Why abolishing the corporate income tax is good for American workers

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Editor’s Note: Our regular Social Security columnist Larry Kotlikoff is taking a week off from answering your Social Security questions. This week, he’s addressing readers’ concerns with his call in the New York Times to abolish the corporate income tax.

On Jan. 5, I published an op-ed in the New York Times titled “Abolish the Corporate Income Tax.”

The piece generated a large number of comments, many of which were indignant at the suggestion that we give the rich a huge handout at a time of terrible and growing economic inequality. Since the column explained why abolishing the corporate income tax would help workers, not the rich, and also advocated using our progressive personal income tax system to make up for any loss in revenue, I was surprised at the negative reaction, but not really.

We’re all so politicized and so short on time that all it took, in this case, was a five-word title (over which I had no control) for my critics to conclude that I was a) nuts, b) a pawn of the capitalist class, c) a right-winger and d) someone to be set straight — all before they even skimmed the contents of what I’d written.

After working out my frustration with Paul Solman on the tennis court to little avail, since his forehand is getting more vicious by the day, I raised with him the idea of answering some of the comments on his Making Sense page.

He generously agreed, not because he felt guilty about demolishing me yet again at tennis, but because he realizes I’m neither a, b, c, or d, and that our country desperately needs to have open non-partisan discussions of critical policy reforms. Accordingly, Paul proposed I answer the letters responding to my column that were published in the New York Times on Jan. 11.

I answer them below, but first, some background. My op-ed reported on a recent co-authored study showing that eliminating the corporate income tax and making up any resulting lost revenue with higher personal income taxes would produce major increases — north of 12 percent — in the real wages of today’s and tomorrow’s workers.

The intuition for this result is the well known (to economists) proposition that those who bear the economic burden of a tax aren’t necessarily those whom the government says have to pay — as in remit — the tax.

Take apple farmers who are now receiving 50 cents per apple and are suddenly told by the government to pay a 10-cent tax per apple sold. Now suppose the apple producers aren’t willing to produce any apples whatsoever unless they net exactly 50 cents per apple. In this case, they will react to the tax by cutting back on their supply of applies until they force the pre-tax price of an apple up to 60 cents.

With apple demanders paying 60 cents per apple, the suppliers will net the same 50-cent price per apple after handing the 10-cent-per-apple tax to the government. If the suppliers who “pay” the tax aren’t hurt by the tax, then who is?

The demanders bear the burden of every cent of tax collected, but they do so in the form of paying higher consumer prices. So even though the apple producers actually mail the government the tax proceeds, they aren’t really paying (being hurt by) the apple tax.

In the case of the U.S. corporate income tax, the ability of corporations to avoid the tax, not by producing fewer apples, but by producing abroad, means that workers in the United States will have fewer companies soliciting their services. This, in turn, will mean lower real wages than would otherwise be the case. Consequently, it’s the workers, not the rich owners of U.S. corporations, who end up being hurt by the corporate income tax. Hence, if the U.S. cuts its quite high corporate tax, indeed eliminates it, this can be a good thing for workers.

With this background, let me respond to these letters.

To the Editor: Re “Abolish the Corporate Income Tax,” by Laurence J. Kotlikoff (Op-Ed, Jan. 6):

For decades corporate income taxes have dropped without benefiting working and middle-class America. Chief executives now make 270 times more than the average American worker, whose real wages have fallen since their peak in the 1970s.

As most workers in America have seen their hours, wages and benefits shrink, corporate taxes have gone down, job creation and growth have gone down, and corporate profits and executive compensation have skyrocketed.

So why does Mr. Kotlikoff think that it will be different this time around? For whom does he think that it will be better? If the past predicts the future, it will not be the American workers or the middle class who benefit.

New York, Jan. 7, 2014

Larry Kotlikoff: You are confusing the marginal and the average corporate income tax rates. The U.S. marginal corporate tax rate — the tax paid on an extra dollar of profits — is perhaps the highest of the developed world. In contrast, the average tax rate — the amount of total taxes actually collected divided by total profits — is quite low thanks, in part, to companies producing abroad to avoid the high marginal tax.

In the extreme, we could have a 100 percent marginal corporate income tax, which would drive out all corporations and, therefore, produce zero tax revenue.

So yes, Carrie, the average corporate tax rate is very low. But the marginal corporate tax rate in the U.S. is very high. The point of my op-ed was to draw the distinction between the marginal and average tax rates and point out that the main impact of our corporate tax today appears to be to discourage production within the U.S., not to collect revenues.

Turning to executive pay, I agree that it’s insane. I’d happily run any top Fortune 500 company for far, far less than the CEOs are earning. (See, for example, my offer to run Barclays. ) But I don’t think the main impact of cutting our corporate income tax will be to further enrich CEOs. I think the main impact will be, as it was in Ireland, to expand corporate production in the U.S. and, in the process, raise real wages.

As for CEO compensation, my hunch is that it reflects, in the main, back-scratching deals between CEOs and members of boards of directors. The CEOs appoint their buddies as directors, pay them handsomely to serve, hold board meetings in exotic retreats, and then invite them to vote on the CEOs’ compensation. Something’s very rotten with this system, and it needs to be fixed probably by having independently appointed board members determine CEO compensation.

To the Editor: Laurence J. Kotlikoff doesn’t mention some key facts.

First, the personal income tax would have an enormous loophole for the rich if we didn’t also have a corporate income tax. A corporation can hold on to its profits for years before paying them out as dividends. With no corporate income tax, rich people could create shell corporations to defer paying individual income taxes on much of their income indefinitely.

Second, even when corporate profits are paid out (as stock dividends), only a third are paid to individuals rather than to tax-exempt entities not subject to the personal income tax. If not for the corporate income tax, most corporate profits would never be taxed.

Third, the corporate income tax is ultimately borne by shareholders and is therefore a very progressive tax, which means that repealing it would result in a less progressive tax system. The Treasury Department concludes that 82 percent of the corporate tax is borne by the owners of stocks and business assets, who mostly have very high incomes.

Director, Citizens for Tax Justice
Washington, Jan. 6, 2014

Larry Kotlikoff: In my op-ed, I wrote,

Eliminating the corporate tax and raising income tax rates or lowering the corporate tax rate and eliminating its loopholes are not the only options. Elsewhere, I have proposed eliminating the corporate income tax, making shareholders pay income taxes on their companies’ profits as they accrue. This leaves companies with no tax reason to avoid operating in the United States but ensures that shareholders, not wage earners, make up for any revenue losses through higher personal tax payments.

The tax reform I proposed, called The Common Sense Tax, doesn’t let the rich avoid paying taxes on their worldwide corporate profits. Instead, it forces them to pay taxes annually and at the personal level on these profits as they are earned. And since taxes are paid by shareholders as they are earned, there is no need to worry, as you are doing, about having corporations shelter profits.

Again, their annual profits would be calculated and imputed to their shareholders for immediate personal taxation. And the shareholders would owe the same tax on their corporate profits regardless of how much corporate profits were either retained or paid out in dividends.

Finally, you write that “the corporate income tax is ultimately borne by shareholders and is therefore a very progressive tax, which means that repealing it would result in a less progressive tax system.”

To see the fallacy in your statement, let’s divide the world into U.S. workers, rich U.S. shareholders, rich foreign shareholders and foreign workers. If we raise the U.S. corporate income tax to 100 percent, all U.S. corporate production would move offshore. U.S. workers would suffer terribly, foreign workers would benefit greatly, U.S. shareholders would be hurt somewhat and so would foreign shareholders.

The key concern I have, and I believe you share, is about U.S. workers. As my study shows, inducing companies to produce in the U.S. by lowering the marginal U.S. corporate income tax will benefit American workers. And doing so by imputing corporate profits to shareholders for taxation at the personal level will preclude benefiting the rich.

To the Editor: Laurence J. Kotlikoff offers an example of how corporate tax reform is an issue that can unite Democrats and Republicans, as well as corporations and workers.

President Obama, Speaker John A. Boehner and leaders in both parties have called for reforming America’s corporate tax code to lower the world’s highest rate of 35 percent to a competitive level and to simplify the system. As the recent budget agreement between Senator Patty Murray, a Democrat, and Representative Paul D. Ryan, a Republican, shows, the country is hungry for bipartisan agreement, and there is no better opportunity than the simplification of the corporate tax code.

Labor and business, left and right, have come together before to reach deals that have boosted America’s economy and created jobs. Mr. Kotlikoff is right that jobs don’t come out of thin air. Now is the time for compromise that leads to sustainable economic growth, higher employment and creation of those jobs.

Washington, Jan. 8, 2014

Mr. Pinkerton is a former domestic policy adviser to Presidents Ronald Reagan and George H. W. Bush. Ms. Kamarck is a former adviser to President Bill Clinton and a senior fellow at the Brookings Institution. They are co-leaders of the RATE Coalition (Reforming America’s Taxes Equitably).

Larry Kotlikoff: Thanks for your letter, with which I fully agree.

To the Editor: Laurence J. Kotlikoff rightly points out the economic benefits of eliminating the corporate income tax. Even though consumers ultimately pay these taxes through higher prices, political support for eliminating it would be difficult to come by, especially on the left.

However, if we eliminated special treatment of capital gains and dividends at the same time, we could garner wider support and realize a more just and simpler tax code.

San Francisco, Jan. 6, 2014

Larry Kotlikoff: I think, and economic theory confirms, that in economics in which capital is mobile, workers bear the corporate tax burden, not via higher prices, but via lower wages.

The Common Sense Tax would tax corporate profits as they are earned, but at the personal level. In the process, we could eliminate capital gains and dividend taxation and, as you say, end up with a more just and simpler tax code.

To the Editor: Eliminating the corporate income tax won’t help American workers because there’s no real-world evidence that lower corporate taxes lead to economic growth.

What would really help working families is having corporations once again pay their fair share of taxes, so that we can adequately finance new investments in education, medical research and infrastructure repair to grow the economy. That means closing offshore tax loopholes that reward corporations for hiding profits and shipping jobs overseas.

In the 1950s, corporate tax receipts represented about a third of federal revenue; now they make up only 10 percent. When corporate taxes decline, everyone else pays more to make up the difference, or loses valuable services and benefits. American workers win when corporate tax loopholes get closed.

Executive Director, Americans for Tax Fairness
Washington, Jan. 6, 2014

Larry Kotlikoff: I think we are talking past each other to a large extent. The Common Sense Tax does eliminate all loopholes by imputing to shareholders the global profits earned by their corporations as they make those profits. But by taxing global profits this way and not differentially taxing profits made in the U.S., corporations will have no incentive to produce abroad rather than in the U.S.

To the Editor: While Laurence J. Kotlikoff may characterize his proposal to eliminate corporate income tax as the product of a “nonpartisan research group,” the evidence suggests otherwise. The Tax Analysis Center, which sponsored his work, is a project of the National Center for Policy Analysis. That organization, at which Mr. Kotlikoff is a senior fellow, is a right-wing policy think tank that advocates ideas in furtherance of free market economic policies and that receives substantial financial support from foundations set up by the Koch brothers and the Sarah Scaife Foundation, among others.

Given these associations, Mr. Kotlikoff’s proposal, which sounds like the discredited trickle-down economic theories of the ’80s, can hardly be characterized as nonpartisan, nor, it seems, is he.

Evanston, Ill., Jan. 8, 2014

Larry Kotlikoff: If you go to www.taxanalysiscenter.org you will find this statement:

The Tax Analysis Center is a project of the National Center for Policy Analysis, which is providing current funding for its work. The center uses models developed over two decades by Boston University economist Laurence Kotlikoff. Development of these models was funded directly or indirectly by Boston University, the National Institute of Aging, UCLA, Yale University, Boston University, Harvard University, the University of Pennsylvania, UC Berkeley, the University of Würzburg, the University of Ulm, the Organization for Economic Development and Cooperation, the World Bank, the International Monetary fund, the National Bureau of Economic Research, the Gaidar Institute, and others.

So, yes, the NCPA, is the current sponsor of some of my tax research, but that research is exploring models that have been developed over decades with the support of a large number of academic and multinational institutions.

I have very deep respect for the NCPA and its director, Dr. John Goodman, whom I’ve known for years. I also very deeply appreciate the NCPA’s support of my research and of The Tax Analysis Center.

I don’t know the specific donors to the NCPA, let alone those that are contributing to support The Tax Analysis Center. They could be the most right or left wing people in the world. That wouldn’t matter one iota to what I write, research, conclude or say.

Our country faces truly terrible economic, fiscal and financial problems. Their solution will not come from partisan analysts, but rather from apolitical experts who can look at the problems objectively and propose solutions, which both sides of the political aisle can embrace.

If you do your homework, you’ll find that I’m not someone on the extreme left or right and that I’ve spent my career doing one thing — good economics. Good economics, like good engineering, is neither left wing nor right wing. Unfortunately, many prominent economists are highly political and closely aligned with one of the two parties. Their often-extreme partisanship has discredited them and the economics profession.

Turning to the donors of the NCPA, I’m sure there are many with whom I strongly agree on specific policy issues and others with whom I strongly disagree on specific policy issues. But the NCPA is not supporting The Tax Analysis Center based on my agreement with its donors. NCPA realizes that the quality of tax analysis being done in Washington — by both parties — is substandard and has agreed to support academic-based, state-of-the-art tax analysis.

When I sought initial funding for The Tax Analysis Center, I approached a number of think tanks and charities, some of which would, from the composition of their donors, be viewed as very left wing and others as very right wing. The NCPA is the first supporter to date, but I’d be happy if you, Evan, were to consider donating as well.

When it comes to supporting truly impartial economic research, a dollar is a dollar and who held that dollar last makes no difference to me or to the work of The Tax Analysis Center.