I’ve been reading a lot recently about the desire to cut the corporate tax rate from 35% to 25%. Most opinions are that the marginal rate is high compared to the rest of the developed world.
It may be an even better idea to eliminate the corporate income tax altogether and instead raise the taxes on the top two brackets while eliminating the special rate for capital gains. I think it is fair to index your capital gains basis to inflation (which could be done by having a table with a coefficient you multiply your basis by to change it to current dollars). I argue that it’s unfair to tax capital gains on the amount you gained due to inflation, and that’s one of the reasons there’s a preferential tax rate. But if you adjust your basis for inflation, you can tax only real gains (i.e., excluding inflation), and the tax rate preference can be reduced.
For example, if I bought 100 shares of GE stock in 1970 (or inherited them) for $2 each and they’re worth $30 today, much of that gain is inflation (assume I already have paid income tax on all the dividends I received for 38 years). So under the current system, this is a long-term gain, taxable at 15% of the change in value. The stock cost me $200, I sell it for $3000, my gain is 2800, and the tax is $350.
My proposal is that the $200 be multiplied by around 5.6, which is how much a 1970 $1 is worth today. Now my basis is $1120, I sell for $3000, my gain is $1880, and applying my normal marginal tax rate (25%) I pay $470.
That looks like a big jump in taxes, and it is, but remember that the preferential capital gains tax rate is the fourth largest “tax expenditure” (preferential rates or exclusions of income that reduce taxes on an activity), after exclusion of health insurance, pensions, and deductibility of mortgage interest. The tax expenditure would be eliminated by removing the preferential rate. At the same time, eliminating the corporate tax would result in (static) loss of about $340B (likely somewhat less than that due to economic effects, but it would still be a loss). The loss could be made up by raising the income tax on the upper brackets. So if you own stock or a share in a corporation, the corporation is going to make more money (because taxes are eliminated), but you’re going to pay more capital gains tax, and the effect will even out.
Why bother? The corporate income tax is filled with special provisions, tax incentives, and other items that are intended to prod corporations in to certain behavior, or to reward those who successfully lobbied for them. If you eliminate the corporate income tax, you eliminate all incentive for those lobbyists, and you end up with efficiency gains due to corporations choosing to do what’s best economically rather than what has a tax incentive. By raising the income tax and removing the capital gains preferential rate, you preserve the progressivity (Suits index of 0.398) of the corporate tax.
Reducing lobbying would be a very good thing. As argued in the book, The Myth of the Rational Voter, people make much better decisions in markets than through politics, because you directly bear the cost of bad decisions in markets, but in politics, you don’t directly bear the costs. By eliminating lobbying and tax preferences from the corporate tax, we’re eliminating those bad decisions from politics and putting them back in the market. On the whole, we’ll end up with better decision making.
The other benefit would be in recordkeeping and the costs of preparing corporate taxes. Corporate taxes are very complicated, and eliminating them would reduce the workload burden for recordkeeping and preparation. Accountants and tax lawyers probably won’t like this aspect, but when was the last time you heard a successful argument to keep doing something inefficient because it preserved jobs?
I could state that eliminating the corporate tax would bring more corporations to do business in the US, but I’m not sure of the effect.