Cutting the Corporate Tax Would Make Other Problems Grow

http://www.nytimes.com/2014/08/26/upshot/cutting-the-corporate-tax-would-grow-other-problems.html?rref=upshot&abt=0002&abg=1

Jared Bernstein
AUG. 25, 2014

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But as imperfect as the corporate tax may be, the end of it would create all kinds of problems and disadvantages. Here is a breakdown of those drawbacks:

The corporate tax is an important balancing mechanism in an era of great inequality. According to the Congressional Budget Office, about 80 percent of corporate income is held by households in the top fifth of the income scale, and about 50 percent is held by the top 1 percent. Unless we could replace it with higher taxes on those same households — a daunting proposition, as I’ll show in a moment — scrapping or even just lowering the corporate tax rate would increase after-tax income inequality.

When corporate profits as a share of national income are the highest on record, with data going back to the late 1920s, it suggests that the current corporate tax system, with all its shortcomings, is hardly killing the competitiveness of American companies.

Another reason abolishment is a bad idea: If you think we’ve got tax avoidance problems now — and if you don’t, you’re not paying attention — we’d have a much bigger problem with a zero tax rate on incorporated businesses. Most of us don’t manage our taxes. We just pay them. But as your tax bill goes up, you will aggressively look for ways to shelter your income. (More precisely, you hire people to do that for you.)

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Here’s another element to understand why abolishing the corporate rate would go badly: In order to avoid corporate taxes, more than a third of business income is now “passed through” to the owners to be taxed at the individual level. That’s up from 13 percent a few decades ago, and it’s one reason corporate taxes as a share of G.D.P. and a share of federal revenue have fallen from about 4 percent and 20 percent in the 1960s to less than 2 percent and 10 percent today.

Those who would get rid of the corporate tax basically argue that the smart move is to go with this flow: As long as so many more businesses are setting themselves up to avoid the corporate tax, don’t fight ′em, join ′em.

The problem is that to do so risks turning the corporate structure itself into a big tax shelter: If income generated and retained by incorporated businesses should become tax-free, then guess what type of income everybody will suddenly start making? Taxes delayed are taxes saved, and with no corporate tax, anyone who could do so would structure their earnings and investments to be “corporate earnings,” untaxed until they’re distributed.

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One study found that the tax gap — the share of taxes owed but not collected — was 17 percent for corporations and 43 percent for business income reported by individuals. That research is over a decade old, but more recent tax gap research found that business income taxed at the individual level was the single largest source of the gap, and that sole proprietors report less than half of their income to the I.R.S.

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