No Rush for a Zero Corporate Tax

An opinion piece by John Steele Gordon in the Wall Street Journal proposes that many good things would come of reducing the corporate income tax to zero. I suggest there are many unforeseen ramifications of doing away with the corporate tax, and instead I propose a flat tax with phased-out deductions, depreciations, and expensing.

The proposed rush to a zero corporate tax would send shock waves through an economic system built, in many instances, upon the complexities of the tax code. The industries reliant upon the tax deductibility of their goods and services would be severely harmed, and there are a host of such industries and businesses.

Other objections to Mr. Gordon’s reasoning include:

Gordon: ”….that engine of tax complexity disappears. And with it disappears an army of lobbyists in Washington working to get favorable tax treatment for corporations."

The same could be said of a lower and flatter tax. The tax consulting industry would be shattered. I harbor no affection for tax accountants, yet those in the industry must not be put out of business in one sudden move. Additionally, lobbyists might lose their nefarious function of carving deals for industries, but they might not as well. Special consideration purchasing will not go away. Witness the last budget passed with the Dodd-Frank carveout for banks.

Gordon: “….corporate managers are currently most concerned with after-tax corporate profits, because that is what the stock market cares about. But after-tax profits are largely an artifact of lobbying success in Washington. With no corporate income tax, management would concentrate on what are now pretax profits, an artifact of actual wealth creation."

Pretax profits are and will remain a preeminent concern of corporations. The stock market seems to be doing pretty well with corporate taxes in place.

Gordon: “…there would be no reason to tax dividends at lower rates to compensate for the fact that they now are paid out of after-tax profits. They would be taxed at the full rate, removing a perennial tool of leftist demagoguery.”

So the net to the shareholder only remains the same if the corporation increases dividends by the appropriate percentage to offset the higher tax treatment on the receiver end. Corporations may choose other courses of action than this, leaving the dividend receiver in a worse position.

Gordon: “…with suddenly increased profits, corporations would increase both dividends and investment in plant and equipment, with very positive effects for the economy as a whole and increased revenue to the government through the personal income tax.”

That is a logical conclusion. Yet, more likely, the corporations would buy back their own shares, activating stock options, and continue with the ever-increasing compensations of their executives. If they indeed buy more equipment and investing, that new business could very well go overseas or be provided by foreign entities. And, there must be a pull from demand for what they produce before they would expand.

Gordon: “…Fifth, stock prices, which are a function of perceived future earnings, would rise substantially, inducing a wealth effect as people see their 401(k)s and mutual funds rising in value. That would lead to increased spending and thus increased tax revenues.”

With the zero corporate tax would come the necessary disappearance of depreciation, expensing, and other writeoffs, loss carry forwards, etc. For if there is no tax, then why deductions? The ramifications of this are unfathomable. Let us take the impact on pro sports, for example. No longer could these big salaries be expensed and the contracts depreciated. Pro golf purses, an advertising writeoff, would plummet. Sport tickets could not be deducted as an expense. While the example is not of a critical economic nature, it points to the ripples through the economy which would rock many a boat.

Gone will be tax breaks for:

  • Vehicle and Equipment Leasing Deductions
  • Entertainment Deductions (Restaurants, Sport Venues, etc.)
  • Travel and Conference Deductions (Convention business, Hotel, etc.)
  • Software and Computer Deductions
  • Charitable Deductions (children’s hospitals, medical research, veteran help services, etc.)
  • Advertising Deductions (sport purses, sport salaries, media advertising all will suffer)
  • Legal and Professional Fee Deductions (professional service, tax preparation, legal services, bookkeeping and accounting)
  • A Host of Operating Deductions

Extrapolate the impacts on all the industries connected to the aforementioned.

Gordon: “Much of the $2 trillion of foreign earnings, now kept abroad to avoid being taxed when repatriated, would flow into this country. That would greatly increase the country’s liquid capital. That, in turn, would cause interest rates to decline and investment in plant and equipment and new technology to go up, boosting the economy as a whole, and thus federal revenues.”

Repatriation would be a one-time event. It may offset the lost revenue of a zero corporate tax, for a while. As for promoting lower interest rates and higher stock prices, one can only say, really? Zero interest rates and record high stock prices don’t really need a push at this point.

Gordon: “The U.S. would now have the lowest corporate income-tax rate (which is to say, zero) instead of the highest, foreign corporations would flock to invest here, especially as they would not have to pay taxes on profits when they brought them back to their home country. Only the U.S. taxes repatriated offshore profits. “

Those corporations in countries with lower corporate taxes do not enjoy all the expensing, depreciation, and deductions that are provided by the U.S. tax code. So to compare their rates with ours is apples and mangos. A phased-in reduction in the rate and a simplification of code is warranted.

Gordon: “…foreign countries, faced with a huge investment boom in the U.S., would be forced to lower or eliminate their own corporate income taxes, increasing domestic corporate profits and thus domestic investment and personal income, helping to end the economic malaise that has lingered since the world-wide financial crisis of 2008.

Many of these countries are already broke. To force them to make further cuts in taxation might cause a worldwide economic collapse. Bond holders would go unsatisfied.

With record high stock evaluations and prices, with record low interest rates, and with an $18 trillion dollar national debt, interfering with revenue generation via eliminating the corporate tax rate is a curious proposal. What is needed are lower rates with dramatically reduced complications of the tax code. A zero tax rate would eliminate deductions for such a wide variety of goods and services that the impact is difficult to gauge on those industries that provide those goods and services. Corporations might indeed have more money on hand, but being bound to making sound financial decisions for bottom line considerations, corporations will resultantly pull back on expenditures once subsidized by the tax code.

Now is not the time for a zero tax code, but it is the time for a flat corporate tax with a reduction, not elimination, of deductions and expensing. And the question remains, why wouldn’t every one incorporate themselves if the corporate tax was zero? From the plumber, to the carpenter, to the restaurant manager, everyone could and should incorporate, bill their services and pay no taxes. What then of tax revenues and the national debt?