Politics

Authored by Jeff Carlson & Hans Mahncke via Truth Over News,

One of the more important policy issues for markets in the US election may be corporate tax rates. Kamala Harris has said she wants to raise corporate taxes from the current rate of 21% up to a lofty 28%. During her 2020 primary campaign Kamala said she wanted to raise corporate taxes all the way to 35% – and this may still be her real target. By contrast, President Trump has said he wants to cut the corporate tax rate to at least 20% but would prefer to drop the corporate tax rate to 15% if possible.

How much revenue is generated from corporate taxes?

The answer to this question may surprise some people. In 2023 the federal government collected just under $420 billion in corporate taxes. This compares to the approximately $2.18 trillion in individual taxes and $1.6 trillion in payroll taxes. The amount paid in corporate taxes is not as large as many intuitively expect – a little more than double the total amount of aid that we’ve allocated to the Ukraine war. 

Corporate tax revenue has actually been declining on a percentage basis for decades. The reasons for the decline have everything to do with incentives and competition – incentives for businesses to invest, locate and produce in the United States and competitiveness of American companies in a global environment. And it’s all intrinsically tied into economic activity, productivity, wages and employment. We as a nation have stymied business activity through a combination of high taxes and excessive regulations.

Who actually pays corporate taxes? Hint: it isn’t the corporations.

Corporations are actually just tax collectors – legal entities that serve to collect taxes on behalf of the corporation’s owners. The true taxpayers are primarily the company’s shareholders – and to some degree, labor and customers – not the corporations that Kamala tries to vilify. When Kamala says she’s going to raise taxes on corporations, what she’s really saying is she’s going to raise taxes on you and me.

As our system stands now, shareholders’ dividends and capital gains are reduced by taxes collected by the corporation. Dividends are profits that a corporation distributes amongst its shareholders. Capital gains come from an increase in the value of a corporation’s assets. If the corporation did not pay corporate taxes on “behalf” of the shareholder these extra dollars would flow through to shareholders in the form of increased profits and dividends, reinvestment in the business (which generates additional profits) and share repurchases. These increased cash flows to shareholders would then be taxed at the shareholder level.

If this argument is not sitting well, consider this example. A corporation could, in theory, give year-end bonuses to its workers such that the amount exactly equaled the corporation’s taxable income. After the payment to workers, the corporation would have zero taxable income. Because the corporation would record no profits in this case, shareholders would pay no tax as they too would receive no profits. But workers would now have a significantly increased tax bill – and in all likelihood be taxed at a higher overall rate than the corporation would have been. The corporation merely serves as the vehicle or conduit – the legal structure – for tax payments.

What about customers and labor – don’t they shoulder much of the corporate tax bill through higher prices for goods or lower wages? 

As it turns out, there is some material debate about these two groups. In a normalized market environment, customers probably don’t pay much in corporate tax as it is very hard to pass this cost through. The ultimate price of the corporation’s end product or service is determined by market forces – not tax rates. And corporations have many differing competitors – including sole proprietorships and foreign corporations with differing tax structures. Market competition determines the final selling price – not taxes.

The amount of corporate taxation that labor bears is less clear – the arguments center around the availability and flexibility of capital – the ability to shift production to lower cost areas, etc. The Tax Policy Center has concluded – fairly close to Treasury estimates – that labor bears about 25% of the corporate tax burden. Some estimates have labor bearing as much as 70% of the cost.

In our opinion, the amount of corporate taxes that are borne by labor is probably north of the 25% figure – but likely well shy of the 70% estimates. The reason for this lies primarily in the mobility of capital. Money is far more fungible and easily moved than labor. If returns are higher abroad due to lower foreign tax rates, investors will quickly move capital to those places. Labor has a more difficult time taking advantage of higher wages elsewhere.

When corporations are burdened with a higher tax rate, their return on capital falls, making them less attractive for investment. In order to attract capital, companies are forced to reduce costs in an attempt to boost returns. And, in general, labor is the largest cost component for most corporations, making it a prime target for cost cutting. The accelerating shift towards the use of AI may lead to an even greater amount of the tax burden being shouldered by labor.

Think of it in simple terms. If corporations were hit with a tax hike tomorrow, which group could more quickly adjust. Investors who could quickly sell and redeploy their capital overseas – or labor with their families and homes? The matter becomes a bit more complicated in real terms because if such a tax was enacted, share prices would be impacted immediately, but hopefully you get our point.

So the answer to who really pays corporate taxes appears to be primarily shareholders with labor sharing in some material percentage of the cost. What should be clear is that corporations do not truly pay taxes – they merely collect them on behalf of third parties for payment.

Why are tax rates different at the corporate level versus the shareholder level?

At the heart of the matter, the tax rate is lower for capital gains and dividends paid to shareholders to reduce the impact of double-taxation – profits used to pay dividends have already been taxed at the corporate tax rate. The capital gains and dividend tax rates are arbitrary but the intent has been to pick a number that was not so high as to completely discourage investment into companies by investors.

Why do we have differing corporate and individual taxation systems in the first place?

Our nation’s tax system evolved in fits and starts with various taxes being implemented and then repealed – some ruled unconstitutional. Our modern tax era began in 1909 – in response to rising political pressure to tax the rich – when Congress enacted an excise tax on corporations at the urging of President William Howard Taft. In a concurrent move, President Taft proposed the 16th Amendment to establish a personal income tax.

The excise tax on corporations did not require a constitutional amendment and was originally intended to be a temporary measure until the passage of the 16th Amendment which occurred in 1913. Like all things government, legislation once enacted does not die and so the two concurrent tax systems – corporate and individual were born. And they have been creating inefficiencies and needless complexities for our nation ever since.

We should consider abolishing the Corporate Tax – not raising it.

Reducing or eliminating the corporate tax rate would go a long way towards drawing businesses and business activity back to the United States. Our corporate tax structure creates countless unnecessary complexities and conflicts with our individual tax code. Do away with that structure – even if shareholder taxes are adjusted in a manner that is revenue neutral to the Treasury – and you have gained significant economic efficiencies.

Some other reasons to abolish the corporate tax:

Removal of political gamesmanship – An entire lobbying force working to get tax breaks for corporations is gone overnight. Gone too are the incentives for politicians to grant their corporate constituencies favors via the tax code. Kill the corporate tax code and you immediately remove a big motivation for corporate money being involved in the political arena – along with special interests.

Legal & Tax Departments – Tax compliance and tax strategy related departments would be rendered obsolete and would result in the saving of literally billions of dollars and countless man-hours. Tax lawyers and consultants would need to find another avenue for work. And smaller businesses would be placed on a more equal footing.

Tax status – There would be no need for non-profit distinction – and the associated games being engaged in by both companies and the IRS.

The entire tax system would be vastly simpler. Any corporate tax burden borne by labor would be removed. The increased level of investment by corporations – along with higher dividends – would re-invigorate our entire economy. Corporations would run their companies based on underlying economics without the distorting influence of tax strategy behavior.

Corporate CEOs would focus on what are now pre-tax profits. Foreign investment would flood back into the United States. International tax problems and distortions would disappear. U.S. corporate cash held overseas could be repatriated for use domestically.

Lowering (or removing) the corporate tax does not mean that taxation of corporate income is avoided. Instead, taxes would now be paid at the individual versus corporate level. Corporations could stop focusing on tax strategies and could instead place their full focus on generating profits. And Labor would see their corporate tax burden lifted.

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