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Should we dump the corporate income tax?

March 02, 2012

The current corporation income tax is ugly. It imposes two levels of tax on the same income while creating all sorts of distortions. The TaxProf explores the issue in "Should We Abolish the Corporate Income Tax?"

The post links an argument by Peter Coy in favor of the tax and one by Megan McArdle against it. The Coy argument for the tax:

The strongest argument for the corporate income tax is one that is rarely heard anymore but was widely used at its inception in 1909—namely, that the tax is a brake on excessive corporate power.

That argument is absurd. The multi-trillion dollar federal government dwarfs even the biggest corporations. Mitt Romney's reputed $200 million net worth would fund about 1/2 hour of federal spending. The $500 billion market capitalization of Apple wouldn't pay to run the government for two months. Between the SEC, antitrust, and dozens of other federal and state regulators, there are plenty of brakes on corporate power without the corporation income tax. The unchecked power of the federal government, run by people you wouldn't hire to watch your dog, is much more worrisome.

McArdle is more convincing when she notes:

Rather, I think the thing's horribly inefficient--companies and rich people spend an exorbitant amount of time arranging their affairs to be lower-taxed, rather than more productive. Taxing capital once, when it hits a person, as ordinary income, would in one fell swoop eliminate most of the tax-avoidance activity that goes on in this country. It's also not necessarily as progressive as its proponents think, and well, you can read all my other reasons for disliking it here.

To the extent there is any decent argument for the corporation tax, it's as a backstop to the individual income tax. If you could incorporate your investments, it would give the IRS a compliance nightmare. That's why I think a dividends paid deduction would be the next best thing to abolishing the corporate income tax. It would enable the tax law to get rid of preferential rates for dividends and capital gains, making the individual income tax much simpler. It would eliminate the current bias towards debt over equity in the tax law (you can deduct interest, but not dividends). To the extent corporations are held by tax-exempt entities, the single tax could be collected as a withheld excise on distributions to exempt taxpayers.

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