On Taxing Corporations

George H. Blackford (7/30/2013)

In considering the latest squabble over Obama's latest proposal to reform the corporate tax code it is worth keeping in mind a few basic facts. 

When it comes to the need to increase taxes on corporations, it is worth emphasizing that corporations benefit from and consume government services to a much greater extent than other businesses. Corporations depend crucially on our legal and law enforcement systems to protect their property rights and to settle disputes among corporations and between corporations and their customers, employees, and the government.

Corporations benefit substantially from the government’s providing and enforcing copyright and patent protections and from the limited liability protection provided by the government. Corporations also benefit substantially from our public transportation systems and from the educated workforce our public education systems provide. And a major reason our defense budget is so large is to protect the foreign interests of American corporations throughout the world. There are reasons why international corporations locate in countries whose governments provide highly developed legal, law enforcement, transportation, public education, and national defense systems. Why should corporations be given a free ride as ordinary people and other forms of business organization are taxed to pay for the government services corporations disproportionately consume and from which corporations derive such economic benefits?

Those who wish to eliminate the corporate profits tax argue this tax is somehow unfair because it taxes income twice—once when it is earned by the corporation and a second time when it is received by stockholders in the form of dividends. This is a fallacious argument. To begin with, not all profits are paid out in dividends. More to the point, however, is the fact that all taxes come out of profits, not just a tax on profits.

A corporation subject to a 50% corporate profit tax on a $10 million before tax profit generated from $100 million in sales would have the same after tax profit as a corporation in the same situation that paid no corporate profit tax but, instead, paid a 5% sales tax, a $5 million property tax, or a $5 million dollar tax of any other kind. In any of these situations the corporation would have the same $5 million after tax profit. Why does it make sense to consider a corporate profit tax to be a double taxation of income in this situation but not an alternative tax? There is, of course, a semantic difference here but not a real difference.

The bottom line is that the same after tax profit is received by the corporation and stockholders irrespective of the kind of tax paid. A corporate profits tax is a cost of doing business, just like any other tax, and the notion that it somehow unfair because it leads to a double taxation of income and other taxes do not is nonsense.

The corporate profits tax is actually a less onerous tax than most since it is paid only when there is a profit. It is not paid during hard times when there are no profits and funds are scarce, or by owners of startup companies that have to make investments before they can make a profit and are forced to take losses as they build their businesses. Alternative taxes must be paid during hard times and by startup companies whether there are profits or not. As a result, the corporate profits tax is a much more business friendly tax than other taxes since it makes it easier for existing corporations to survive during hard times and for investors to start new corporations. In this sense, a corporate profits a tax is much fairer than other taxes.

It is argued that since other countries have lower corporate taxes, if we don’t cut our taxes corporations will relocate to countries with lower taxes and we will lose jobs, but this is only a problem because we allow corporations that locate in countries that serve as tax havens free access to American courts and markets. Corporations that locate in tax havens should be forced to pay a compensating tax to the American government in order to access our courts and markets. Not only would such a tax save jobs by preventing corporations from relocating, it would force corporations to pay their fair share for the government services they demand and on which their very existence depends. It would also help to make it possible to rebuild and maintain the public infrastructure and social capital provided by the government that is essential to obtaining and maintaining economic prosperity.  What's more, failing to tax corporations has ominous implications for the future.

For the past sixty years, American corporations have been able to minimize their contribution toward paying for the government services they consume within the United States by migrating or threatening to migrate from high tax states to low tax states as they play one state off against another to obtain lower taxes. This has led to short-term economic benefits to corporations and to low-tax states as people in the high-tax states that provide better public services follow the jobs created by corporations in the low-tax states that provide inferior public services, especially education. It has also shifted the burden of paying for government services, especially education, away from those who benefit from these services the most—people in the low-tax states to which the corporations and the people who are educated in the high-tax states migrate—on to the backs of those who benefit from them the least—the people in the high-tax states who are unable to migrate and who are loosing their tax base to the low-tax states.

The long-term nature of this effect has been particularly dramatic in the area of education where the private cost of higher education has increased to the point where student debt today is larger than either credit card or automobile debt. In 1970 the United States led the world in the percent of young adults with a college degree. By 2011 we had fallen to 16th place. Instead of educating our own to meet the needs of corporate America, as corporate taxes fell and American educational standards lagged behind, American corporations have begun to rely on foreigners to fill their ranks in those jobs that require higher education—especially in math, the sciences, and engineering—and an ever increasing number of positions at our colleges and universities are being filled by foreign students. If this trend is allowed to continue to its logical conclusion we will evolve into a society in which only the children of the wealthy are able to afford a quality education, and the quality and productivity of our labor force will fall.

Forcing countries to compete for corporate favors by lowering taxes is no different than forcing states to compete in this way, and there is no reason to expect the results to be different if this drama is allowed to play itself out on the world stage than they have been as it has played itself out on the national stage within the United States over the past sixty years. There will be economic benefits to corporations and low tax countries in the short run, but, in the long run, government services will deteriorate throughout the world, and, in the end, there will be a loss in economic and social wellbeing for the vast majority of the world’s population. What’s more, we can expect the losses to be greatest in those countries, such as the United States, that have the most to lose.