How to Tax Corporations

In the preceding pages we saw two different ways that the current tax system favors big corporations:

  1. Corporations are discouraged from releasing their profits back into them market; they are thus encouraged to use their profits to grow bigger.
  2. The horrendous complexity of the tax code increases overhead, thus favoring bigger corporations, which can spread their overhead costs over more products.

There are also serious questions of fairness of the corporate tax code. In any particular year one can find corporations making huge amounts of money but paying no income tax. Maybe this is fair due to prior losses; maybe this is clever accounting trickery in action. We have at least the “appearance of an impropriety” if not outright unfairness.

From the freedom lover’s point of view, the current system is also anathema.

  1. The huge paperwork requirements are a burden on both corporate and individual taxpayers.
  2. To collect personal income taxes, the government has to pry into people’s private lives, tracking their spending habits.
  3. The tax code is used as a way to manipulate personal behavior, bypassing due process.
  4. Tax payment does not correspond well to government services rendered.

To have a fair tax system, it should be based on measurable numbers. Profit is not such a number! What constitutes depreciation and goodwill are not directly measurable; one must resort to accounting conventions. There is also a blurry line between business expenses and personal use. Was that business trip to Hawaii really for the purpose of boosting profits?

Measurable numbers include sales, salaries paid out, dividends issued, money spent on stock buy-backs, bond interest paid out, and the market capitalization of the corporation. Some of these numbers are easier for the outside world to see than others. Tracking sales taxes still requires showing the government all the sales receipts; it also requires tracking which items are for resale. Market capitalization can be found on any financial web site; it is simply the product of the stock price times the number of shares outstanding. Any computer hooked up to a stock quotation service could compute the tax liability of every listed corporation in minutes at the close of each trading day.

From a libertarian perspective, such a corporate value tax has much to be said over the current system:

  • The protection of property is the primary duty of government. Thus, a flat rate tax on the value of property protected is an approximation of a fee for service.
  • The paperwork for such a tax is tiny.
  • The information required by the government is tiny, and already publicly available.

I did a very rough calculation and found that a 1.5% annual tax on corporate value would give the government what it currently gets with the corporate income tax. I would recommend going to an even higher rate and eliminating double taxation: no taxes on capital gains or inheritance of corporate stock. This partially eliminates the need for the government to track people’s personal accounts.

We could simplify even further by having a flat rate tax on dividends paid by the corporation as it issues the dividend and then eliminating personal reporting of dividend income. Whichever way dividends are taxed, if we want to eliminate artificial corporate growth, the tax (over time) on retaining earnings should be as great or greater than the tax on dividends.

Some Objections

What about corporations with no earnings? Corporations with no earnings could always pay their value taxes in stock. The government would be required to sell the stocks using a deterministic formula.

What about private corporations? With a private corporation, we don’t have a market price, but we still have the “ask” price of the people who own it. That is, the price is whatever the owners would happily sell the entire company for. The IRS posts the price on its web site, and anyone who thinks the owners are cheating by undervaluing the company would be allowed to buy the entire company at this price.

What about startups? Well, we don’t want to clobber startup companies which have no value other than the ideas of the founders, so we might allow some grace period before this tax cuts in. Any corporation that applies for such a grace period should have strict limitations on how the owners could take money out: no dividends, owner draws, or large owner salaries might be a place to start. I leave it to the reader to decide whether the grace period should be a tax deferral or a time of no tax.

What about bonds? One way to dodge a corporate value tax and a corporate dividend tax is to finance as much of the corporation as possible using bonds. This is not good. Bonds are destabilizing. A company financed with bonds can quickly go bankrupt during a bad year. A company financed with income producing stocks shrinks gracefully during hard times. Indeed, the double taxation of corporate income has favored the bond market over the stock market, which has increased the rate of bankruptcies and destabilized the economy. Bond interest should be taxed at a higher rate than dividends. This tax could be collected at the time of issuance as an in kind tax (government gets and resells a fraction of the bonds) or as a fraction of the interest payments as they are paid out.

Going Further

I prefer taxing corporations to taxing individuals since the accounting for a corporation is more of a sunk cost, and the information is less private. My dream is to completely eliminate the personal income taxes. This is not an easy thing since these personal income (including labor) taxes are the chief income source of the federal government. I am going to hint at possibilities at several places on this web site, giving plusses and minuses for each.

Here is a first cut: we already have a way to eliminate all personal income taxes related to corporate ownership. The remaining source is salaries. We could get much of the effect of the personal income tax without tracking individuals by simply taxing the total value of the salaries and benefits paid out by corporations. This would be in place of federal withholding, Social Security, Medicare and federal unemployment insurance payouts. Lump all these payments together and consider the effects of the various tax deductions and the personal income tax is already rather flat. I do not know the full ramifications of such a tax change.

One serious loophole in such a tax change would be that partnerships and sole proprietors would be exempt from federal income tax under such a system. This is possibly a good thing: make people pay for the benefit of limited liability. Perhaps the economic distortion would be too great, but maybe not. It would certainly cut down the amount of wealth controlled by corporations! But note that such a tax change would also eliminate the use of private businesses as tax shelters of income earned elsewhere.

Homework Assignment

I derived my tax rate figure using some fairly rough numbers. You might want to double check my work.

  1. How much does the U.S. government collect in corporate income tax?
  2. What is the total market capitalization of public corporations in the U.S?
  3. Divide the first number by the second and multiply by 100 to get a rough idea of the percentage rate needed to break even.
  4. How much does the government collect in personal capital gains taxes on shares of corporate stocks. Make sure this is a net figure, since many people are taking capital losses right now.
  5. How much does the government collect in estate taxes from the passing on of corporate stock?
  6. Add the values from 1, 3 and 4 and divide by value in 2, and then multiply by 100 to get the percentage rate for a corporate value tax if we were to eliminate these personal taxes.
  7. What is the market value of corporate bonds? How are the above percentages changed if we add bond values to the mix?
  8. How much do corporations pay out in dividends and bond interest? How much could we reduce the personal income tax if we were to tax these at the source at a flat 20%? 25%?
  9. How much does the government collect in personal income taxes on dividends and bond interest?