Let's Eliminate the Corporate Tax

Article: Wall Street Journal, A Short History of the Income Tax, John Steele Gordon

Lately there has been a lot of talk about corporations who do not pay their fair share of tax, big oil getting all matter of tax-based subsidies, General Electric  paying an effective tax rate of 0% last year, etc.

When Democrats go after millionaires and billionaires, corporate jet owners and the like, and ask them to pay their fair share, I'm all for it.  The gap between rich and poor in this country is greater than it's ever been, and rich folks have been making a sport out of hiring talented tax advisers to game our country's Byzantine tax code for decades.

But when it comes to bashing corporations, and asking them to pay more, I have mixed emotions.  Corporations are not people.  But they do hire people.  They pay wages, produce useful goods, add value and innovate.  And they are highly regulated--depending on the industry.

But the key fact is that corporations are owned by individuals, and individuals are taxed.  So why tax corporations as well as individuals?  In the interest of simplicity and fairness, lets' just stop taxing corporations.  Instead, let's impose a truly progressive tax on all individual earnings--including on the money that people earn from their corporate investments.    Then we could stop doing silly things like taxing capital gains and dividend income at a lower rate than ordinary income.   If we did this, Warren Buffet would be paying a higher tax rate than his secretary, and all would be right with the world.  And we would see a massive shrinkage in the the tax compliance industry--a wasteful drag on our nation's productivity.

Graphic from www.taxpolicycenter.org
Note the small portion of revenue that corporate tax actually comprises.....

Not only that, but we would see the U.S. become much more competitive as a location for corporate headquarters.  This could only be good for employment.

Mr. Steele's article notes that the Corporate Income Tax was instituted in the early 20th Century as a stop-gap measure.  Unfortunately, it was never phased out.  I hope that Mr. Obama will take up tax simplification, as he promised.  It is an issue with bi-partisan support, which can do the country a world of good.  And I hope he will give serious consideration to the simple but dramatic step of eliminating the corporate tax altogether.

Profits Are Up, What About Jobs?

This WSJ article by David Wessel gives an interesting analysis of why we have not seen job growth commensurate with the recent growth in corporate profits.

Courtesy of Wall Street Journal

Yes, unemployment is a complex and multi-layered issue, with a mixture of  long-term structural factors and short-term economic factors.  As labor productivity goes up, businesses can use fewer staff to generate a profit; labor is less mobile than it used to be because many people are stuck in homes with underwater mortgages and cannot move; the housing market (and therefore construction) is stuck in a medium-long term rut; our educational system does not produce workers with the high-tech skills that many businesses need (also in today's WSJ: U.S. Business Leaders Press Senate Panel for More Work Visas); executives are uncertain about the effects of Obama-care, Dodd-Frank,  etc, etc.

However, I wonder how much this might have to do with incentives that are out of wack.  Corporations focus on setting up a proper compensation system so that senior executives' incentives are aligned with shareholder's incentives --basically CEOs and other fat cats are paid very little in wages and receive most of their compensation in stock or options.  Executives make more when profits go up.  But regular employees simply receive a wage, and executives have every incentive to reduce costs (i.e., other people's salaries) as much as possible.

My first question which has nagged at me as I studied corporate governance: why the big difference between senior executives and other employees?  In the end, aren't they all supposed to make an important contribution?  As a customer, if I go into a Starbucks, the performance of the guy making the coffee is much more important to me than the performance of the CFO--why does the corporate governance structure make a qualitative distinction between the two?  Why are a few people given the privilege of having their compensation "aligned with the shareholders' interests" --which means they may have earnings measured in the millions-- while others have earnings measured in the tens of thousands, and can get canned at the drop of a hat, by some brilliant new cost-cutting executive?

Executives have a big incentive to cut costs and get rich in the process.  But isn't there some benefit to having long-term stable, loyal employees, to treating employees as valued partners, not to mention the "Corporate Social Responsibility" that many corporations preach in their annual reports?  Perhaps so, but my sense is that these are factors that will generate benefits over the long term--years and decades-- and require patience and skill to capitalize on.  Cutting heads, if it can be done without driving customers away in the short term, generates a quick jump in the bottom line.  Traditionally, another big disincentive to laying  people off wholesale were the unions, which have all but disappeared in the private sector.  No, I do not advocate a system like Spain's, where unions made it nearly impossible to fire under-performing employees, thus leading to an 10% structural unemployment rate (now around 20% due to the bursting of their real estate bubble).  But look at the growing discrepancy in pay between executives and line employees in the US, look at the gap between rich and poor, look at corporate profits, and look at the unemployment rate.  And then maybe take a look at the tax structure.

Executives who get paid mostly in stock or options make most of their income from capital gains, which are taxed at 15%.  Other employees get salaries, which are taxed based on a sliding scale, with a maximum rate of 35% (25% for incomes between $34,500 and $83,600).  This is the U.S. government doing its part to make employee wages even more expensive for corporations, relative to what they pay executives, therefore increasing the incentive to use salaried employees as little as possible.   Is this really what we want to be doing?

Why can't we have a fair, simple tax structure which values work as well as deal-making?  And why can't we have an informed, well-educated work force?  Is this too much to ask?

Astonishing Household Wealth Gap Between Whites and Blacks, Hispanics Increases

Wall Street Journal: White Minority Wealth Gulf Widens

Washington Post: Wealth gap widens between whites, minorities, report says

This was an eye-opener.  The story was that while the recession destroyed household wealth across the board, it had a worse effect on Blacks and Hispanics than on Whites.

Courtesy of Wall Street Journal

But what strikes me is the following: while the median White household has some modestly significant wealth, the median Black and Hispanic household has virtually nothing.  Yes, the gap widened, but qualitatively it was the same story after the recession as before.

Meanwhile, Congressional Republicans fight tooth and nail so that the marginal tax rates on those making over $250K per year cannot possible go up-- rates which Warren Buffet pointed out are often close to 15%, much lower than the rate on middle-income earners.

I am all in favor of fair, simple taxes, and of the U.S. being a meritocracy.  Naive redistribution of wealth is not the answer.  But it is in everyone's best interest for us to have a level playing field.  It must start with education.  You should not have to be from a rich family to get a good public education.  If we could effectively address the educational slide in our country relative to the rest of the world, I think it would mark the beginning of the reversal of such disheartening statistics.