Support the American Worker: End the Corporate Tax

Yes you read that correctly

For better or for worse, corporations have been instrumental in the economic development of the world. At a time when Americans hardly agree on anything, they remained united in their distrust of corporations. Polling data suggests that almost ⅔ of Americans distrust the Fortune 500. 

 In this blog post, I will first describe the economic effects of corporate taxes and then suggest some alternatives for raising revenue.

Corporate Tax Definition

The corporate tax is a tax on the operating earnings of a corporation, that is Total Revenue minus Cost of Goods Sold (COGS) minus indirect costs.  As of January 10, 2021, the US Corporate tax rate sits at a flat 21%. This does not necessarily mean that all corporations pay exactly 21% of their operating earnings to the US government; corporations can reduce their taxes with deductions. These deductions include insurance premiums, travel expenses, bad debts, interest payments, sales taxes, fuel taxes, and excise taxes, and more.

Issues with the Corporate Tax

The economic effects of this tax are highly distortionary. An OECD analysis found corporate taxes to be the most distortionary form of taxation. This is because corporations can very easily pass the burden of this tax onto the workers and/or move their capital abroad.

Contrary to public perception, the board members of the corporation and shareholders would not be the only people affected by this tax. Most economic evidence suggests that workers most of the burden of the tax. A special report from the Tax Foundation suggests that labor bears “between 50 percent and 100 percent of the burden of the corporate income tax, with 70 percent or higher the most likely outcome.” How is this possible? Economic theory indicates that the least responsive factor of production tends to bear the burden of the tax. So the question then becomes which is more sensitive to changes in taxation: labor or capital?  Intuitively, capital is more sensitive because it is generally easier to move financial assets than workers. Therefore the workers would bear the majority of the burden of the tax. 

Because the burden on workers is so high, eliminating the corporate tax would result in higher wages for workers. One study found:

“when wage taxation is used as the substitute revenue source, eliminating the U.S. corporate income tax, holding other countries’ corporate tax rates fixed, engenders a rapid and sustained 23 to 37 percent higher capital stock, depending on the year in question, with most of the added investment reflecting capital inflows in response to the U.S.’ highly favorable corporate tax climate. Higher capital per worker means higher labor productivity and, thus, higher real wages. Indeed, in the wage-tax simulation, real wages of unskilled workers end up 12 percent higher and those of skilled workers end up 13 percent higher.”

Essentially, eliminating the corporate tax and substituting it with a more personal income tax results in more capital which in turn makes workers more productive and thus raises wages. 

Even by the progressive scorecard of income inequality, the corporate tax fails. While there is evidence corporate tax cuts can result in higher income inequality, One study from the University of Michigan and NBER found that corporate taxes can encourage “idiosyncratic risk” which “dampens or possibly even reverses the effect of corporate taxes on the concentration of higher incomes.” This is because corporate taxes disincentivize the expansion of corporations and lead to riskier non-corporate businesses. This leads to more business failures and thus more people at the bottom of the income distribution. 

Alternatives to the Corporate Income Tax

There are plenty of alternatives to the corporate income tax. First, there is the carbon tax. In standard economic theory, one way to correct for externalities (like pollution) is by leveling a Pigovian tax on the activity. This tax disincentivizes the activity and thereby corrects the behavior to a socially optimal level. There is evidence to suggest that carbon taxes can effectively raise revenue while reducing pollution. A general rule of thumb is: when you tax something, you get less of it. Why tax something good (profit) when you can tax something bad (pollution)? 

The other alternative I will present is a tax on undeveloped land. Before I delve into the argument for a tax on undeveloped land, let’s go back to Econ 101 and talk about factors that determine the amount of deadweight loss (DWL) associated with taxation. Elasticity is a measure of the sensitivity of quantity to price. The more elastic the supply and demand curves, the greater the deadweight loss. Tax on undeveloped land has low deadweight loss because the supply of undeveloped land is relatively inelastic. Unlike the corporate tax, a tax on undeveloped land is a cost-efficient way to collect revenue.

While appearing to only burden the wealthy, the corporate tax is neither progressive nor an efficient way to collect revenue. The government ought to look to alternative sources of tax revenue.