Corporate taxes are not productive

For a book that is supposed to provide objective analysis, the title of this chapter may seem a little overbearing. After all, aren’t there two sides to every story? Well, when it comes to the economics of corporate tax, the answer is a big fat no. There is no economic justification for its existence. This statement boils the blood of liberals, and it surprises most of the general public. Sorry to hurt people’s feelings, but there is no escaping the truth. And this is the almost universally accepted view among economists, both Republican and Democrat. In fact, of all the bad taxes out there, economists consider the corporate tax the most harmful to economic growth. If the corporate tax must exist, of course we should strive to make it as efficient and simple as possible. And much of Part 2 of this book discusses the possibilities along these lines. But we must always keep in the back of our minds that all we are doing is making a fundamentally flawed situation less awful—like when we order a Diet Coke with our double cheeseburger. Why are economists so whiny about the corporate tax? Are they so enamored with free-market capitalism that they are willing to let the world’s most powerful and rich organizations shirk the responsibility of contributing to the national welfare? Economists are devoted to minimizing government interference in the marketplace. They want the government to stay clear of market decision-making. They want a level playing field. In the realm of business taxation, this veneration of the free market translates into the commandment, Thou shalt tax all business income equally. That means all business income should be taxed once. The corporate tax double-taxes business profits. When economists condemn the corporate tax, they are not thinking about politics or even about popular conceptions of fairness. They are focused on long-term economic growth. Their models tell them the corporate tax is a drag on national productivity. There are two reasons for this. First, the corporate tax shrinks the size of the nation’s capital stock. And second, because it alters the allocation of capital, the efficiency of the capital stock is diminished. Besides—and here’s the main point—corporate profits are already taxed at the individual level. To illustrate their concerns, let’s suppose we lived on island that had only two kinds of businesses: apple growing and peach growing. Now suppose all production is subject to tax. But also, for some reason that no one can remember, apple production is subject to a second tax. The second layer of tax on apples has two effects. First, the tax reduces the overall profitability of the fruit business. Overall investment in the island’s economy declines. The second problem with the additional tax on apples is that it shifts the mix of the production away from apples to peaches. If there were no second tax on apples, the allocation of resources between apple and peach production would be determined purely by efficiency considerations. Besides making island production smaller, the tax-induced switch from apples to peaches makes the mix of production less efficient. If government must have the revenue, it would be better to tax apple and peach production equally, or even better from the economists’ perspective, tax the consumption of fruit instead of its production. The corporate tax is analogous to our hypothetical second tax on apples. It not only reduces the capital stock, but it leaves us with a mix of capital that is less productive.