Time to eliminate the federal corporate tax

October 25, 2011

OPINION By GORDON MULLIN

The unemployment rate remains stuck around 10 percent; higher for youth and minorities.

Incomes are stagnant and the greatest wealth creation machine in history, the U.S. economy, is jammed in neutral.  You can hear the gears of industry grinding away but there’s no forward movement.  The happiest comment I’ve read lately is that we’re not sliding backwards.

Pundits all have their “fix” and me too.  If I had to pick just one policy change to get the economy moving again—just one— I’d lower the federal corporate tax to…..zero.

We all hope and pray for an uptick in the economy and thereby creating job growth and rising incomes. However we’re at historic lows in interest rates, taking away the Fed’s principal tool, and the federal government has tried throwing money at the problem, to the tune of over $800 billion dollars, and nothing changed.  The reason is that governments can’t create jobs nor increase incomes.  All it can do is tax away current income (or worse, borrow income from my grandchildren via increased debt) and hand it back out to other levels of government or the politically favored. These policies were tried over the last three years and, as we know, failed.

Now this is not to say that the public sector accomplishes nothing, it does. But it can’t create wealth and income. Only the private sector can do that.

And the private sector job creating machine is business, both big and small. Only private enterprise can create those four wonderful things which we all love: goods, services, jobs and income. The government can’t or when it tries, it does it badly.

It’s a long standing axiom in economics that companies don’t pay taxes, they only collect them.  To understand why that is, let’s do a thought experiment.  Mary’s widget manufacturing company paid $1000 in corporate taxes last year.  Now the tax rate goes up 10 percent.  They owe $1100 in taxes but had the same amount of sales and expenses as last year. Where can they get the extra $100?  Only by passing the increased cost on to one of four places.

One, from the shareholders/owners. They will get $100 less income or dividends and therefore pay less tax on their share of the profit.

Or, from the employees. Their wages are cut proportionately and they in turn pay less tax on their foregone income.

Next, consumers. One of the perverted advantages of a universal business tax is that every business, except those who buy favored treatment from our politicians (the ‘tax loopholes’  we all despise), will jointly experience a raise in cost and thus will pass it along, in full, to you and me as consumers.

Finally, the suppliers are paid less, if they comply and, note, they in turn must pass along the loss to the same categories on their balance sheet which also must experience a loss of income and thereby pay less tax.

In short, people, not business, pay all taxes.

Of course, the reverse happens when taxes go down.  Either the shareholders get to keep more, or the employees get paid more or the consumers pay less- or some combination- but you get the idea.  When this happens, there is more income which in turn is then taxed come April on the individual’s taxes at their marginal rate.

Again, companies don’t pay taxes; they only collect them. If we just wait till the increased income generated by this policy lands in the pocket of the effected players, it will more than pay for itself.  Taxes will not be lost to the Treasury, simply repositioned to incomes of taxpayers.

So, what happens when we chop our insanely high corporate tax rate, the second highest in the world, down to zero?

First will come the flood of profits held offshore to avoid our punitive tax rates. Next, business, including non-American, will flock to our shores and set up shop, creating jobs and income.  We will become the tax haven for the world’s businesses.  American based industry will respond to the incentive and create more jobs here rather than overseas.

The profits then being reinvested in industry here will prod our economy in a far more efficient way than any government stimulus or the Fed’s Quantitative Easing could do.  Think increased productivity—the font of our wealth as a society.

The businesses of America will have access to their own capital and hence will be less likely to borrow from banks.  A perversion of the current corporate tax system is that it encourages borrowing, which can be deducted as an expense, rather than by raising capital which can’t.

Incomes will rise and go into the pockets of both capital and labor, which is after all the purpose of this exercise and total tax revenues will increase because economic growth will occur once again.

Another dysfunction inherent in our current system is that politically favored sectors and corporations get special tax treatment that is unavailable to the not-so-well-connected. To wit-General Electric paid no taxes last year.  We all know the tax code is riddled with special favors- i.e. tax preferences, loopholes, etc.  Politicians love having the tax code to play with and thereby can offer up these favors to supporters by way of the tax system- “well, there is an election just around the corner and I do need funding for my campaign” says the congresswoman.  You know the rest.

Eliminate the corporate income tax and we diminish much of the lobbying that corporate America does with congress.

We must accompany this course of action with solid assurance that the rules won’t change for long periods so planning and capital can have certainty. Business needs that and they don’t have it now.  Currently American industry is sitting on a pile of retained earnings but they won’t spend it because of the political and economic ambiguity.

Still not convinced?  Consider that we’ve created institutions in our world to accomplish that which we cannot do as individuals (or find it very difficult to do).  Charities, fraternal organizations, co-ops, federally chartered credit unions, churches, not for profit medical associations and the Lawn and Garden Club, et al, exist to achieve specific tasks.  We applaud their works and many of us devote considerabile time, effort and income to support these institutions and their goals.  And, yet we tax none of them.  The only institution we tax in our world is business. Why?

All institutions work to insure that, come the end of their fiscal period, they have money left in the bank. If you’ve ever been involved in a non-profit that is sliding backwards financially, you know the feeling- dread.  Every effort will be given to get back into the black for all know that if they can’t the institution will die. But, if there is money left at the end of the year, we don’t tax the excess as we do businesses.

You might say that all others are devoted to ‘good works’ but business is motivated by greed, i.e. profit.  So what?  A number of these institutions overtly exist to benefit their members financially- e.g. credit unions, co-ops, and not-for-profits such as health associations. Aren’t lessened costs just the flip side of the income coin? And, note, all of these institutions must strive to be in the black on their financial statements, otherwise they die. They have profits.

All institutions exist to benefit humanity in their own way; business too.  Moreover, is there any greater advantage to our society than an institution that creates those wonderful benefits that we all, obviously, clearly love- goods, services, jobs and income (from which flows wealth).  Why do we want to discourage the creation of these benefits by taxing the excess, i.e. the profits. I want more jobs and income flowing to the American public and private enterprise is, hands down, the best institution to create them.

This isn’t a new idea; it’s been around for a long time.  The Fair Tax, another fine idea, is based on it.

We all want more jobs created; it’s as simple as that.  t’s one of the few national aspirations that all can agree on and this is the best way to get there.

More jobs, more income, more wealth, more tax revenues. What’s not to like?

Gordon Mullin is a financial advisor in San Luis Obispo.