Corporate tax reform is an evergreen issue in Washington. Most recently, House Ways and Means Committee Chairman Dave Camp has produced a reform proposal that has justly been praised by the tax expert Martin Sullivan as “monumentally important” for its seriousness and workmanship. It is also, as Sullivan, among others, admits, not likely to be enacted anytime soon.
Rather than try to reform the beast, isn’t it time to think about getting rid of the corporate income tax with all of its complexity, enormous compliance costs, and perverse loopholes put in place by business lobbyists who regard tinkering with the tax as their own perpetual ATM machine? Intelligent observers have suggested as much. For example:
- Paul O’Neill, when he was Secretary of the Treasury under George W. Bush, called for scrapping the tax. He took a lot of heat for doing so at the time. To his credit, now that he is out of government he continues to advance the idea along with a progressive consumption tax on the individual level (in itself a good idea).
- Lefty writer Matthew Yglesias, for his part, has given up on the possibility of corporate tax reform and advocates something “bigger and tougher:” abolition.
- Economist Laurence Kotlikoff of Boston University believes that the there is a “worker based,” pro-jobs case for eliminating the corporate income tax, particularly for “young and future workers.”
- Another commentator, Mark Levey, writing at the beginning of President Obama’s first term, somewhat optimistically hoped the new President would press for cutting the corporate tax rate to 0% as the “quickest way” to bolster the credit markets and “get money into the economy for true job creation.”
If getting rid of the corporate income tax seems hopeless, consider that in some ways it is already happening. As ABC Chairman Al West testified before the Center for Strategic and International Studies’ Strengthening of America Commission two years ago, there has been an “explosion” of firms organizing themselves as Subchapter S corporations or as partnerships.
These “pass-through” entities avoid the corporate tax entirely and their growth in number therefore erodes the corporate tax base. Nor are they all small businesses. More than 14,000 Subchapter S corporations have revenues of more than $50 million. We are thus, West noted, “in the position of having businesses of similar size selling similar products and services, yet facing different tax obligations based solely on the way they are organized.”
Ignoring, for a moment, the political difficulties, how would one eliminate the corporate tax while insuring that the wealthy do not subsequently use corporations as tax shelters?
One possible approach draws on Canada’s Gordon Commission from back in the 1960s. It involves what might be called an extreme integration of the corporate and personal taxes. Each year shareholders would get a report (like a 1099) that would say, in effect, “we paid you X in dividends and paid Z in corporate taxes on that portion of profits. Add X+Z to your taxable income and take Z as a tax credit. We also reinvested A in the corporation and paid B corporate tax on that part of profits. Add A+B to your taxable income and take a tax credit of B. Also raise your cost basis in the stock by A for the purpose of capital gains taxes.”
That approach effectively does away with the corporate tax. However, there are complications. How do you deal with sales of stock during the year? How do you deal with different classes of shares – preferred, voting, nonvoting, etc.? The first problem could be dealt with using year-end records. Presumably the market would recognize that stocks purchased during the year came carrying a tax credit. The latter problem could be dealt with arbitrarily.
This proposal was deemed far too radical for conservative Canadians. But it has a certain intellectual purity. The equivalent of a 1099 for shareholders would not be that complicated. As for keeping track of adjustments in cost basis for stock held for a long time, presumably this would be done through brokerage accounts (the vast majority of shareholders own stock through brokerage accounts).
Another approach could be drawn from the world of non-profits. Foundations pay a tax based on failure to payout a percentage of principal every year. There are clear formulas and all foundations try to avoid paying taxes by meeting the disbursement requirements, which is the objective of the tax after all.
The same concept could be applied to corporations and undistributed profits. It could be based on a percentage of profits which would be easy to do as GAAP are clear and disbursements would be easily audited. The percentage to be paid out could begin by simply adopting the existing tax rate structure. It could be changed annually by reviewing tax revenues generated.
Actually most individual taxpayers that would receive these dividends would be in a higher tax bracket than the corporations and if the government so chose it could make this class of distributions taxed at a higher rate than ordinary income, capital gains or dividends. There could be thresholds of exemptions and accelerating rates based on levels of income. “This,” one ABC member has written,” could be a no-brainer benefiting corporations and giving the government the opportunity to generate even more tax revenue. The money that corporations would save by not having to file tax returns would be substantial as would domestic business expansions and job creation.”
Of course if neither of these ideas, or anything similar, is likely to be put on the political table, if only for discussion. That’s because, on tax policy, the power centers in Washington, while ostensibly in intellectual opposition to one another, almost always converge to enshrine the status quo, which is what they know best. The problem is, in the current competitive world, the status quo is a recipe for decline.