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Friday, February 06, 2004

Corporate tax debate

The following is an editted version of a debate in the comments to this post at Crooked Timber:

Can we use this to discuss the morality of corporate taxes as well? Many on the right claim corporate taxes unjustly put a second tax on income that would otherwise only be taxed once, and we are therefore ““punishing”” a choice of business entity. But things like limited liability show that the corporate is not a tax on income, but a fee for a government-granted priviledge - and the fact that you can conduct business without the corporate form, but people choose to do so, shows that the benefits of corporate existence are worth the price.

When ““corporate taxes”” are levied, what is not understood is that they are in fact taxes on individuals. The taxes are paid for by the owners of the company through lost profits, the workers of the company through decreases wages, and the consumers of said companies’’ products and services through price increases. Taxes are always levied on individuals. There is no way to be taxes and have that tax not affect each of us in the form of lost assets or increased cost of living. The complaint is that the corporation has no soul to damn or pants to kick, but it also has no individuality to tax, any and all added costs (taxes included) trickle down to we the people.

As for your response to the tax issue, you are committing serious zero-sum thinking. Corporations are created by government and individuals because the individuals can produce more ecconomically with the corp than they can without it. The question then arrises, how is this extra sum to be split among the creators? I am simply suggesting that the community/government act like any other self-interested participant and get as much of the extra as it can. If you really believe that the government contributes no extra benefit by passing laws that create corporations, then please explain why people choose to do business in the corporate form when it costs them money to do so in the form of corporate taxes, and it is possible to conduct all of the same business activities without the corporate shell.

To clarify my point:
Limberwulf wrote: ““When ““corporate taxes”” are levied, what is not understood is that they are in fact taxes on individuals.””
What I am suggesting is that corporate taxes are not paid for by individuals, but they are paid out of the extra wealth created by the existence of the corporation. I suggest this is obviously true, for otherwise no one would bother doing business in the form of a corporation. Is there a flaw in this argument?

I see two issues in your argument. One is the assumption that the corporate model is being chosen only for the sake of increased profit. I have seen many corporate models (worked for some of them) that could have made more money as a sole proprietership, but chose the corporate model as a rick management move. As it turned out, this company was indeed hit with a lawsuit that bankrupted the company, but, fortunately, did not take the personal assets of the founder. He was able to start over and is currently doing well.
The second issue is that the corporate model actually has CHEAPER taxes than partnerships and sole proprietorships when all monies are not distributed as income. Before I knew this, I had a business of my own. I set aside a portion of business profits to put into capital growth, but had not used all of it for business equipment at the end of the year. The tax rate on that money was equal to my personal income tax, around 25% at that time. Equivalent corporate tax on those funds would have been 15% at the time. Because of the sum of money I had set aside, 15% tax on total profits would have been a savings even though it would have double taxed the profits going to payroll.
So, yes, perhaps a greater capital growth can be had in a corporate model, but the taxation of this money, particularly the sums that end up being double taxed, are still a decrease in the profits of the corporation. Those profits would have otherwise gone to: a) business growth and capital investment, a benefit to the economy. b) employee payroll, a benefit to the economy through job creation and/or increased disposable income. c) increased payout to shareholders, a benefit to the economy through increased disposable income. d) decreased consumer prices, and benefit to the economy by providing a good or service at a lower rate, allowing an effective increase in disposable income. The fact that the corporate model may allow increased profitability does not mean the monies taken by the government could not have been better spent by individuals. All taxes are a tax on individuals, there is no way to escape this. Money doesnt just appear, it is created through the efforts of people.

1. Risk managemant IS a profitability issue.
2. The service of risk management through limited liability obviously has value to those who use it. Why should the government not charge for this service in proportion to the amount of investment protected from risk?
3. Limited liability does NOT explain the continued dominance of the ecconomy by corporations in the past decade. Thanks to LLCs (Limited Liability Corporations), which as taxed as parternships, limited liability can now be had for free. Those who chose C corps do so to take advantage of the other benefits of corporate existence, presumeably because these increase profitability.
4. Your point about retained corporate earnings being taxed at a lower rate than parternship profits passed through to rich partners is, I admit, a good theoretical answer to my question about why anyone would choose to pay corporate taxes if the corporate form does not increase profits. This suggests an empirical test of my hypothosis: Would C corporations cease to dominate the ecconomy if the corporate income tax was higher than the individual income tax? I believe tha answer is no, just as giving out limited liability for free did not end corporate dominance, but I am willing to be proved wrong.
5. Your arguments about the social goods that would result from leaving the profits with the corporation rather than taxing them are empirical utilitarian arguments that I simply disagree with for reasons far beyon this thread. At any rate, these are arguments for a LOW corp income tax, but not for NO corp income tax. Presumeably, for example, the government could do many good things with the revenue from a 1% corp income tax without interfering with any of the positive externalities you mention. Beyond that 1%, we are just negotiating.
6. ““Money doesnt just appear, it is created through the efforts of people.””
Oh, please! I’’M the one making the positive sum argument here. Wealth is created through the efforts of individuals AND the community (government). Assume PI is the production of individuals and C is the existence of corporations. I’’m saying:
The > is created by the C, which is created by both the government and the individuals, and therefore the both the government and the individuals should split the >.

do you have a formula for determining the quantity of the ““>”” in your formula? If I were to agree with the concept of splitting that between the government and the rest of us (which I dont for reasons that go beyond this post) there would still need to be a quantity defined that could be split. Does 1% split it? How about 10%, or 25%? I understand your point that we are simply negotiating, but to do so we need to know what we are negotiating over.
Risk management is indeed a profitability issue, but it is indefinable in exact terms. It is much like the value of insurance. My insurance does me no good at all if I never have to use it. It becomes a complete waste of money. However, if I do have to use it, its value is enormous. How do you quantify risk management into exact taxable dollars?
LLC’’s do not issue stock for public ownership. The dominance of C corporations as far as I know is directly tied to their ability to raise very large sums of capital from a far broader base of people to accomplish goals of production that require immense startup sums. I currently work for an LLC. We can get investors, but we can not issue stock on public markets. There may be LLC’’s that can, I have not fully researched this.

limberwulf -
1. ““How do you quantify risk management into exact taxable dollars?””
Beats me, but people in the insurance industry do it all the time. This may sound like a cop-out on my part, but it is not. If you were to ask me how I could possibly build an internal combustion engine, I would say that I would hire one of those people who build those that I see all over the roads. The expersis to do this rather precisely is out there for hire.
2. Personally, I would set the percentage the same way that Scholastic decides how much to charge for a Harry Potter novel. Recognizing that demand goes down as price goes up, charge what ever will bring in the most revenue. Again, assuming my theory that corporate taxes are paid out of increased revenue due to corporate existence is correct, this rate will represent the best ““deal”” the government can get.
A reasonable conservative position would be to set the rate at what will maximize social goods, which means public revenues plus the net of positive externalities over negative externalities. I would still disagree with this though, because I do not think the public should be any more willing ot count the birds in the bushes any more than corporate investors do.
3. ““The dominance of C corporations as far as I know is directly tied to their ability to raise very large sums of capital from a far broader base of people to accomplish goals of production that require immense startup sums.”” Bingo! Now you’’re giving me support for my position. The C corps DO provide economic advantages that are confered by the government granting corporate existence. Thanks.

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