Robert Reich on why corporate income tax should be abolished

The result of this anthropomorphic [treatment of corporations] is to give companies duties and rights that properly belong to people instead. This blurs the boundary between capitalism and democracy, and leads to a host of bad public policies. Consider, for example, the corporate income tax. The public has the false impression that corporations pay it, and therefore they should be entitled to participate in the democratic process under the old adage “no taxation without representation.” But only people pay taxes. In reality, the corporate income tax is paid—indirectly—by the company’s consumers, shareholders, and employees. Studies have attempted to determine exactly how the tax is allocated among these three grouips, but the distribution remains unclear. What is clear is the corporate income tax is inefficient and inequitable.

It’s inefficient because interest payments made by corporations on their debt are deductable from their corporate income tax while dividend payments are not. This creates an incentive for companies to overrely on debt financing relative to shareholder equity, and to retain earnings rather than distribute them as dividends. The result, in recent years, has been for many corporations to accumulate large amounts of money that the company then uses to purchase other companies or to buy back its shares of stock. Capital markets would be more efficient if these accumulated profits were redistributed to shareholders as dividends. Decisions by millions of shareholders about how and when to reinvest these funds are likely to be, as a whole, wiser than decisions made by a relatively small number of corporate executives. Abolishing the corporate income tax would thus help capital markets work better.

The corporate income tax is inequitable in that retained earnings representing the portion held by lower-income investors are taxed at a corporate rate that’s often higher than the rate they pay on their other income, while earnings representing the holdings of higher income shareholders are taxed at a corporate rate often lower than they pay on the rest of their income. As we have seen, under supercapitalism, investors have far more power than they did decades ago. Their decisions about where to put their money to maximize their returns are similar to any other decisions they make about how to increase their earnings. Logically, there is no reason why their ‘corporate’ earnings should be taxed differently than their other earnings. Abolishing the corporate income tax and treating all corporate income as the personal income of shareholders would rectify this anomaly.

An idea advanced by Professor Lester Thurow of MIT is to get rid of the corporate income tax and have shareholders pay personal taxes on all income earned by the corporation on their behalf—whether the income is retained by the corporation or is paid out as dividends. This would essentially reveal the corporation to be what it is in fact—a partnership of shareholders. All corporate earnings would be treated as personal income. But shareholders would not feel the pinch. As their ‘corporate’ earnings accumulated throughout the year, the company would withhold taxes owed based on the shareholder’s tax bracket—as did the shareholder’s employer on his or her salaried earnings. At the end of the year, shareholders would receive from the company the equivalent of a W-2 form telling them how much income should be added to their other sources of income and how much income tax had been withheld. This way, shareholders would automatically pay taxes on ‘their’ corporate earnings at rates appropriate to their own incomes.

This would rectify the two problems. Corporations would have no artificial incentive to retain earnings, and taxes would be lower for low-income shareholders and higher for higher-income shareholders. One mportant byproduct of this reform would be to puncture the widespread but false notion that corporations pay taxes and therefore deserve to be represented in the political process. Again, companies should have no rights or responsibilities in a democracy. Only people should.

Robert Reich - Supercapitalism, pp. 218-9