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Corporate Tax Reform

There is now talk of tax reform in Washington. Both the personal and corporate tax codes are under discussion and the President has also signaled his interest in the reform of the corporate tax code. Here is a suggestion courtesy of, you guessed it, Milton Friedman (I will post a reference if I can find it). Eliminate it entirely and tax the income through the personal income tax code.

Corporations are treated for tax purposes as though they are taxable entities separate from households but this is clearly not the case. Corporations are assets owned by households (the stockholders) just as houses and bonds are assets owned by households. Except for firms, we do not have a separate tax code for stocks, bonds, and the other assets owned by households although there are tax differences based upon the source of our income. The income earned by a firm is owned by the stockholders but the stockholders allow the management to decide how much of it is retained or passed out to the owners as dividends. Taxing corporate income through the personal tax code does not end the taxation of corporate income. It does eliminate the transaction costs imposed on society of all the tax machinery in place to tax corporate income. So in this system, corporations determine taxable income and then apportion it to each unit of stock which gets reported on the personal returns of the stock owners. Think of the the resources that would be freed up in firms that could be devoted to wealth creation.

I sometimes think of the government as running a lawyer relief service since we continue to be burdened with more and more laws and regulations. Eliminating the tax code that exists for corporations would remove a big chunk of that burden. Isn’t it wonderful to think of all the accountants and lawyers that would be out looking for a job if this reform were carried out?

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Categories: Fiscal Policy, Taxation
  1. August 6, 2013 at 10:58 AM

    For clarification, the tax code does treat income from stocks, bonds, and other passive income as unearned income. This kind of income is not subject to the ceiling rate that applies to earned (wage and salary) income. In addition, the transfer of such investment income is subject to a capital gains tax, one that varies over time at the discretion of Congress. Occasionally, Congress (with pressure from lobbyists) drop the cap-gain rate. This encourages the disposal and trading of assets in the market from time-to-time.
    I agree with you that corporate executives and their “friendly” boards tend to be self-serving in respect to bonuses, retained earnings (that find themselves going to salary increases in the following FYs), and taxable income apportionment. However, the last one is often manipulated to increase stock price (maintaining a constant ROI in the market), especially before companies are sold outright. Manipulating profit for a few years before sale is something that I’ve seen in large-, medium-, and small-cap firms.
    In all, corporate earnings are (or should be) a flow-through individuals. However, stockholders have had to take rights cases to court as the “best and the brightest” abused these rights. In terms of accountants and attorneys, I would expect a shift in revenue to a different class of them, as individuals would opt to form closely-held S corps and LLCs as conduits to protect their increased unearned income from taxation.

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