The Mythology Surrounding the Corporate Tax Rate

While there’s seemingly a bipartisan view that the U.S. corporate tax rate should be lowered, the mythology about this same levy is impressive even by Washington standards. The more it’s debated and discussed, the more in the way of untruths about it reveal themselves.

First up is the notion that the U.S. corporate rate of 35 percent is the second highest among OECD nations; Japan being first. While that’s true in a sense, it has to be remembered that the effective tax rate on U.S. businesses is lower than the headline rate. It would be folly to presume most corporations pay 35 percent of their profits to the federal government given the myriad deductions offered by the favor factory that is Congress. Simplified, whenever readers see an abnormally high rate of taxation on anything, they should look behind that number to find the various tax breaks that lower the same rate.

President Obama has gestured that he would like to close some of the loopholes that lower the rate, particularly with regard to foreign earnings, but absent a parallel reduction in the corporate rate itself, it’s charitably naïve for him to assume that corporations will let their profits lie in wait for the greedy hand of the federal government. When profits are targeted by the tax man, they often disappear. On the other hand, many on the right engage in similarly naïve thinking which suggests profits made overseas, if treated benignly by the feds, would return here such that jobs would multiply. That’s a nice thought, but as dollars are fungible, no matter their locale, they’ll always return here depending on the growth opportunities available.

It’s also frequently stated that businesses don’t in fact pay the corporate tax, but their customers do. What’s striking here is how many free market types buy into this notion. The obvious problem with it is that companies only pay corporate taxes after they’ve made a profit on the goods and services they sell. The prices of both reach market-clearing levels based on what the market will bear, so while corporations would doubtless love to pass taxes paid after profits onto their customers, simple market forces make this a logical impossibility.

Customers do, however, ultimately pay the corporate tax, but for reasons that often go unspoken. Indeed, profits earned by companies are the reward for doing well by their customers. The greater the profit, the more a firm has taken care of the unmet needs of its customer base. When corporations spend time avoiding taxes, as opposed to serving their customers, the latter suffer.

But more than customers, enterprising individuals are arguably harmed most by the corporate tax in the same way that high levies on the rich ultimately hit the non-rich most acutely. When governments succeed in expropriating the earnings of the rich, they reduce the amount of capital in the private sector that would otherwise be available to fund economic growth. Along those lines, it can’t be stressed enough that without capital, there are no wages.

Looking at the impact of corporate taxes on the individual, at first glance we should say that profits retained can be banked so that healthy companies can essentially save for a rainy day. When those profits are confiscated, companies have less of a cushion to tide them over when the unexpected occurs. This should be remembered by readers the next time they hear about mass layoffs within one or many corporations.

Taking this further, when corporations forfeit a percentage of their gains to the federal government, they by definition have less capital to invest in future growth. Democrats and Republicans both talk incessantly about their love of jobs, but in maintaining a tax on corporate profits, they’re allowing the very expropriation of capital that would in many cases fund the kind of expansion that would require hiring.

About the tax treatment of corporate profits, it ultimately must be said that when we tax business success, we create disincentives to greater success while robbing those same companies of their future. Better to abolish corporate taxes altogether so that companies have the incentive to be intrepid agents of growth, rather than careful evaders of the IRS.

In short, corporations very much do pay corporate taxes. But as opposed to passing on the pain directly to their customers, they do it in unseen ways that make them distracted servers of their customer base, and those distractions retard the kind of positive economic activity that if allowed, would lead to more in the way of employment opportunities.