Should We Abolish the Corporate Income Tax?

Photograph by Ken Schles/Gallery Stock

No. Bad idea.

OK, sorry, that was a little blunt. After all, there are a lot of smart people who think President Barack Obama didn’t go far enough in his recent proposal to cut the corporate income tax rate to 28 percent from 35 percent. They would like to see it go all the way to zero. They say trying to tax corporations is a waste of time because they aren’t like people—ultimately they just pass along the cost of the tax to their shareholders, workers, and (to a small extent) customers.

The abolitionists aren’t all conservatives, either. The Atlantic‘s Megan McArdle has said the corporate income tax “may be the stupidest tax we have.” Even a liberal like blogger Matt Yglesias asked on Feb. 24 why the U.S. doesn’t just ditch the corporate income tax. (He decided that getting rid of it now and replacing the revenue in a fair way is politically unrealistic.)

But this just might be a case in which the policy elites of both left and right are wrong—and ordinary Americans, who kind of like the corporate income tax, are right. The strongest argument for the corporate income tax is one that is rarely heard anymore but was widely used at its inception in 1909—namely, that the tax is a brake on excessive corporate power.

The person who has pressed this argument is Reuven Avi-Yonah, a professor at the University of Michigan Law School. Avi-Yonah is well-credentialed, with both a PhD in history from Harvard University and a JD from Harvard Law and consulting work for the U.S. Department of the Treasury and the Organization for Economic Co-operation and Development. His 2004 paper, “Corporations, Society and the State: A Defense of the Corporate Tax,” is a classic. Here’s an excerpt:

Why is the corporate tax so politically resilient? The reason seems to be the same as the reason the corporate alternative minimum tax was enacted in 1986—ordinary Americans have a viscerally negative reaction to the notion that large, profitable corporations should pay no tax while they bear the income tax burden. This is universally dismissed as an example of ordinary people’s “fiscal illusion,” the misguided belief that corporations bear the burden of the tax, while every economically literate person knows that taxes can only be borne by natural persons.

But are people really that ignorant? I would argue that the answer is no, and that in fact what people perceive is closer to reality than the economic models of incidence would suggest. The corporate tax is imposed on corporate income, which adds to the economic resources of the corporation. These resources are managed by individual corporate managers, and their control over such resources gives them significant economic, social, and political power. In that sense, imposing a corporate tax reduces the economic resources and therefore also the power of corporate management. Whatever the economic incidence of the corporate tax, from this perspective its most immediate burden falls on corporate management, and not surprisingly they are the strongest supporters of corporate tax repeal.

Republican William Howard Taft, who was President in 1909, was initially skeptical of taxing corporations, but ended up giving a full-throated defense of the measure in his message to Congress. Avi-Yonah dug up a quote:

While the faculty of assuming a corporate form has been of the utmost utility in the business world, it is also true that substantially all of the abuses and all of the evils which have aroused the public to the necessity of reform were made possible by the use of this very faculty. If now, by a perfectly legitimate and effective system of taxation, we are incidentally able to possess the Government and the stockholders and the public of the knowledge of the real business transactions and the gains and profits of every corporation in the country, we have made a long step toward that supervisory control of corporations which may prevent a further abuse of power.

Avi-Yonah considers this a stronger argument than the ones usually advanced by defenders of the corporate income tax, such as the idea that not taxing corporations would make it easier for people to shelter income by stuffing it into their own personal corporations. A century after the Progressive Era, Avi-Yonah comes down pretty much the same way as Taft:

My basic argument is therefore that the corporate tax is justified as a means to control the excessive accumulation of power in the hands of corporate management, which is inconsistent with a properly functioning liberal democratic polity.

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