Tuesday, February 18, 2014

The Foolishness of Corporate Taxes


NOTE: I am reproducing a number of essays on taxes which originally appeared in my now defunct blog Random Notes. I will also be reproducing articles on the FairTax in the next few days. I hope these essays will provide a good background for my planned essay examining the current state of the FairTax, as well as summarizing all my objections to it, those which have been answered and those which were not. Those interested in the topic may also find useful material in a number of essays printed in this blog (many reproduced from Random Notes), including: "Passing Thoughts on Taxes", "Two Thoughts on Taxation", "Government by Emotion", "Minimal Reforms", "Simplicity", "Reframing the Debate", "A Partial Reply to yt_knight", "Another Reply to yt_knight", "The Runaway Stagecoach", "The VAT Versus the FairTax", "Ch-Ch-Changes", "Gardasil and Logical Errors", "What is Wrong with a Prebate?", "Making Taxes Hurt", "Reply to FairTax Comments", "Reply to FairTax Comment II", "Reply to FairTax Comment III", "Short Reply to Doctor Adams", "Revisiting the FairTax", "If we must...", "What We Need", "The Consequences of Bad Laws" and "Truths About Taxation".

When we discuss taxes, and I have done a lot of that recently ("Why I Dislike the FairTax", "The Best Argument Against the FairTax"), one of the points I always make is, if we are going to have a federal tax, rather than restoring tax power to the states alone ( "What we need", "Making Taxes Hurt", "The Benefits of Federalism", "A True Conservative Platform"), is that we should not use a multitude of taxes, but should instead rely on only a personal income tax. I am sure many have accepted my arguments against corporate taxes, fees, death duties, tariffs and the rest, but for those who have not, I want to make clear why I think taxes should be applied only to the individuals, and should be assessed directly or not at all. (I briefly made this point in a postscript to my post "How Not To Argue About Social Security" today, but did it in very little detail.)

The reason I oppose any non-individual taxes is based upon one simple fact, that is that every bit of wealth in the nation is owned by someone. Now, yes there are legal fictions such as corporations, trusts, and so on, but, with the exception of a few non-profits, which also are almost always tax exempt, those fictional entities are themselves owned by one or more individuals. And so, when we talk about taxing "a corporation", we do not mean that a corporation will pay the tax, and the burden of that tax will fall of the corporation. No, we mean the tax will be assessed against a corporation and paid by individuals.

Now, it is a commonplace among conservatives of a certain type to argue that corporate taxes are pointless as they are passed on to the consumers. This is partly true, and part of my argument, but they also overstate the case. Yes, part of any business tax is applied to the cost of goods or services, and thus is basically assessed somewhat randomly, falling upon consumers of the corporation's products. So, a tax meant to "soak the rich" could, in reality, be paid almost entirely by the poor, the elderly, the sick, or some other group who the politicians do not wish to tax.

But that is not the whole story. Because, though companies would like to pass along 100% of taxes to consumers, supply and demand determine what can and cannot be passed along, and so only part of any taxes can usually be put into costs, and, in some cases, none can be passed along. Whatever is passed along as costs comes at a cost to the company, anyway, as higher prices result in lowered sales and reduced profits. Add to that the part of the taxes the company must "eat", and you can see that the other effect of corporate taxes is reduced profits, which can take two forms, reduced dividends or reduced investment and expansion.

Now, some may ask "who cares if fat cats get lower dividends?" But that ignores the fact that most stocks are held, not by "fat cats", but by middle class investors, whole life insurance plans, pensions, and other "ordinary folks", who will feel the loss of a part of the dividends more than the more affluent will, especially in the case of the retired who rely upon dividends for income. So, in addition to the taxes turned costs which hit the public randomly based upon consumption, the remainder of corporate taxes then hit those who have invested or purchased pensions or insurance, not exactly the groups intended when populists start ranting about corporate taxes.

And then there is the third option. If a company cannot pass along the costs to consumers, and cannot reduce dividends without seeing stocks plummet in value, they will have to bite the bullet and reduce expansion, replacement allowances, and other investments. On the surface, this is probably the least harmful, but only in the short term. Actually, even in the short term it does harm by cutting consumption of capital goods and plant, as well as new employment, so there are losses in unpredictable sectors of the economy, completely unrelated to the corporations being taxed. But, over time, it gets worse, as the failure to allow for depreciation and replacement tends to cause profits to decline rapidly in a few years, while the inability to expand leads to economic stagnation, loss of business to more dynamic firms, and, likely, eventual closure.

And that is why I argue that corporate taxes are such a bad idea. They are one of the worst ways to assess taxes. They strike random individuals through both product costs and loss of investment income, they tend to slow overall economic growth, harm the bottom lines of completely unrelated companies, and cause overall economic stagnation, and all that while producing no more revenue than a much less harmful, and much more predictable, income tax would. Not that I think an income tax is a good idea, but choosing between the two, the income tax would always win.

POSTSCRIPT

There is one other aspect of the corporate tax that is problematic. By hiding the cost of taxes in higher prices, lower dividends and slowed economic growth, these taxes make it easy for the public to avoid recognizing how much they pay in taxes. As I argued in "Why I Dislike the FairTax", if we must have direct federal taxation, I would argue that the public should always know precisely how much each and every person pays in taxes. If not, it becomes far too easy for the government to use taxes to buy votes by convincing each voter he gets more than he pays, which is rarely true.

Originally posted in Random Notes on 2010/02/16.



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