So, paradoxically, raising rates would have the effect of lowering revenues. Alex Brill and Kevin Hassett do a more rigorous analysis and find that revenue is maximized at about a 26 percent federal rate - a full 9 points lower than the current U.S. rate of 35 percent.
The reason is that capital is mobile, and increasingly so. Corporate decision makers have a fiduciary responsibility to maximize shareholder value, which is achieved by maximizing sales (making customers happy, both here and abroad) while minimizing costs, including tax costs. When a company chooses to move operations to, say, Switzerland, it is because there is a better mix of tax costs, social benefits, and business opportunities. America is simply losing on this front, and the tragedy is that it could be changed very quickly by lowering the statutory rate.
While there is a lot of movement to lower corporate rates, many politicians and policy wonks think individual tax rates need to go up. President Obama would raise the top individual rate to (effectively) over 43%, and for left-side think-tanks like Citizens for Tax Justice, the sky's the limit.
Tax Analysts eocnomist Martin Sullivan notes that increasing marginal personal tax rates would increase taxes on many businesses:
Now we can quibble about whether the percentage of passthrough income potentially exposed to higher rates is 45 or 48 or 50 or even 60 percent. (There is no one way to do the calculation.) But the point made by Hassett and Viard in their article stands irrespective of the computational details. Tax increases on high-bracket taxpayers will hurt passthrough businesses because a large share of all passthrough business activity is from businesses owned by those taxpayers. Democrats in and out of the Obama administration should stop trying to deny it. It cheapens the legitimate arguments against extending tax cuts for the wealthy.
So how long would it take businesses that now pay taxes on owner tax returns -- S corporations and partnerships -- to opt into a corporate tax system with a 26% top rate if they face a 43% or higher marginal rate on their 1040s? Slightly longer than it takes to write this sentence.
As mobile as capital is among countries, it is even more mobile within the tax system. Every pass-through entity could move into the corporate tax system tomorrow by filing some token paperwork. If 35% rates are too high for business income, certainly 43% is too -- especially if corporate rates go down to 26%. Given the choice of 26% rates, businesses won't meekly pay a 43% rate. That means advocates of higher personal rates will be greatly disappointed by their revenue take if they ever succeed.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to