Berk: Kill Business Profit Tax; Dock Investors Instead

The corporate income tax, part of the U.S. tax code since 1909, is a failure on all counts. It isn’t raising much money. It isn’t creating socially desirable incentives, and it isn’t immune from manipulation. We should get rid of it in favor of more efficient levies on capital.

There are two commonly held myths about corporate taxes. First, that they bring in a lot of money. They don’t. Last year, only 8.9 percent of government revenue came from such sources. Second, that companies pay the tax. They don’t; only people pay taxes. The corporate tax is extracted from persons associated with a business: investors, employees and customers. Government revenue from these people has been dropping steadily since the peak of almost 30 percent in the 1950s.

One reason why the corporate contribution is low is the tax break for debt. Companies’ payments to debt holders are deductible, while dividends for equity holders aren’t. This imbalance was written into law a century ago, when corporate-tax rates were so low that the disparity didn’t seem to matter. As those levies have climbed, corporations have become eager to take on leverage and thus lower their payments to the Internal Revenue Service.

We witnessed the consequences of this policy in 2008. Corporations, especially banks, opted to issue too much debt, ultimately imposing huge costs on society. One might argue that the leverage subsidy could be better eliminated by simply removing the exemption for debt payments. But that solution is unlikely to succeed, given corporations’ immense lobbying power in Washington.
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