Taxation is a weak deterrent and embeds indeterminacy in enforcement---independently, it’ll be circumvented AND distort the economy.

Corporate tax policy has had many, often concurrent, policy justifications over the decades, from distributive justice to market stimulation and regulation. Furthermore, there are major political justifications for this a tax, which makes the finding of this exact goal difficult.1 The US Corporate Income Tax (CIT) is not the only tax policy with indeterminate justification, but the addition of such polarized public views on the topic frustrates this endeavor greatly. Brauner rightly points out that the CIT is one of the more popular taxes, politically speaking. 2 Indeed, around 52% of Americans believe that the corporate tax rate should be increased.3 This indicates that around half of the American populace believe that corporations should be paying their fair share, whatever that may be. What qualifies as a fair share, however, is hard to quantify, especially given concerns that such a tax may not actually felt by corporations. Put another way, the incidence of the CIT is not clearly known, and this statement is acknowledged by both critics and proponents of the CIT, even though both will stress this fact differently in order to make it fit their view point. 4 It has been proposed by Avi-Yonah that the corporate tax should be modified to look more like the original CIT that was adopted in 1909. This would mean a steeper progressive rate system and the grand aim of disincentivizing monopolistic behavior.5 This paper seeks to reject this particular modification of the CIT. Though the deterrence of monopolistic behavior is admirable, it may be done better through more direct means and regulatory action. Furthermore, this paper will investigate the other myriad of justifications proposed for the CIT, and then discuss which justifications coincide with the policy aim of taxing wealthy corporate ownership. Taking the view that the actual, correct policy aim of the CIT is to tax corporate shareholders (i.e. the wealthy owners of the corporation), this paper will seek to evaluate all iterations of the CIT (as is and as proposed herein) by such standard.6 Thus the modifications proposed by AviYonah in order to tax monopolies are close to this correct purpose of the CIT, but are a bit too indirect and do not capture all corporate profit. Moreover, this paper will not try to propose a new type of corporate tax; the goal of this paper is to merely discern the best aspects and justifications for the CIT in hopes that it may shed some light on current corporate tax policy and debate.

I. What are the aims of the CIT?

There have been many aims, both suggested and officially stated by economists and academics, for the CIT. However, public opinion on the CIT is the single most important policy driver, as close to half of the adults in the US in 2017 agree that the corporate tax rate should be raised.7 This suggests that most people are in favor of a high (or at least higher) US corporate tax rate in order to make sure large corporations are paying their fair share to the IRS. What is so interesting about this general public insistence of increasing the CIT is the fact that most economists are not actually sure who actually bears the burden of this tax.8 This fact is important, because, as stated at the outset, this paper will evaluate all justifications, policy aims, and reforms to the CIT against the accepted aim that the CIT’s purpose is to tax wealthy stakeholders in corporations. Gravelle suggest it is not easy to understand who bears the incidence, even with sophisticated modeling; the burden of the tax may fall together on corporate shareholders, the corporate workers, and even the consumers. 9 This indeterminacy of the incidence leads to a further indeterminacy of how the CIT actually functions, let alone how the CIT should function.

Avi-Yonah proposes that the CIT should revert back to its original purpose from when it was proposed in 1909, which was the limitation and regulation of corporate behavior and, in a narrower sense, monopolistic tendencies. 10 This is in contrast with what Avi-Yonah calls the “traditional aim,” which is the indirect taxation of rich shareholders (i.e. the aim in which this paper has chosen to evaluate all other justifications and modifications of the CIT). 11 The current CIT provides a tax when income is earned through the corporation (i.e. the shareholders), and not just when those shareholders earn a dividend.12 The current CIT therefore maintains the idea that the income inside the corporation cannot just be held passively by rich shareholders and deferred until it is earned to them through a distribution of dividends, but that it will be taxed as earned to the corporation (i.e. the controllers of the corporation). Taxation on earnings realized is one of the main pillars of US taxation, and can be best exemplified through I.R.C. §1001 (gain on amounts realized). 13 Avi-Yonah, however, suggests that because of the incidence problem mentioned above, there are better ways to target those wealthy shareholders, thus mitigating the incidence issue.14 In his view, the corporate tax was instituted in the early 20th century in order to regulate monopolistic behavior and the accumulation of wealth, by incentivizing corporations to engage in antimonopolistic behavior. 15 Avi-Yonah proposes a completely new corporate tax with such antitrust incentives in mind: the new tax base will be large corporations, the shareholders will be taxed on a mark to market basis, and there will be a tax on the distribution of dividends.16 Importantly, the tax will be highly progressive so as to restrain such large, mega-corporations corporations from forming (and incentivize them to break up). Avi-Yonah states:

I would suggest that the effective tax rate on normal corporate profits…be zero. On super-normal returns, since the main concern is monopolies and quasi-monopolies, the tax should be progressive, with a very high tax rate (e.g., 80%) for profits above a very high threshold (e.g., $10 billion). In between, there should be a series of graduated tax rates, similar to the individual rate schedule before 1980.17

This rate structure would allow very little tax to be paid by the normal/small corporations, thus effectively eliminating corporate tax on that end of the profits spectrum. However, the highly progressive structure captures those massive corporations (such as Big Tech, Big Pharma, etc.) in such a high tax rate that there is little incentive to get so big (or stay so big). Furthermore, under this structure, only the corporations with “super-normal returns” (rents) will be targeted by such a policy, as it is those major corporations who have super-normal returns. This means that anything that is not a return on capital (i.e. normal return) should be taxed. Though Avi-Yonah’s modification to the CIT would still target wealthy stakeholders, it would only target those wealthy stakeholders of monopolies or near monopolies (or those large enough to generate rents). This means that a wealthy shareholder of a medium to small sized corporation with just returns on capital will go untaxed on corporate profits, thus going against this paper’s accepted justification for the CIT: to tax all wealthy shareholders.

The fact that Avi-Yonah’s new corporate will give effectively zero corporate tax on those smaller corporations, or those who only have normal returns on capital, is not inadmissible. Interestingly, some critics of the current CIT would agree with this part of his proposal, and would go further to suggest a total elimination of the CIT or a replacement with something more direct, in the hopes of curbing the aforementioned incidence problems. 18 Entin argues that the incidence of the CIT falls on labor to a large extent.19 He suggests that the classical modeling of incidence misses the allocation of burden falling onto labor, which suppresses investment, productivity, and wages. He also takes issue with how the traditional models use “super-normal” returns to apportion incidence between labor and capital, suggesting that these models include portions that should not be attributed to such “supernormal” returns and which are actually highly sensitive to tax.20 In light of this data, it may be questioned whether a tax on “super-normal” returns is proper for the CIT.

Gordon and Sarada have analyzed the traditional concept of taxing super normal returns in order to come up with a new and improved CIT which better maintains productive efficiency while better taxing the realization of gains to corporations (i.e. to mitigate the deferral factor), suggesting that the role of the corporate tax is solely to mitigate deferral of corporate earned profits. 21 They propose that, in a fully closed economy, corporate tax should be set at a rate that harmonizes with personal income tax, thus eliminating the benefit of deferral to the corporate shareholders. In an open economy, however, productive efficiency will only be maintained if the overall rate of the firm’s income is the same regardless of the jurisdiction in which it is reported.22 Thus, the anti-deferral regimes, which militate towards a higher percentage of profits brought back into the US jurisdiction for taxation purposes, help to increase the effectiveness of the CIT. Gordon and Sarada argue, though, that the distortion between the CIT and personal income tax has lowered the overall effectiveness of income tax as a source of revenue.23 They are instead in favor of a consumption tax as a replacement to personal taxation, and, therefore, the CIT. This would limit the ability to shift personal income into the corporate sector, where the income gets reduced tax rates or deferral, thus capturing those wealthy shareholders much better. 24 This proposal has its merits, as consumption taxes are said to be more direct and just, taxing people on what they consume, instead of what income is earned. Thus, the wealthy, who spend more on expensive or luxury items will be taxed in proportion to their spending. The consumption tax is outside of the scope of this paper, but it should be noted that this approach does have merit. 25

II. Other Traditional Justifications: Revenue Raising and Distributive Justice?

Other rationales for taxing wealthy shareholders indirectly through the CIT include revenue raising and distributive justice. According the to the Tax Policy Center, the corporate income tax raised $230.2 billion in 2019, which equates to about 6.6% of the total federal revenue raised.26 This equates to anywhere between 4-10% of revenue raised in any given year.27 Furthermore, this only equates to about 1-7% of GDP per annum.28 In comparison to the personal income tax and the payroll tax, the CIT brings in substantially less revenue.29 These figures are surprising given its popularity, which Norton suggests may be due to the fact that it does indeed raise revenue, no matter how small in relation to the income tax. However, he suggests that the most compelling reason for the CIT’s popularity is the fact that the incidence, as stated, is not known: because no one political constituency actually sees itself as the primary taxpayer, none are willing to lobby for change.30 This may be a stretch given that 52% of Americans are in favor of high CIT rates, suggesting that the proponents of the CIT may be winning. 31 It should also be noted that the incumbent Biden administration have proposed increase for the CIT rates, solidifying the idea that the CIT is probably here to stay.32 Overall, while there is strong evidence that the CIT is popular, there is also equally strong evidence that such tax does not actually fall on the correct target (i.e. the wealthy), and further that the CIT is not as strong of a revenue raiser as most might believe. Thus, the revenue raising justification might not be particularly on point.

The argument against distributive justice being the primary justification for the CIT is much within the same vein. Distributive justice justifications for the CIT insinuate that such tax is present in order to promote equity and fairness within the tax system. The Tax Justice Network is very concerned with the CIT and states adamantly that the CIT is necessary for a just and democratic society.33 They further suggest the CIT regime helps to curb political and economic inequalities and rebalance distorted economies.34 These are large claims and very hard to measure. However, the evidence provided above on revenue raising indicates that distributive justice (i.e. rebalancing economies) may not be the CIT’s main goal. The amount of revenue raised as a percentage of GDP is incredibly small, and, as stated, the incidence is not actually known, suggesting that fairness considerations are not presently shown, or are at least very muddled.35

III. Is there a correct justification for corporate tax policy aims?

As discussed, it is very hard to find cohesive justifications for the CIT, signifying that there may not be one specific justification for the CIT, or that the CIT may be based on a multitude of rationale. Brauner agrees with the former, stating that any justifications for the current CIT are not convincing given the stated incidence problems and the low percentage of revenue raised. 36 While some are completely against the corporate tax altogether, others like Brauner advocate for a corporate tax in a different form.37 He suggests a “tax on the appreciation of stakes (shares) in publicly traded corporations” with a mirroring look-though tax for shareholders of non-publicly traded corporations.38 This would eliminate the double layer of tax, and put all of the corporate tax liability on the wealthy shareholders, thus eliminating the stated incidence problems. While this system might have the advantage of clearly allocating the burden of the tax to those who should be the target of the CIT (i.e. the wealthy shareholders), there are certain practical problems that might stand in the way.

Looking past the fact that that this would mean a total overhaul of the CIT regime as it stands presently, there may be a conflict with the traditional principles of tax law, namely the concept of taxation upon realized gain (i.e. income earned). 39 This tax would be placed on the appreciation of shares held by an investor or corporate owner. Appreciation on shares is not earned, it is just passive growth of a share price. The income becomes earned when there is an event in which such appreciation can be realized (i.e. sale or other disposition).40 Moreover, even if timing issues are solved (i.e. when such gain on appreciation is to be “realized”), there may be issues with valuation, as publicly traded corporations have volatile market valuations. Closely held corporations might have an even more difficult time in valuing their shares, as there is not a general public valuations index like seen with publicly traded corporations in the stock market; though these private business could be valued at their asset basis potentially. These two issues can be easily solved with conventions,41 but it may be more difficult to deal with issues of depreciation. Manipulating the price of a corporate stock in order to evade tax in certain years may be difficult to regulate and enforce against. Overall, this method of taxation could be implemented with conventions and regulation on the shareholders, which is compelling, given its advantages in fixing the incidence problem. Therefore, this could be a better tool for the taxation of rich shareholders than the current CIT.