden among stakeholders face not only the usual difficulties of finding the right data set and specifying the right econometric model, but other problems, too.

One factor that complicates the analysis is the degree to which an economy is open to trade and capital flows. The earliest estimates of corporate tax incidence for the US economy, which were  conducted  in the early 1960s, at the dawn of the era of globalization, concluded that the tax burden rested almost entirely on shareholders. As the economy became more  open to trade and financial flows, however, that changed. Capital is much more mobile internationally than labor. If one country imposes a high corporate tax rate while others have lower rates, investors move their capital to low-tax jurisdictions. That means less investment per worker, and therefore lower wages, in the high tax countries. The downward pressure on wages shifts part of the burden of the tax to workers. That effect is especially relevant to the United States, which has the highest statutory corporate tax rate of any major economy.

Estimates of just how much of the tax burden is shifted to workers vary widely. Influential studies cited in the report from the Tax Policy Center conclude that workers bear 70 percent or more of the burden. At the other end of the scale, the Tax Justice Network, in a report titled “Ten Reasons to Defend the Corporate Tax,” points to research suggesting a smaller burden on workers. A footnote in the report approvingly cites work by the Congressional Budget Office, which uses 25 percent for its estimate of the labor share.

The degree to which the corporate tax is shifted to workers also depends on the time horizon. Because changes in the global pattern of investment happen only slowly, in the short run, an increase in the corporate tax rate is likely to be absorbed almost entirely by shareholders. However, any shift of the burden to workers, via outflows in capital, persists once it becomes established.

The lag is important because, while economists tend to focus on the long run, politicians, with their eye on the next election, and corporate leaders, with their eye on their next quarterly report to shareholders, tend to focus on the short run. For example, the report from the Tax Justice Foundation notes that corporate executives typically behave as if tax burdens fall on shareholders. “Would they spend so much time and energy finding clever ways to dodge tax,” the report asks, “if they believed that taxes didn’t fall ultimately on their shareholders, to whom they are accountable?” The time lag in tax incidence answers the question. Even if the burden of the corporate tax were shifted entirely to workers in the long run, executives would resist the short-run effects of any corporate tax increase.

The fact that a significant part of the burden of the corporate tax is born by workers should give pause to the progressive supporters of that tax, even though no one can be certain exactly what its incidence is. Supporters can, of course, hope that the true incidence on workers is near the low end of the range of estimates. They can spin the research and cherry pick their citations to support their hopes, as the Tax Justice Foundation report does, but simply ignoring research whose conclusions you don’t like doesn’t guarantee the validity of the research you do like.

Instead of playing econometric Russian roulette with estimates of corporate tax incidence, then, shouldn’t progressives look for a better tax—one for which the burden is more certain actually to be borne by the corporate shareholders they want to pay it? Fortunately, there is just such a tax.

The right way to tax shareholders if you really want to

As background to explaining the better way to tax corporate profits, we need to understand the issue of double taxation. Double taxation occurs when corporate profits are taxed once when earned by the company itself, and again, as individual income, when they are paid out as dividends or realized as capital gains. The US tax code as it stands now imposes a high rate of tax at the corporate level, and then mitigates the double taxation by taxing the dividend and capital gains income of individual shareholders at preferential rates, about half that charged on other income.

In contrast, other advanced countries not only tax corporate profits at a lower total rate, but also collect less tax at the corporate level and more at the individual level. For the United States to match their lower corporate rates would sharply decrease incentives for outflows of investment, even if the lost revenue were recouped by raising individual income taxes on dividends and capital gains. That would,  in turn, reduce the incidence of the tax on labor.

In addition to bringing jobs back by slowing investment outflows, cutting corporate taxes while taxing investment income at the ordinary individual rate would have another effect—that of increasing the progressivity of the tax system as a whole.

Some progressives just don’t seem to get this. As one of its ten reasons to love the corporate tax, Tax Justice Network argues that “the corporate income tax is one of the most progressive taxes a state can levy,” and that “the corporate tax curbs inequality and protects democracy.” They base that conclusion on the fact that corporations are predominantly owned by the well off—in the United States, the wealthiest ten percent of people in the country own an estimated 90 percent of corporate stock and the top 1 percent own over half. But focusing on the distribution of ownership misses the point.

Yes, it is true that cutting the corporate tax in isolation would make the tax system less progressive, but that is not what serious reformers want. Most of them, instead, advocate a package that cuts or even eliminates the corporate tax but taxes dividends and capital gains at the same rate as other individual income in order to achieve at least approximate revenue neutrality.

Taxing profits more highly at the individual, and less highly at the corporate level would unambiguously increase tax progressivity. That is true, first, because such a reform would reduce the share of the corporate tax that is shifted to labor, and second, because stock ownership is so highly concentrated at the top of the income distribution.

One of the Tax Justice Foundation’s ten reasons to love the corporate tax does reflect a legitimate concern, however. Unless reform is  done right, it could open the door to a new kind of tax shelter:

If the corporate rate is zero or very low, then people—and here we are talking mostly about wealthy individuals—could leave their earnings inside the corporation and defer paying personal income tax on them indefinitely until the corporation pays them a dividend at a date of their choosing, or perhaps never. Those corporate profits will not be effectively taxed over that period.

A plan jointly advanced by Eric Toder of the liberal-leaning Urban Institute and Alan Viard of the more conservative American Enterprise Institute addresses the tax shelter problem directly. Toder and Viard propose that any reduction of the corporate tax be offset  by an “accrual” or “mark-to-market” tax, at the full ordinary rate, on shareholder income. Mark-to-market income would be calculated as the sum of dividends and net accrued capital gains, that is, the change in the market value of shares during the year. Gains and losses would be smoothed to reflect share price volatility by allowing deductions for losses in one year to offset profits in a  previous  year. In that way, shareholders would pay tax on the earnings of the corporations they own whether or not they were paid out  as dividends, and whether or not they sold the stock and realized their capital gains.

Corporate tax reform, even if revenue neutral, would spur growth

Conservatives regularly claim that cutting corporate taxes would spur growth, but progressives tend to be skeptical. In part, that is because the conservative argument too often invokes  a trickledown effect. The claim is that giving corporations more after-tax profit will spur them to invest and create new jobs. Even if they do not invest, and just pay out the profits as bonuses and dividends, more spending by the rich will create jobs indirectly. When the case for corporate tax cuts is framed that way, I am skeptical, too.

But the argument for the type of reform discussed in the previous section in no way depends on a trickledown effect. It would increase after-tax income of corporations but, under the mark-to-market principle, it would increase taxable personal income of shareholders by the same amount. It would be revenue neutral, or nearly so.

But even a revenue neutral reduction in corporate taxes would have a beneficial effect on growth because, as things stand now, the total economic burden of the corporate tax substantially exceeds the revenue it raises. Economists call that the excess burden of the tax.

Progressives often underestimate the true economic burden of the corporate tax by pointing to the many firms that pay little if anything, despite high profits and the high statutory tax rate. The Tax Justice Network report includes a long list of corporations, including General Electric, Verizon, Boeing, and others, that pay no taxes at all. What they gloss over, though, is the fact that the tax avoidance strategies these corporations use are far from costless.

Consider a hypothetical example. Suppose that if your corporation paid taxes at the full statutory rate, it would owe $35 million in tax on $100 million in profit, for a net income of $65 million after tax. By changing your product line, moving your corporate headquarters, and using more tax-deductible debt instead of equity financing, suppose you can cut your taxes to $10 million. Unfortunately, taking those measures incurs administrative costs of $12 million and cuts your revenue by $8 million. You end up with after tax income of just $70 million, even though the government only gets $10 million in revenue.

Yes, that’s still worthwhile in the sense that you are $5 million better off than if you had just paid your taxes. But what is the accurate measure of the burden that the US corporate tax system places on your company? Is it the $10 million, or 5 percent, that you pay on your remaining $80 million in before-tax profits, or is it 30 percent—the bite that $10 million in taxes plus $20 million in tax avoidance costs takes out of your original $100 million? Obviously, it is the latter.

We can’t be sure what corporations would do if they could cut back on the administrative resources and executive energy they now waste on costly and unproductive tax avoidance strategies. They might expand, they might pass cost savings along to consumers through lower prices, they might bring jobs back home that they had previously sent offshore for tax reasons, or they might just pay higher dividends, thereby increasing tax revenue under a regime in which dividends were fully  taxed. But why would progressives not welcome any one of those outcomes?

The bottom line

To sum it all up, it is time for progressives to end their love affair with the corporate income tax. That tax is not well  targeted at corporate shareholders. Too much of its burden spills over onto workers—even the lowest estimates of the labor share are too high, since there is a better alternative. The alternative is to eliminate the corporate tax altogether and tax shareholder income, measured on a mark-to-market basis, at the full individual rate. On top of that, in addition to being  poorly targeted, the corporate tax undermines economic growth by encouraging wasteful tax avoidance strategies.

To be sure, none of this means that progressives should simply sign off on GOP reform plans, either the House version or Trump’s own. Both of those plans cut the top corporate rate while retaining preferential treatment of dividends and capital gains earned by shareholders. As a result, despite various other tweaks to deductions and preferences, both of the GOP plans result in net reductions in total revenue: $1.7 trillion over 10 years for the House plan and $2.6 trillion for the Trump plan.

Those prospective revenue losses in the Trump and House plans should give Senate Democrats some bargaining power, since Senate Majority Leader Mitch McConnell , along with some other Senate conservatives, has repeatedly expressed the view that tax reform should be revenue neutral. A bipartisan compromise could achieve revenue neutrality while sharply cutting the top rate for the corporate tax as long as it also reduced or eliminated the preferential rate on dividends and capital gains. Moving toward mark-to-market treatment of corporate profits would also increase revenue while cutting tax rates at the corporate level.

Given the diversity of political views and the complexity of procedural rules, there is no guarantee that of any bipartisan consensus on tax reform in the immediate future. However, the balance of power in the Whitehouse and Congress that will prevail in 2017 will not last forever. Even if immediate compromise turns out to be impossible, progressives should begin to rethink the kind of tax system they would like to see when and if they are able to enact a plan of their own. In my view, the ideal toward which they aim should include complete elimination of the corporate tax while recouping the lost revenue through full mark-to-market taxation of corporate profits paid to, or accruing to, individual shareholders.

A shorter version of this post was previously published by The Milken Institute Review









38 Responses to “The Progressive Case for Abolishing the Corporate Income Tax”

BlissexJanuary 17th, 2017 at 7:49 pm

Tax systems are designed not just on the basis of incidence or optimality, they are also and mainly designed to be hard (or in some cases easy…) to game. Part of this is to have a range of smaller taxes rather than a few big taxes, and taxing income at various stages rather than just at the end, as in “tax shareholder income”, so as to spread a wide net.

In practice corporation tax was designed to make less profitable to do a wide range of schemes based on laundering personal income through corporations. Of course other schemes have been designed to pay less tax, such as laundering personal income as capital gains, but that’s one of the things that is made harder by corporate taxation.

Tax system policy cannot be simply reduced to economic policy…

Ed Dolan EdDolanJanuary 18th, 2017 at 7:07 am

Suppose shareholder X buys ABC Corp. stock at $100 a share. ABC then earns a profit of $10 per share which it retains as cash. Value of stock goes up to $100 per share if there is no corp tax. Shareholder x sells the stock at $10, pays $3 tax at an assumed 30 percent personal income tax rate, has $7 in after tax income. Now introduce a 30 percent corporate income tax. ABC earns $10, pays $3 in tax, retains the $7 as cash, stock price goes up to $107. X sells his stock with a capital gain of $7 per share, on which he pays $2.10 in personal tax. Total tax paid on the $10 profit is now $5.10. Sure looks like double taxation to me.

To be sure, my example is oversimplified, in that changes in stock prices reflect more than past earnings. Expectations of future earnings also count, and sometimes tax laws or accounting conventions mean that profits and losses as measured by economists differ from those perceived by financial markets. Still, as long as stock prices on average, over the long run, reflect corporate profits, taxing them at the shareholder level should be effective as a matter of public policy.

Ed Dolan EdDolanJanuary 18th, 2017 at 7:12 am

You make a valid point in saying that tax policy cannot be entirely reduced to economics, and that ease of collection matters. However, the US corporate tax has been uniquely easy to game. As the chart in the post shows, actual revenues have fallen steadily (in relation to other tax sources) despite, or in part because, of the fact that the US has among the world's highest marginal rates. Part of the problem is that corporations, as fictive persons, are more mobile internationally than real persons. Part of the problem is that corporations are rich and have extremely effective lobbyists. In sum, although I take your point, I still think the corporate tax has outlived its usefulness

Gerald ScorseJanuary 17th, 2017 at 8:43 pm

"Double taxation occurs when corporate profits are taxed once when earned by the company itself, and again, as individual income, when they are paid out as dividends or realized as capital gains."

I agree with the main thrust of this piece (there's definitely a progressive case for abolishing corporate taxes), but I take strong issue with calling taxes on capital gains double taxation of corporate profits. IMHO, the tax on capital gains is a tax on one thing only: the difference between the basis price and the selling price of whatever it is that's being sold. Of the various arguments for preferential rates on capital gains, this strikes me as one of the lamest.

One further thought on capital gains (and dividends too): there's no good reason for income from wealth to be taxed at a lower rate than income from work. That basic tax disparity is in fact the single biggest reason for income inequality.

Gerald ScorseJanuary 18th, 2017 at 9:46 am

One other comment re "double taxation". It's only an issue when it involves capital income, i.e., dividends and capital gains. For transparent, unequivocal double taxation, nothing beats sales taxes. Ah, but those fall on labor income; no problems with double taxation on labor income, right? We really do have a rigged system, and there's little question in whose favor it's rigged.

windrivenJanuary 18th, 2017 at 11:21 am

In principle this is a fine sounding idea. But the devil lurks in the details. Mark-to-market schemes are difficult to administer and have the same potential to be gamed as other tax programs.

I have become entirely convinced that tax reform has evolved into nothing more than a shell game to distract the rubes while protecting the interests of the top decile.

So while the economics make sense, the politics probably won't.

ShayreJanuary 20th, 2017 at 6:13 pm

Ed,__Would the zero-tax rate also be applicable to U.S. subsidiaries of Japanese and E.U. multinationals? Or, would the zero tax rate only apply to corporations that are, one way or another, significantly owned by Americans?__Would foreign corporations be able to somehow manipulate this tax policy?

Ed Dolan EdDolanJanuary 20th, 2017 at 7:55 pm

The US owners of shares in foreign corporations would be taxed, as would US owners of foreign corporations.. The foreign owners of US corporations and foreign owners of foreign corporations would not be taxed by the US. If corporate rates were the same in all countries and the corporation tax were borne entirely by shareholders it would not make much difference. As it is, getting rid of the corporate tax and taxing US shareholders of all corporations fully regardless of their legal residence makes us come out ahead, as far as I can see. Individuals might be able to manipulate the tax by changing their citizenship, but it is not that easy to do under US rules. Not many people want to spend their lives in Qatar just to have lower taxes.

Jim StoneJanuary 28th, 2017 at 2:56 pm

Thank you, Ed!

I've been telling my progressive friends this for years. Robert Reich, in Supercapitalism explained that corporations spread the cost of taxes to three groups: workers, consumers, and shareholders. They do all they can to avoid passing it on to shareholders. So they try to pass it on to consumers and workers. Since the average worker and consumer is poorer than the average shareholder, corporate income taxes can often wind up being regressive.

The strange thing is that lately I see Reich defending higher corporate taxes. I'd like to hear his thinking on this. Is he just being a pragmatist about going where the money is? Or has he changed his thinking about this? Don't know.

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