No cause is dearer to Washington than corporate income tax reform. The president is for it. The Republican House leadership is for it. Max Baucus, Democratic chairman of the relevant Senate committee is for it. (And boy, oh boy, is he for it. A New York Times article over the weekend revealed that no fewer than 28 former Baucus staffers are currently lobbying on tax issues.)
The very size and success of the K Street tax lobby suggests that something much bigger than mere reform is required. Closing loopholes while lowering rates would still leave the basic structure in place, with well-connected companies ferociously lobbying for their tax breaks. We need something much bigger and tougher that corporate income tax reform: an alternative source of revenue that will let us do away with the corporate income tax entirely.
Loophole lobbying succeeds because behind every tax break lies not just a corporate fat cat but an array of middle-class workers and customers. Take something seemingly absurd such as the tax breaks for corporate jets that the White House likes to lambaste. This turns out to be nothing more than a decision to allow jets to be depreciated on the same five-year schedule as bulldozers, computers, and other business equipment rather than the seven-year schedule used for regular commercial planes. It’s a way of encouraging firms to plow their earnings into capital goods—airplanes—that support American manufacturing firms and well-paying skilled jobs. Just ask the Machinists’ Union that represents workers in the aerospace industry and they’ll tell you Obama’s got this one wrong.
The issue is that, in the immortal words of Mitt Romney, “corporations are people.” To be more specific, what economists call the “incidence” of corporate taxes ultimately falls on people—executives, shareholders, rank-and-file workers, customers, or someone else.
Who ultimately pays those corporate income taxes? This is a fascinating question in the economics literature, and a bit of a black box, with nobody quite sure who’s paying or why.
The one thing that’s really clear about the current corporate income tax is that there’s a huge divergence between theory and practice. In theory, profits are taxed at a 35 percent rate. In practice, many companies pay much less than that. General Electric, famously, managed to pay no income tax whatsoever in 2010. The murky incidence of corporate taxation means GE’s lobbyists can push to preserve its tax breaks in good conscience. But firms that do pay high taxes can plausibly argue that the current system is unfair and we drastically need rate cuts in good conscience. Meanwhile, other companies such as Apple manage to pay a high rate while also squirreling away untold billions in untaxed allegedly offshore accounts.
Looking at any one of these corporate tax avoidance strategies suggests particular solutions: If you’re bothered about companies like GE, scrap various tax breaks. If you’re worried about companies paying high rates, lower the rate. If you’re annoyed about Apple, go after foreign accounts. But looking at them all simultaneously suggests an alternative to reform. Just give up. Though the corporate income tax as presently constructed supports a small army of accountants, tax lawyers, lobbyists, and CNBC talking heads, it doesn’t raise very much revenue. The 1-2 percent of GDP it brings in to the federal government is too much to do without but hardly too much to raise through other means.
Rather than trying to mend the tax, we ought to end it and replace it with something else. My preference would be to structure its replacement to ensure that the costs are born by rich executives and wealthy shareholders rather than middle-class workers. That suggests curbing the current tax preference for dividend income over labor income. That way corporate profits that are paid out to firm owners would end up being taxed about as much as they are today, but profits reinvested in hiring new workers and expanded capacity wouldn’t be. Or if the concern is that too much of the benefits of a corporate income tax cut would accrue to highly paid executives, we could raise the payroll tax cap so highly compensated workers would pay more. A conservative might prefer to replace the corporate income tax with cuts to Medicaid or the EITC to make low-income families pay. The whole range of options is worth debating. But the goal should be to replace the mystery meat of the corporate income tax with a clear target. Pick who or what we want to tax, and tax it deliberately.