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How Corporate Income Taxation is Misunderstood

Summary:
By Richard McKenzie "Don't tax me, don't tax thee, tax the man behind the tree!"~ The late U.S. Senator Russell Long (D-LA) Republicans are being excoriated by pundits, journalists and Democrats for proposing to lower the corporate income tax rate from 35 percent to 20 percent. The critics claim the reduction is an unjust and extravagant tax break for President Donald Trump and his rich business compatriots. The reduction will transfer the country's tax burden onto the backs of the middle-class and lower-income groups, or so we are told. The critics, however, don't appreciate two major problems with corporate taxes: First, the critics fail to grasp the wisdom in a widely repeated tenet of public

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by Richard McKenzie

"Don't tax me, don't tax thee, tax the man behind the tree!"
~ The late U.S. Senator Russell Long (D-LA)

How Corporate Income Taxation is Misunderstood Republicans are being excoriated by pundits, journalists and Democrats for proposing to lower the corporate income tax rate from 35 percent to 20 percent. The critics claim the reduction is an unjust and extravagant tax break for President Donald Trump and his rich business compatriots. The reduction will transfer the country's tax burden onto the backs of the middle-class and lower-income groups, or so we are told.

The critics, however, don't appreciate two major problems with corporate taxes:

First, the critics fail to grasp the wisdom in a widely repeated tenet of public finance economics: Corporations don't pay taxes, people do. This is to say that while corporate taxes are directly drawn from corporate profits, those taxes must ultimately come out of the pockets of real people - and the real people affected are not just stockholders whose dividends are undercut by the tax.

These taxes also come partially out of the hides of consumers as corporate managers seek to offset any reduction in after-tax profits (and dividends and share prices) by charging higher prices. More generally, to the extent that corporate taxes reduce companies' after-tax rates of return, investments in their production facilities will be impaired, curbing the supplies of products and further raising market prices. Hence, high corporate taxes can impair American firms' ability to sell abroad and to fend off foreign competition in their domestic markets.

Workers do not get off scot free, either. With curbs in corporate production attributable to the corporate tax, the demand for labor can be tempered, undercutting worker wages and fringe benefits.

How much are the stakeholders - investors, workers, and consumers - affected by corporate income taxation? It's hard to say, because the so-called "incidence" of the corporate tax depends on a multitude of factors, not the least of which are the elasticity (or responsiveness) of supply and demand in capital, labor, and product markets. The incidence of corporate taxation necessarily varies from market to market and even firm to firm.

The corporate tax is, effectively, a means of taxing people hidden "behind trees," which is one of its chief attractions to politicians interested in garnering additional tax revenues for the government. They don't have to admit that the corporate tax is a disguised tax hit on median and low-wage workers and low-income consumers and not on just the rich Trumps, Bill Gates, and Warren Buffets of the world. The exact size of the various hits felt by all income classes are literally unknown and unknowable (although many econometricians feign that their statistical equations reveal truth).

This means that the proposed corporate-tax-rate reduction will likely pad the pockets of the rich by some undiscernible amount, but it will also increase the disposable income of people all the way down at the bottom of the income ladder.

Second, capital - financial and real - and goods and services are now more mobile across national boundaries than ever before. This is because many highly valued modern products - such as the iPhone - are relatively lightweight and can be shipped economically (and in volume and rapidly) by air. Other valuable modern products weigh nothing. Consider the digital nature and economic value of operating systems and the multitude of apps for smartphones and the growing value of "big data." Financial capital and services are also weightless. These products can be shipped globally with a few strokes on a computer and at the cost of a few electrons.

A major and unheralded problem for modern governments is that they are landlocked, while firms and their plants and equipment and job bases can move with growing ease among countries at decreasing cost. The growing mobility of production has, of course, forced companies to compete by finding the most cost and tax-effective venues in the world. Their corporate prosperity, if not survival, depends on their doing so.

Of course, the growth in the mobility of firms, and the greater demands they face to be cost competitive, mean that governments have necessarily been forced to consider in the development of their tax policies the tax rates charged by other countries. Indeed, the most important, powerful, and least touted argument in favor of the Republicans' corporate-tax-rate reduction is that the United States has the highest tax rate in the industrial world, which puts the country and its firms at a distinct competitive disadvantage, domestically and globally.

For example, Ireland has a corporate tax rate of just 20 percent, but which is a third higher than Canada's, at 15 percent. Austria, Demark, and Finland have corporate tax rates of, respectively, 15, 22, and 20 percent. Socialist France has a corporate tax rate just under the United States', at 34.43 percent, but the French government is now proposing to lower the rate to 28 percent. The reason given? Its rate is noncompetitive.

No wonder American firms now have a tax-induced bias toward producing and selling their products abroad, and then holding their profits there as well.

Just as firms must keep their prices competitive with rivals, so do governments have to keep their tax rates competitive vis a vis other governments, now more than ever. It's the nature of the global economy. The reality of the fluidity of capital and goods in the global economy can be, and will be, a hard taskmaster.

Richard McKenzie is the Walter B. Gerken Professor of Enterprise and Society (emeritus) in the Merage School of Business at the University of California, Irvine. He is also co-author, with Dwight Lee, of Quicksilver Capital: How the Rapid Movement of Wealth Has Changed the World.



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