If tax dodging were an Olympic sport, corporate America would be a front-runner for the gold. The latest reminder comes thanks to the furor in Washington over “inversions,” tricky maneuvers whereby U.S. companies reincorporate themselves overseas and flee the IRS by merging with a smaller foreign business. These deals aren’t new, but their pace has picked up—at the moment, the pharmacy chain Walgreens is considering making itself a Swiss citizen for tax purposes, and Mylan pharmaceuticals moved to change its corporate tax address from Pennsylvania to the Netherlands, inspiring a memorable Jon Stewart rant.
The whole issue has President Obama railing against “corporate deserters” while in the Washington Post, Treasury Secretary Jack Lew has demanded that Congress close the tax loopholes that make inversions possible. Of course, that’s exactly what the government tried to do in 2004, when President Bush signed a bill meant to clamp down on the rash of inversion deals that began during the 1990s. Obviously, the job wasn’t finished.
To borrow a phrase from radio legend John Peel, the debate over corporate taxes in the U.S. is always different, always the same. It’s always different because lawyers and accounting firms are paid handsomely to come up with new and novel ways to skirt the IRS. (Apple is particularly creative in this regard.) It’s always the same because lawmakers keep struggling over a single fundamental problem. It’s not that the U.S. has the highest official corporate tax rates in the developed world—that fact may not help matters, but we’re not the only nation that struggles with tax avoidance. The problem is rather that the corporate income tax is a product of the early 20th century, a time before globalization and before havens, such as Ireland and the Cayman Islands, made it relatively easy for companies to minimize their government tab. Fixing that will require international cooperation that may well never materialize.
If enforcement is such a hopeless cat-and-mouse game, why do we keep the corporate income tax around at all? The obvious answer: It still makes up about 10 percent of federal revenue. But theoretically, at least, it should be possible to get at that money in other ways. After all, corporations are (made of) people, and their profits are eventually handed out to their shareholders. That’s why corporate tax critics such as Bloomberg View’s Megan McArdle argue that the government should stop collecting from the companies and just “take the money from the people.”
Killing corporate taxation and collecting from investors instead sounds like an elegant fix. Eduardo Saverin aside, America’s rich aren’t all that likely to give up their citizenship to save on capital gains. But making the switch would be far from simple because the main justification for the corporate tax is, in fact, to prevent personal income tax avoidance. As economist Gabriel Zucman of the London School of Economics puts it, the corporate tax is “fundamentally a backstop.” Without it, investors could simply pile up their money in stocks and let it sit there, gaining value without the government ever touching it. Just imagine if the Koch brothers knew that their wealth wouldn’t be taxed if it could marinate in a company bank account. And sure, some profits would be taxed as dividends. But that would simply incentivize corporations to find other tax-free ways to reward shareholders, like stock buybacks.
Preventing that sort of hoarding would require all sorts of other policy steps. Earlier this year, Eric Toder of the Tax Policy Center and Alan Viard of the American Enterprise Institute released a long paper outlining how it might be done. The key would be to change the way the government treats taxes on capital gains, which are generally collected when investors sell their assets and book a profit. If we wanted to prevent the rich from hoarding their wealth as untaxed corporate equity, the government could instead tax gains in real time as the value of their shares rose year to year, regardless of whether or not they sold them. If your stock portfolio jumped 10 percent in a year and you didn’t unload a penny of it, you’d still owe the IRS on that 10 percent. This is called “accrual” or “mark-to-market” taxation, and it would only work for companies with publicly traded shares, since their value can be easily judged. If we killed the corporate income tax, privately held companies—Koch Enterprises, for example—would need to be taxed the same way as partnerships such as law firms and other small companies, whose profits are distributed to the owners and treated as personal income.
Those edits to the tax code could keep the rich from stowing away their money in stocks. But there would be other concerns to consider. We would probably have to start taxing endowments at nonprofits. Plus, we’d lose the ability to use the corporate tax code as a policy tool by giving companies subsidies for investment or hiring. States would likely have to abandon their own corporate taxes, since companies wouldn’t be calculating them for the feds anymore, making the logistics far harder. And more likely than not, we wouldn’t be able to tax shares held by foreign citizens, who I imagine would pile into the U.S. stock market pretty quickly as a result.
Then there’s the biggest downside. Simply changing the way we treat capital gains still wouldn’t cover the cost of ending the corporate tax. Viard and Toder estimate that Washington could end up $168 billion short per year—a tax cut that would largely go to the rich. One solution might be to raise rates on capital gains or personal income. Another would be to swap part of the corporate income tax for something a like a carbon tax. But making the math work would be tricky and require big trade-offs.
If that math can’t work, then taxing investors instead of corporations might have too many disadvantages to be anything more than an intellectual exercise. It certainly isn’t an easy solution. But leaving out the possibility of a massive international accord to stop companies from taking advantage of the world’s competing tax laws, it seems like an interesting idea to make sure the government keeps getting its fair share of business profits without encouraging companies to deport themselves. Instead of fighting tax havens, America could consider joining them.
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