Corporate Taxation

Interesting blog post by Jason Furman at The Economist's blog Free Exchange. He defends the idea of taxing income at the business level (corporate income tax), which he and Larry Summers recently put forth as one way to make our tax system more progressive. His main reason: corporate income tax is paid mostly by rich people, and we need corporate tax to combat rising income inequality.

Arnold Kling, a pseudo-economist (meaning he writes about economics but doesn't study it), disagrees, saying that, since corporate income eventually comes out of someone's pocket, it makes no sense to tax businesses in addition to individuals.

Although I'm only a proto-economist myself, I'm going to have to side with Kling on this one. Sure, corporate income taxes are mostly paid by rich people, but not entirely. If we want to tax rich people, why do it indirectly? Just raise taxes on high-income earners. This might be politically difficult to do - a corporation seems like a thing, an object, not a person, and so one tends to feel less guilt about taxing it. So the only reason for corporate income tax seems to be that it lets you sneak some progressivity into the tax system when the rich people aren't looking.

Also, Furman offers little economic justification for corporate income tax. Do business-level taxes make the economy more efficient or less? Every economic model I've ever seen says that business-level taxes are less efficient than straight-up income taxes. So if you're going to challenge that paradigm, I'd like to see a model.

Actually, when I was 17, knowing nothing about economics, I wrote a newspaper column in favor of corporate income tax - but I've since changed my tune. Living in Japan, where corporate income tax is very high, I got to see first-hand some of the negative effects of that policy. Corporate income tax applies to profits, not revenues; so when corporate-level tax is high, companies have a strong incentive to "hide" their profits. Salaries for board members (who tend to be either the owners of companies or executives of the banks that provide companies' loans) get pumped up, which counts as "expenses" and is therefore not subject to corporate tax. That means outside shareholders have little or no power over the company, since the insiders and banks hold all the stock and exert all the control. Companies get bloated and inefficient, are slow to change, and end up in massive crippling debt.

I say, if we want to tax rich people, let's just tax rich people.


Addendum 1: Greg Mankiw weighs in on the debate from a different angle, asking why progressivity (taxing rich people more than poor people) is a good thing in our tax system. He points out that the idea of a "social welfare function" (basically, the idea that rich people care less about a dollar than poor people, so let's take a dollar from rich people and give it to poor people) is philosophical, not economic. I say: So what? The idea that economics should be only positive (descriptive) and never normative (philosophical) is itself a philosophy. And even Mankiw's treasured idea of Pareto efficiency (basically, giving people as much of what they want as they can afford) is based on the philosophy that it's good to give people what they want. Basically, everyone takes a philosophical stand whenever they champion a policy. Moral responsibility is inescapable.

Addendum 2: Mark Thoma comes up with a number of good reasons for progressive taxation - correcting for inequality of opportunity, preventing the populace from getting pissed at globalization, and the "equal marginal sacrifice principle" (i.e. the "social welfare function" that Mankiw pooh-poohed). These are all political-economic reasons, not pure economic reasons. Which is to say, they have more to do with keeping people happy than keeping the economy efficient.