Why End Corporate Taxes
I recently posted that I had come to the conclusion that we should do away entirely with the Corporate income tax and only tax corporate earnings at the stockholder level.
Today, I am explaining some of the reasons why I have have taken that position.
We want company managers to succeed – to create efficient companies that innovate, develop products that make life easier/better, and thereby improve society and our standard of living. We largely depend on the free market to guide companies in accomplishing these goals – going back to Adam Smith’s “invisible hand” to push companies to allocate their resources to the highest and best use. This is pretty basic economic theory, and underlies the capitalist system.
However, every aspect of the Corporate Tax Code creates incentives for company managers. Many of them are intentional – for example, the tax code has a litany of incentives to encourage domestic oil production. Similarly, we have tax incentives for fuel-efficient vehicles, for easing access for the disabled, to encourage higher education, etc. Presumably, every one of these tax incentives made sense to the Congress that passed them and the President that signed them into law. Every one of them, however, distorts the workings of the market to allocate resources efficiently.
The very fact that the expenses of a business are deductible distorts the decisions of the company’s management – if a company pays taxes at the 35% corporate rate for federal income taxes and 10% for state income taxes, it will only end up reducing its net income by 55 cents for every dollar of expense that it incurs. The state and federal governments will incur the other 45 cents through reduction of the tax bill. That can lead the company to over-spend and be less efficient than it needs to be. And the more profitable the company, the more it focuses on reducing taxes rather than creating new efficiencies.
I see this every day in my venture capital practice. When a company is a brand-new start up, it is almost always unprofitable. It is not paying taxes anyway, so it has no incentive to reduce its tax bill. These companies are the most efficient engines I have ever seen. They get every bit of value out of every penny. My grandmother would say that they squeeze a penny it so hard that Abe Lincoln’s eyes water.
After companies are profitable and have burned through their net operating losses, they begin to pay taxes. Invariably, they calculate tax savings into all of their strategic planning (as they should in the current system). And that calculation leads them to spend more than they would without taking tax savings into account – marginal projects that would have been rejected become marginal projects that are accepted.
If, on the other hand, the tax system were changed so that corporations paid no tax, with the lost revenues for government offset by stockholders paying a higher tax on dividends and capital gains, companies would invest in projects that produced the most profit, without the distortions created by the tax code. The companies would generate higher profits, resulting in either higher dividend pay-outs or increasing stock prices. Since stockholders would reap the benefits of both higher dividends and increasing stock prices, stockholders would end up better off even at higher tax rates.
Finally, such a system would be much simpler to administer for the government and be much less burdensome for companies and individuals. Just the efficiencies gained through administration would save huge sums of wasted resources throughout society – with those resources allocated to productive work rather than tax compliance.
Better for government, better for companies, better for stockholders, better for citizens.