A Populist Argument For Eliminating The Corporate Tax

By Harvey Golub

The U.S. is now in the fifth year of the Obama recovery, which began just a few months into his first administration. His spokespeople have argued strenuously that we’ve had a number of months of economic and job growth, and therefore we’re on the right track. However, by almost any reasonable standard it has been a dismal recovery. Indeed, every recession is followed by a recovery, so an increase in GDP and jobs is not noteworthy in and of itself.

The Minneapolis Federal Reserve Bank, which tracks and maintains data on all eleven recessions and recoveries since World War II, and updates the data with monthly reports, defines the current recovery as about the worst in terms of economic growth and job creation in sixty years. Specifically, fifteen quarters after the start of the economic rebound:

• Real GDP is up cumulatively by 8.3%, the worst of the eleven recoveries, and less than half the average cumulative gain of 17.9% of the other ten; and

• Non-farm private sector employment has increased by only 3.7%, making it the second worst recovery and less than half the average cumulative gain of 9.6% of the others.

This performance record represents a real tragedy, not solely in economic terms, but also in human terms as well. It has hit hardest those at the bottom of the income ladder – recent high school and college graduates and minority African American and Hispanic populations – ironically the populations that have been the most ardent supporters of the Obama administration.

The aggregate cost to the nation has been unusually large because of the dual effects of the inability of people to find jobs, and the concomitant necessity of their relying on government support payments to survive. Thus, we have increased numbers collecting unemployment insurance, Social Security disability payments, food stamps, Medicaid benefits, and funds from a host of other programs, all of which raise the current cost of government. While these programs do provide immediate assistance to people, they also serve to more deeply embed a culture of dependency and despair. Worse yet, the longer these people are out of work, the harder it becomes for them to get back to work, no matter how much they would like to. Their spirit is sapped and their view of themselves as independent, contributing people becomes increasingly negative. AB a result, the percentage of adults who are in the workforce – either working or looking for work – is the lowest in four decades.

On the revenue side of the federal budget, lack of economic growth reduces the amount of taxes collected through all sources – social security, Medicare, payroll, capital gains, personal income and corporations. For the past decade or so, average federal revenues averaged about 18% of GDP. During this recovery, federal receipts have been about 16% of GDP, and that percentage against a lower level of GDP than would exist with a more robust recovery. The shortfall in revenue to the government can be reasonably estimated. If our nation had grown at the average rate of previous recoveries, revenue collected could have been higher by about $500 billion per year. This combination of higher outlays because of low growth and lower tax receipts because of low growth accounts for the vast bulk of the more than $1 trillion annual deficit, and is devastating our nation. Since we finance this deficit with borrowed money we are increasing the burden that must be assumed by future generations.

What must be clear to even the most biased is that the stimulus spending and monetary policies of the Administration, which should have increased economic activity if conventional economic thinking is to be believed, have not worked. Those Keynesian policies have been swamped by, and arguably have piled on to the unrelenting, negative impacts of Obama administration policies – in higher tax rates, massive new or extended regulations, whether supported by law or by overreach throughout the federal bureaucracy.

The Administration apparently believes that a larger, more intrusive government can be the driver of economic growth. The beliefs shape the policy; that businesses need more regulatory oversight by the EPA, unions need to win more elections, banks need the rough oversight of Dodd Frank to manage risk, and the healthcare system needs the management of the Affordable Care Act to deliver adequate medical care to our people, that government bureaucrats can allocate resources better than can the private markets, and that federal agencies can be effective venture capitalists. Sheer nonsense.

Those inside the Administration also believe that the well off and corporations are not paying enough in taxes. The latter view is a function o fan even more offensive view held by President Obama himself that financial success is not earned by being entrepreneurial and hard-working, but rather is the result of government support and personal luck. More nonsense. With these beliefs, it is very unlikely that a reasonable, comprehensive approach to encouraging economic growth can be crafted while this Administration is in power.

That does not mean that there is nothing positive that can be done. Recently, there has been a great deal of discussion about reforming the corporate tax code as one way of encouraging economic growth. Most economists, job creators and even liberal politicians believe that our corporate tax system is uncompetitive with other nations in a number of ways, and thereby holds back investment and job growth in this country.

• First, U.S. marginal corporate tax rates are the highest in the developed world. (Japan’s used to be higher than the U.S., but has recently been lowered.) Since corporate taxes can be an avoidable cost of doing business in the U.S. in some cases, high rates encourage businesses to locate outside our country, do as much business as possible in lower tax jurisdictions, and to keep capital abroad.

• Second, the U.S. corporate tax code is replete with special deductions and other provisions that reduce average effective tax rates well below the high marginal tax rates for the politically connected businesses or industries that can successfully influence the policy-making process in Washington. For a largely U.S. domestic, non-capital intensive company, the effective rates are very close to the highest marginal rate, and they need to be high to make up or the deductions granted to the more favored enterprises.

• Third, this combination of high nominal rates, which affect decisions at the margin, result in excess costs and complexity in running businesses. The high rates discourage investment projects and require large administrative overhead. Perhaps most importantly, they encourage rent seeking and competitive advantage through the tax code rather than by producing better products. For all these reasons, most corporations have large tax departments and Washington lobbyists whose mandates are to find ways of lowering their corporate tax burden.

Most people believe that corporations pay taxes. They are wrong. Every economist will tell you that corporations are not people and that the people who own corporate equities ultimately bear whatever part of the tax cannot be passed on to others. The true incidence of the tax on owners of capitol is likely far from dollar for dollar since higher corporate taxes to some extent can be passed to consumers through higher prices and employees through lower wages. There is some argument as to the size of each in the mix, but no argument as to these elements.

In recent months there is a growing consensus toward making our corporate tax code more competitive globally largely by reducing deductions and lowering the top marginal rate. These steps would certainly help, but to keep these actions revenue neutral, some corporate taxpayers would see their rates go up. No doubt that outcome would increase substantially the lobbying effort to “get the other guy to pay higher rates.” Once such a so-called “flattening” scheme is put in place, inevitably there will be pressure to restore deductions, causing Congress to also restore higher rates.

A much better approach would be to eliminate the corporate tax and the corporate tax code entirely, remove the corporate veil and integrate the corporate and individual tax systems. All corporations would pay zero, but owners of capitol would not. A simple way to accomplish this would be to tax dividends and realized capital gains at the shareholder level and at the shareholder normal rate. In fact, a number of businesses already function this way, where all corporate profits are passed through directly to the owners. All corporations should operate under these same rules.

What would we lose? Over the last 20 years, corporate taxes averaged under $200 billion a year and slightly more than 10% of total taxes collected by the federal government. But the economic benefit of eliminating this part of the code would be substantially larger than the cost over a reasonably short time.We could also take advantage of this change to simplify certain elements of the individual tax code as well and choose the individual level tax rates to offset ( under dynamic scoring) the nominal revenue loss.

Taking this action would make the U.S. the most desirable place in the world to locate and build businesses. Our country would experience an economic boom: a flock of foreign companies would locate factories here; jobs would be created by the millions; companies would make investment decisions based solely on economics, without regard to tax effect; the market value of publicly and privately held stocks would explode. Revenue to the government would increase massively as a result, and crony capitalism would suffer a body blow.

Currently corporate dividends and capital gains are taxed at lower rates than income from wages, because these sources of income are partially paid for through the corporate tax code and because we have a reasonable policy of trying to encourage investment. This proposal would increase individual tax rates on dividends and capital gains relative to today, but the total tax on capital holders would likely be much lower because of the growth and efficiency effect of eliminating the corporate tax. Taking these steps would increase substantially the pool of investment capital available to fuel economic growth. The only losers would be tax consultants and politicians; the winners would be the entire nation. All in all, the United States could become the best place in the world to invest.

Harvey Golub is Chairman of Miller Buckfire.

This article is available online at: http://onforb.es/13NZRC6 2014 Forbes.com LLC'” All Rights Reserved