Tax Corporate Income as Personal Income

Countries around the word have been gradually reducing their corporate income tax rates in order to gain a competitive advantage over their trading partners. Those with lower tax rates attract factories and corporate headquarters, while those with higher rates send factories and headquarters abroad. This trend has been gradually reducing the percentage of income paid by the rich while shifting the tax burden to the middle class.

Both Democrats and Republicans in Washington have put proposals on the table that would reduce the U.S. federal corporate income tax rate. Neither proposal is very good. Both proposals would leave the U.S. tax rate relatively high and would come with riders that would actively destroy U.S. jobs.

America’s top federal corporate tax rate is 35%. Many states charge additional corporate taxes, bringing the combined top federal with average state rate up to 39%. Even without the state rates, the United States had the second highest corporate tax rate of any major country in the world in 2014, as shown in graph below. In 2015 Japan cut its rate further, leaving the U.S. with the highest rate.

Obama’s Proposal

Obama’s proposal should actually be called the “Move Your Corporate Headquarters Offshore Act” because it would send many American corporate headquarters jobs abroad. He would bring the top federal corporate income tax rate down to 28%. The combined federal plus state rate would be 32%, putting the U.S. tax rate between France and Belgium, still one of the highest rates in the world in the above graph.

At the same time, he would tax American corporations on money “parked” abroad that was earned abroad. Such earnings have been kept abroad by U.S. corporations in order to avoid paying the difference between lower foreign corporate income tax rates and higher American corporate rates. Obama claims that his proposal would earn the U.S. government $238 billion in additional tax revenue.

If Obama’s proposal were enacted, many American corporations would have a stronger incentive to move their headquarters abroad (i.e., “inversions”) so that they would no longer be liable to pay the difference between American taxes and foreign taxes on any earnings earned abroad, ever. This would cost the United States thousands of good paying corporate headquarters jobs.

The Republican Establishment’s Proposal

The Republican proposal, being put together by House Ways and Means Committee chairman Dave Camp, should actually be called the “Send American Manufacturing Jobs Abroad Act.” Camp would lower the maximum federal corporate income tax rate to 25%. The combined federal plus state rate would be 29%, putting the U.S. tax rate between New Zealand and Luxembourg, still one of the higher rates in the world in the above graph.

In order to deal with the huge amount of past profits “parked” abroad, Camp would let corporations bring those earnings home subject to a low tax rate. American corporations would be converting their foreign currencies to dollars, which would bid up the dollar. The higher dollar would make American producers less competitive in the world marketplace, costing American producers thousands of manufacturing jobs.

At the same time, Camp would free U.S. corporations from any tax obligation on future foreign earnings (the “territorial system” of taxation). Profits from U.S. factories would continue to be punished by a high U.S. tax rate, but profits from factories located abroad would be completely free from U.S. taxes.

Our Proposal

There is a much better alternative, not being considered in Washington, which would bring in more revenue, make the tax system more fair, and end the tax system’s punishment of corporations for building factories and/or headquarters in the United States.

We propose eliminating the corporate income tax entirely and taxing corporate earnings under the personal income tax, whose maximum rate is 39.6%. There is precedent for this because that is the way partnerships, proprietorships and “S” corporations are already taxed.

This is also the original way that corporate income was taxed. For centuries, under its “Income and Property Tax Acts,” Britain taxed corporations at the basic rate of tax of personal income, and shareholders were credited for the tax paid by the corporations, the earliest example of tax withholding. We should return to that system, which worked quite well.

Instead of paying corporate income tax, corporations would withhold the corporate income tax that their shareholders owe. They would do so at the maximum personal income tax rate, currently 39.6%.

Meanwhile, shareholders would be credited with the withheld earnings against their personal income tax liability. So if they are in a lower tax bracket than 39.6%, they would get the difference back when they paid their personal income taxes.

Where an IRA or pension plan is the owner of corporate stock, the owner of the IRA or the recipient of the pension plan would be treated as being liable for the tax on the corporate profits. He or she would get a tax credit that would be more than enough to pay that liability.

Where foreigners earn America stock, they would pay America’s 39.6% tax rate. Where Americans own foreign stock, they would be liable to pay tax on the income earned by those corporations.

There are many good reasons why corporate earnings should be taxed as personal income.

  1. Fairness. Currently, stock holders in lower tax brackets pay the same tax rate on corporate earnings as millionaires and billionaires. If this change were made, the middle class would get the rate difference back in tax refunds. Meanwhile Warren Buffett’s tax bill would have been at least $1.6 billion in 2010, not just $6.9 million.
  2. Outsourcing. U.S. workers are disadvantaged by the higher rates of corporate income tax in the United States when they are competing with subsidiaries that pay lower corporate tax rates abroad. Partly as a result, U.S. corporations usually build their new factories abroad. Under our proposal, profits earned by U.S. corporations abroad would be taxed at the same rate as profits earned in the U.S., so U.S. firms’ tax incentive to offshore would be eliminated.
  3. Inversions. U.S. corporations are liable for the difference between lower foreign taxes and higher American taxes, which gives them an incentive to move corporate headquarters abroad. Under our proposal, U.S. owners of corporations would receive no tax benefit from inversion, and would instead pay higher taxes because the corporation would be liable for corporate taxes paid to its new home country.
  4. Revenue. The revenue from the federal corporate income tax in 2013 was $384.9 billion on $1,703.8 billion profits, an effective corporate tax rate of just 22.6 percent.

Under our proposal, foreign profits earned by Americans would be taxed, American profits earned by foreigners would pay a 39.6% tax, and the rich would pay 39.6% tax rate on corporate income. As a result, we estimate that at least $100 to $200 billion more government revenue per year would be generated, permitting lower tax rates overall.

Who Actually Pays the Corporate Income Tax?

Corporations are legal entities that are owned by their shareholders. The burden of the corporate income tax is borne by shareholders, unless the corporation succeeds in passing the tax on to its consumers or workers.

Professor Arnold Harberger, renowned expert on the corporate income tax, has found that corporations that compete only against domestic producers are often able to pass the tax forward to consumers or backward to their employees, but that manufacturers who compete with international competition cannot pass the tax forward or backward, so they, instead, reduce their investments in American factories.

Partnerships are legal identities owned by their partners. They produce goods and services, competing with corporations in the product markets. They can have a large number of partners and some are even listed on the stock exchanges. Their chief difference from corporations is that they are taxed differently. There is no reason why corporate earnings should be taxed differently.

How did we get stuck with the corporate income tax? The Constitution required federal taxes to be apportioned equally among the states according to population, something obviously impossible with an income tax. But the corporate income tax got passed as an excise tax and was kept in existence when the 16th Amendment was adopted and the personal income tax enacted.

So what are the arguments in favor of the corporate income tax? Only that we have learned to live with it in spite of its defects. The public likes it because they think, contrary to fact, that it is solely paid by the rich.

They don’t realize that pension funds containing the savings of millions of middle and low income families bear much of the burden and that it encourages corporations to move their factories and headquarters abroad, costing thousands of jobs.

The Richmans co-authored the 2014 book Balanced Trade: Ending the Unbearable Costs of America’s Trade Deficits, published by Lexington Books and the 2008 book Trading Away Our Future, published by Ideal Taxes Association.

Countries around the word have been gradually reducing their corporate income tax rates in order to gain a competitive advantage over their trading partners. Those with lower tax rates attract factories and corporate headquarters, while those with higher rates send factories and headquarters abroad. This trend has been gradually reducing the percentage of income paid by the rich while shifting the tax burden to the middle class.

Both Democrats and Republicans in Washington have put proposals on the table that would reduce the U.S. federal corporate income tax rate. Neither proposal is very good. Both proposals would leave the U.S. tax rate relatively high and would come with riders that would actively destroy U.S. jobs.

America’s top federal corporate tax rate is 35%. Many states charge additional corporate taxes, bringing the combined top federal with average state rate up to 39%. Even without the state rates, the United States had the second highest corporate tax rate of any major country in the world in 2014, as shown in graph below. In 2015 Japan cut its rate further, leaving the U.S. with the highest rate.

Obama’s Proposal

Obama’s proposal should actually be called the “Move Your Corporate Headquarters Offshore Act” because it would send many American corporate headquarters jobs abroad. He would bring the top federal corporate income tax rate down to 28%. The combined federal plus state rate would be 32%, putting the U.S. tax rate between France and Belgium, still one of the highest rates in the world in the above graph.

At the same time, he would tax American corporations on money “parked” abroad that was earned abroad. Such earnings have been kept abroad by U.S. corporations in order to avoid paying the difference between lower foreign corporate income tax rates and higher American corporate rates. Obama claims that his proposal would earn the U.S. government $238 billion in additional tax revenue.

If Obama’s proposal were enacted, many American corporations would have a stronger incentive to move their headquarters abroad (i.e., “inversions”) so that they would no longer be liable to pay the difference between American taxes and foreign taxes on any earnings earned abroad, ever. This would cost the United States thousands of good paying corporate headquarters jobs.

The Republican Establishment’s Proposal

The Republican proposal, being put together by House Ways and Means Committee chairman Dave Camp, should actually be called the “Send American Manufacturing Jobs Abroad Act.” Camp would lower the maximum federal corporate income tax rate to 25%. The combined federal plus state rate would be 29%, putting the U.S. tax rate between New Zealand and Luxembourg, still one of the higher rates in the world in the above graph.

In order to deal with the huge amount of past profits “parked” abroad, Camp would let corporations bring those earnings home subject to a low tax rate. American corporations would be converting their foreign currencies to dollars, which would bid up the dollar. The higher dollar would make American producers less competitive in the world marketplace, costing American producers thousands of manufacturing jobs.

At the same time, Camp would free U.S. corporations from any tax obligation on future foreign earnings (the “territorial system” of taxation). Profits from U.S. factories would continue to be punished by a high U.S. tax rate, but profits from factories located abroad would be completely free from U.S. taxes.

Our Proposal

There is a much better alternative, not being considered in Washington, which would bring in more revenue, make the tax system more fair, and end the tax system’s punishment of corporations for building factories and/or headquarters in the United States.

We propose eliminating the corporate income tax entirely and taxing corporate earnings under the personal income tax, whose maximum rate is 39.6%. There is precedent for this because that is the way partnerships, proprietorships and “S” corporations are already taxed.

This is also the original way that corporate income was taxed. For centuries, under its “Income and Property Tax Acts,” Britain taxed corporations at the basic rate of tax of personal income, and shareholders were credited for the tax paid by the corporations, the earliest example of tax withholding. We should return to that system, which worked quite well.

Instead of paying corporate income tax, corporations would withhold the corporate income tax that their shareholders owe. They would do so at the maximum personal income tax rate, currently 39.6%.

Meanwhile, shareholders would be credited with the withheld earnings against their personal income tax liability. So if they are in a lower tax bracket than 39.6%, they would get the difference back when they paid their personal income taxes.

Where an IRA or pension plan is the owner of corporate stock, the owner of the IRA or the recipient of the pension plan would be treated as being liable for the tax on the corporate profits. He or she would get a tax credit that would be more than enough to pay that liability.

Where foreigners earn America stock, they would pay America’s 39.6% tax rate. Where Americans own foreign stock, they would be liable to pay tax on the income earned by those corporations.

There are many good reasons why corporate earnings should be taxed as personal income.

  1. Fairness. Currently, stock holders in lower tax brackets pay the same tax rate on corporate earnings as millionaires and billionaires. If this change were made, the middle class would get the rate difference back in tax refunds. Meanwhile Warren Buffett’s tax bill would have been at least $1.6 billion in 2010, not just $6.9 million.
  2. Outsourcing. U.S. workers are disadvantaged by the higher rates of corporate income tax in the United States when they are competing with subsidiaries that pay lower corporate tax rates abroad. Partly as a result, U.S. corporations usually build their new factories abroad. Under our proposal, profits earned by U.S. corporations abroad would be taxed at the same rate as profits earned in the U.S., so U.S. firms’ tax incentive to offshore would be eliminated.
  3. Inversions. U.S. corporations are liable for the difference between lower foreign taxes and higher American taxes, which gives them an incentive to move corporate headquarters abroad. Under our proposal, U.S. owners of corporations would receive no tax benefit from inversion, and would instead pay higher taxes because the corporation would be liable for corporate taxes paid to its new home country.
  4. Revenue. The revenue from the federal corporate income tax in 2013 was $384.9 billion on $1,703.8 billion profits, an effective corporate tax rate of just 22.6 percent.

Under our proposal, foreign profits earned by Americans would be taxed, American profits earned by foreigners would pay a 39.6% tax, and the rich would pay 39.6% tax rate on corporate income. As a result, we estimate that at least $100 to $200 billion more government revenue per year would be generated, permitting lower tax rates overall.

Who Actually Pays the Corporate Income Tax?

Corporations are legal entities that are owned by their shareholders. The burden of the corporate income tax is borne by shareholders, unless the corporation succeeds in passing the tax on to its consumers or workers.

Professor Arnold Harberger, renowned expert on the corporate income tax, has found that corporations that compete only against domestic producers are often able to pass the tax forward to consumers or backward to their employees, but that manufacturers who compete with international competition cannot pass the tax forward or backward, so they, instead, reduce their investments in American factories.

Partnerships are legal identities owned by their partners. They produce goods and services, competing with corporations in the product markets. They can have a large number of partners and some are even listed on the stock exchanges. Their chief difference from corporations is that they are taxed differently. There is no reason why corporate earnings should be taxed differently.

How did we get stuck with the corporate income tax? The Constitution required federal taxes to be apportioned equally among the states according to population, something obviously impossible with an income tax. But the corporate income tax got passed as an excise tax and was kept in existence when the 16th Amendment was adopted and the personal income tax enacted.

So what are the arguments in favor of the corporate income tax? Only that we have learned to live with it in spite of its defects. The public likes it because they think, contrary to fact, that it is solely paid by the rich.

They don’t realize that pension funds containing the savings of millions of middle and low income families bear much of the burden and that it encourages corporations to move their factories and headquarters abroad, costing thousands of jobs.

The Richmans co-authored the 2014 book Balanced Trade: Ending the Unbearable Costs of America’s Trade Deficits, published by Lexington Books and the 2008 book Trading Away Our Future, published by Ideal Taxes Association.