Corporate Taxes are Personal

The Organization for Economic Cooperation and Development (OECD) recently released a report showing the United States as a low-tax country as compared to other OECD countries. Of course, the term “low-tax” is all relative.

It also doesn’t give us a very good picture of what is happening. For example, in the U.S., 39% of all government tax collections (at all levels) come from taxes on personal income, profits, and gains as compared to just 25% from the OECD countries. However, the U.S. wins out in not having a value-added tax (VAT).

It is also important to note that we are talking tax collections here, as opposed to overall government spending. Since the U.S. federal government has had a habit of massive deficit spending, some of our wealth is confiscated indirectly through the use of debt. But this is also the case in other countries. It is worse in Japan.

Perhaps one of the most interesting things to note is corporate taxes. In 2014, 46% of U.S. federal revenues came from the personal income tax, and only 11% came from corporate income taxes.

When comparing the OECD average with the average of overall tax collections in the U.S., both account for about 8% of tax collections. Yet the United States has one of the highest corporate tax rates in the world. How could this be? We will get to that question later on.

Corporations are Individuals, Sort Of

The U.S. Supreme Court ruled that corporations are like people, but this had to do with free speech. I would like to apply this analysis in a different aspect.

When we talk of corporate taxes, many people simply just don’t care. Worse, many on the left are quick to say that we should raise corporate taxes and close loopholes. They want to stick it to big business.

But let’s walk through an exercise of just who owns a business. When it comes down to it, every piece of property that has an ownership claim is owned by some individual or group of individuals. The only exception I can think of here is government, which does claim ownership to certain land and buildings. Perhaps there are other exceptions, but for the most part, all wealth is owned by individuals (unless the state lays claim to it).

If the government taxes corporations, this means that a certain amount of wealth is going to the government. You can think it is just magically coming from the big, bad corporations, but it is ultimately coming out of the pockets of individuals.

All companies are ultimately owned by individuals. Every building and piece of equipment is owned by individuals, even if it is done through shares. If you own shares in a company, you own that company’s assets, even if it is just a tiny fraction of a percent.

When a corporation is forced to pay taxes, it is coming out of somebody’s pocket. More accurately, it is coming out of a lot of different pockets.

In many cases, the corporation has to pass those costs down in order to stay profitable. This can mean lower salaries for employees. It can mean higher product prices for consumers. If the costs can’t be passed along, it may mean lower dividends and share prices for shareholders. And let’s not forget that some of those shareholders are middle-class people with 401(k) plans and pensions.

Therefore, we can stick it to these big companies all we want, but we are ultimately hurting ourselves. Wealth is being confiscated from society and being spent by politicians on their projects. This wealth is not being spent to meet consumer wants and needs as determined by the market.

The Laffer Curve

In the 1970s, economist Art Laffer came up with what is now known as the Laffer Curve. He supposedly sketched this out on the back of a napkin.

It really wasn’t earth-shattering news. It is just a curve to show that there is some tax rate where government revenues will be maximized.

(As a side note, the term “government revenues” has always bugged me. To me, revenues are sales from people buying something. When the government gets “revenue,” it isn’t selling anything, except that you will end up in jail if you don’t pay up.)

The Laffer Curve is just common sense, although sometimes that is not that common. It is common sense in the fact that raising marginal tax rates will not always yield increased tax collections to the government. At some point, “revenues” will actually decline.

Let’s say the government declared that after you make $100,000 per year, your marginal tax rate would go up to 100%. Would you work any extra beyond that income so that you can turn over every additional penny to the government? There might be a few crazy people that would, but not many.

Even at a 95% marginal tax rate, most people aren’t going to work any extra in order to keep $5 for every $100 they earn.

One of the problems with the Laffer Curve is that we really have no idea where the top of the curve is. Laffer didn’t claim to know this either. In terms of maximizing government tax collections, the top rate could be 90% or 30%. The only thing we can be sure of is that it isn’t 0% or 100%, both of which would yield virtually nothing.

The biggest problem with the Laffer Curve is that it was used to justify higher spending, especially during the 1980s. Personally, I don’t think our goal should be to maximize government tax “revenue.” We should be going the opposite way, where the government takes as little as possible.

Still, it is ridiculous for a country to have such high tax rates as to actually be able to lower tax rates and get higher tax collections.

The Reagan administration lowered the top personal income tax rate from 70% down to an eventual 28%. On the other hand, the Reagan administration also increased payroll taxes. Both moves led to increased money being paid to the government, but it was also a time of economic recovery.

Although Reagan has a reputation of having been a fiscal conservative, spending and debt increased dramatically during his eight years in office. So regardless of whether the Laffer Curve “worked” or not, the increasing tax money coming in could not match the increases in government spending.

The Laffer Curve on Steroids

Is the Laffer Curve an explanation for the relatively low tax collections by the U.S. government from corporations? Would a decrease in corporate taxes lead to more money being collected?

I think there is little question that a modest decrease in the corporate tax rate would actually yield higher tax revenues. I would be in favor of eliminating the corporate tax altogether, but we know that isn’t going to happen anytime soon.

When personal income tax rates are high, the theory is that people are discouraged from working. But unless the rates are really high, there probably aren’t going to be that many people who work significantly less. There might even be people who work more to make up the difference. So while the Laffer Curve does apply to personal income tax rates, we shouldn’t overstate its effects, especially with rates below 50%.

Corporate taxes may be a different story, though. The reason is that companies have more choices. Most individuals aren’t going to move out of the country, but it is easier for a company to establish headquarters in another country.

There is a recent wave of U.S. company inversions, meaning that companies re-incorporate in a foreign country with lower tax rates in order to reduce their tax burden. This means that several major companies are paying far less to the U.S. government as compared to what they would have paid if they had stayed in the U.S., even under lower corporate tax rates.

You can call this the Laffer Curve or whatever you want, but the fact is that the high corporate taxes, along with the regulatory environment, is driving multinational companies overseas.

The U.S. needs to get with the rest of the world (or do better) and dramatically lower corporate tax rates, which have been at a marginal rate of 35% for over two decades.

But I don’t want this to maximize government “revenues.” I want this so that businesses will feel welcome in the United States. We will all ultimately benefit from higher wages, lower prices, and an overall better business environment.

In addition, the high corporate taxes misallocate resources and even cause companies to get into financial trouble. For example, companies are more likely to take on debt, as interest payments on debt are tax deductible, whereas equity financing is not.

There are a lot of things to blame for the struggling economy and the struggling American middle class. You can add high corporate tax rates to the list.

Until next time,

Geoffrey Pike for Wealth Daily