It’s obvious: Businesses should pay their fair share of taxes, after all, they use public resources and benefit from government activities.
Why do we tax business income? A business is not a person, or hasn’t been until recently when the SCOTUS awarded limited “personhood” to certain legal entities in the Citizens United case ruling. We seem to regard them as different from people in that the federal and state business taxes are, for all practical purposes, flat, while individual federal taxes are progressive. Revenues from taxes on businesses comprise about 18% of total tax revenues collected by the federal government and smaller portions of state and local tax revenues. These revenues can and should be replaced by other taxation.
Nevertheless, there are at least four arguments for taxing businesses:
- They use shared resources that are developed or maintained (or both) by the public through the use of government funds;
- They need to be regulated because we cannot trust them to behave in the public interest only when they view it as the same as their interest, at least, and effective regulation costs money;
- They rely on a work force that is educated at the expense of taxpayers at every level of government; this reliance is critical to their survival;
- The federal government funds a large portion of the research and development conducted by private and public educational, research and commercial institutions,
Three of these arguments are arguments for a use/benefit tax, i. e., which businesses use and benefit from public resources. Thus, it resembles a highway toll or a “student activity fee” or a parking meter. The second argument appears to be a psycho-sociological and based on assumptions about how people are likely to behave in commercial contexts, but, is, indeed, a use tax: incentives to misbehave are strong enough for individual companies to persuade management to misbehave, thereby, creating monitoring and enforcement costs to society. By misbehaving (breaking the rules), such companies cause society to incur costs they would not incur otherwise by requiring the use.
These are my eight arguments against taxing business. Eliminating taxes on commerce would:
- Obviate the need of businesses to lobby Congress and the White House on tax policy, thereby, reducing or eliminating their impact on tax policy formation;
- Remove tax considerations from investment decisions by corporations, thereby, liberating economists and financial/economic analysts to evaluate cash flows resulting from investment within an economic framework tainted less by government policy considerations than with such taxes in effect;
- Eliminate the need to monitor business economic behavior with respect to the tax code and enforce compliance with it;
- Release into the workforce a large number of very skilled individuals who apply their skills and aptitudes to productive activities;
- Provide resources companies use to invest in tax optimizing behavior to invest in economic optimizing behavior;
- Attract more business investment by foreign companies in the U. S.;
- Reduce the value of corporate perquisites and reduce incentives to use corporate resources as a form of tax-subsidized compensation to employees (primarily executives);
- Reduce of operating the IRS.
I need to elaborate each of these reasons.
First, I acknowledge that businesses lobby Congress and the White House on many other issues that may consume more of their resources than lobbying on tax issues. Nevertheless, enormous amounts of time and money are invested in tax lobbying. Congressmen and women insert provisions that favor industries, states, localities and specific companies with regard to taxation; in many instances such insertions function as “trading cards”(although less so these days). Not only must companies pay for their influence, but our elected officials must invest time in responding to it. This time and money could be deployed more effectively. Such lobbying also skews political behavior in favor of the “special” interests of individual companies, frequently at a meaningful cost to other constituencies and with no larger benefit to those constituencies taken as a whole. Examples of this lobbying include opposition to carbon taxes, support for accelerated depletion allowances for extraction companies (oil, gas, copper, coal, iron ore, etc.), exemptions on income earned and taxed in foreign countries, reduced taxes on income earned from exports and capital gains treatment of carried interest in private companies owned and realized by investors. Such lobbying consumes enormous resources, skews economic behavior and is inequitable.
Second, companies base investment decisions on their estimates of the future net cash flows from future projects, adjusted for perceived risks. Differences in tax rates, deductions and credits can determine the outcomes of such decisions at the margin (where all decisions are made). Such decisions include whether to build, lease or buy plant or equipment, which equipment to build, lease or buy and how to pay for it; whether to acquire a company (competitor, customer, vendor or unrelated), which parts of that company to buy, what part of the balance sheet to acquire (assets or stock) and how to pay for it (debt or equity or some other form such as royalties). Ex post facto, many corporate investment decisions would have different, if taxes incurred or reduced had not been a factor in estimating cash flow; “go” decisions would have “no” decisions and vice versa. Let’s reduce the impact of political decisions on investment decisions.
Third, there is an enormous professional structure devoted to reducing, avoiding, deferring, or “managing”, the amount of taxes companies incur. These professionals are largely very capable people whose capabilities could be put to more productive use. The direct cost of supporting this industry could be deployed in research, training, product development, project management, education or any large number of other value-adding fields. The opportunity cost of not deploying these people and the funds used to support their industry is even greater. Consider the opportunities never considered, missed or delayed as a result of the need to focus time, attention and money on managing corporate taxes. In addition to the costs of companies’ self-monitoring, there is the cost of monitoring and acting (legal action, civil or criminal, say) by such external groups as accountants, lawyers and the Internal Revenues Service. All of these assets could be deployed more productively elsewhere.
Fourth, eliminating taxes on business would release the professionals into the work force where their talents, knowledge and skills could be employed more productively, say, in the production of real goods or of knowledge services.
Fifth, instead of using the staff of the accounting department, or, in the case of larger companies, having a tax accounting department, and paying for this human capacity, that money could be applied to designing new products, improving factory floor layout, improving customer service, or any number of other activities.
Sixth, foreign companies would have greater incentive to locate operations in the U. S. The increment in the cost of labor in the U. S. would be a smaller factor in such investment decisions and, in some cases, the tax saving of building a facility in the U. S. might exceed the higher cost of labor. At the margin, this factor could alter the decision whether to build in Mexico or the U. S. or even to build at all.
Seventh, the current tax code subsidizes corporate and personal ownership of private airplanes, corporate retreats, corporate apartments, other travel, entertainment, meal and lodging costs. Monitoring abuses of these subsidies is costly to the IRS and managing these deductions is costly to the company. In addition, such subsidies provide incentives for companies to invest in abusive practices, as the cost of protecting them is far less than the cost of investigating them.
Eighth, it would reduce the operating expenses of the IRS. The IRS is already efficient, very efficient. But, it could reduce its resources or use them to monitor behavior and enforce tax law still more efficiently and more effectively under tax code that has been simplified and automated greatly.
Many of the benefits of this change would be amplified by other changes to business law. For example, if we eliminate all deductions (including charitable deductions) and preferential treatment of so-called capital gains for individuals, all of the 18% of revenues forgone by this change would be recaptured without changing tax rates appreciably. This calculation is a simple back-of-the envelope calculation based on income data from FRED, the database of the St. Louis Federal Reserve Bank and the US Census Bureau and tax “expenditure” data from the White House Office of Management and Budget.
Another change that would improve the effectiveness and efficiency of the tax code and its administrative structure is to eliminate the many types of legal entities available to businesses. When an individual starts a business, he or she may choose its legal structure from among several legal entities: “C” Corporation, “Subchapter S” Corporation, partnership, limited partnership, professional association, sole proprietorship or limited liability company. In limited liability companies and “Subchapter S” corporations, the shareholders may choose to have the profits of the company to be taxed as if the company were a C corporation (at corporate tax rates) or have those profits divided among the shareholders and taxed at individual income rates. Each business type serves different purposes with respect to taxation and legal protection from liabilities incurred by the company in the course of its operations. By eliminating tax considerations, such structures need only address the question of personal liability of the owners of the business. This question is simple. The owners are liable or they are not, therefore, only one legal distinction is required. Either the structure protects the owners or it doesn’t. Therefore, we need only one such structure that protects the owners and one that does not. But, who would choose one that doesn’t? No one, thus, we need only one legal structure for business entities. Which structure we choose or what we call it is irrelevant, as long as the owners are protected from civil liabilities incurred by their companies (except in cases of gross negligence or direct violations of law).
Think about it. Imagine an economy and a government, in which businesses don’t lobby Congress or state legislatures for tax breaks, investments would be made on the economic merits and risks of opportunities only, companies wouldn’t gain economic benefit from maintaining a staff of tax accountants and lawyers as well as use outside tax counsel, foreign companies could locate facilities in the U. S. without regard to corporate taxes, fewer resources would be devoted to minimizing, deferring or avoiding taxes due and resources devoted to litigation that results from differences of opinion about taxes, legal structures and criminal or civil liabilities would be significantly less. Indeed, a few other changes to the tax code for individuals and corporations would transform revenue collection at every government level into an equitable, efficient, equitable and enforceable endeavor.