18 April 2011

Corporate Taxes Revisited

Corporate Taxes as a Percentage of Federal Revenue
1955 . . . 27.3%
2010 . . . 8.9%
Corporate Taxes as a Percentage of GDP
1955 . . . 4.3%
2010 . . . 1.3%
Individual Income/Payrolls as a Percentage of Federal Revenue
1955 . . . 58.0%
2010 . . . 81.5%
Anyone who is serious about closing the US deficit should consider the changes in what corporations pay in taxes and the rise of the deficit.

Mr. Ritholtz seems to have neglected debt as a form of raising revenue, which is why his corporate tax contribution rate is 9%, whereas the IRS places it at 4% (an approximate value).  Actually, once you factor in debt as a means of revenue, the “taxes as a percentage of federal revenue” rates are cut in half for 2010 figures, which suggests that the biggest issue facing the federal budget is deficit spending, not low corporate tax rates.  As it stands, I find Mr. Ritholtz’s recommendation of raising corporate tax rates to be absurd for a couple of reasons.

First, there is absolutely no reason to believe that an increase in one tax rate will lead to an increase in net revenue in a meaningful way.  For the last sixty years, federal tax revenue has been capped at roughly 20% of GDP.  This has been the case when tax rates were and when tax rates were low.  Additionally, fluctuations in revenue are better explained by the business cycle than the actual rate.  The reason why this is important is because it suggests that government spending should be no higher than 20% of GDP.  Since spending is considerably higher than that, it seems reasonable to conclude that solving the fiscal problem is going to require spending cuts, not tax hikes.

Second, tax avoidance exists, and explains the soft cap on revenue.  If corporate tax rates increase, money will be spent to avoid paying taxes and money will be diverted to avoid paying taxes.  People don’t like paying taxes, and that fact doesn’t change with the rates.  What changes is the profitability of tax avoidance.  Those who avoid paying corporate taxes will have a greater incentive to do so in light of a rise in the rates.  Those who don’t have a reason to avoid paying taxes will have even more of a reason to do so once these rates increase.

Third, only people pay taxes.  Raising corporate taxes will not work the way Mr. Ritholtz thinks, because whatever money is confiscated from corporations is actually confiscated from either customers or shareholders.  This in turn means that whatever is confiscated at this time cannot also be confiscated later (in case Mr. Ritholtz was asleep during Econ 101, this is known as an opportunity cost).  Taxes are merely systemic price points, and should be treated as such.  Having more price points doesn’t necessarily mean an increase in revenue, for people will have less money after each price point (because taxes are mandatory). 

This sort of thinking, then, is too clever by half, for it is built on ignoring fundamental principles of economics.
Mr. Ritholtz has thus allowed populist sentimentality to influence policy recommendations, leading to advice that is not grounded in reality, and should thus be discarded.  My personal recommendation for fixing the fiscal mess is simple:  eliminate all unconstitutional spending and implement a single tax (either an income or sales tax) at a single rate, with no exemptions, credits, or deductions.  I see no point in setting the rate higher than 20%, since history has shown that the federal government is incapable of raising revenue in excess of that.


  1. "Raising corporate taxes will not work the way Mr. Ritholtz thinks, because whatever money is confiscated from corporations is actually confiscated from either customers or shareholders."

    Or employees. But the point stands.

  2. I don't know why I tend to overlook employee costs. Probably because they're indirect. At any rate, people are still paying taxes.