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One problem with eliminating the corporate tax is the potential for abuse. High income individual incorporates and has all income funneled through the corporation, then takes only a small salary, resulting in a much lower tax rate.

I worry about maintaining revenue neutrality. The rich and powerful would do their best to keep rates down. Recent history suggests they would succeed. Raising top rates and reducing corporate welfare are extraordinarily difficult.

A benefit of eliminating the corporate tax, which you don't get with a rate reduction, is decreased compliance costs. You'd eliminate, or greatly reduce, the cost of filing plus the likely larger cost of figuring out clever strategies (both direct costs and the inefficiencies of acting for tax reasons).

I would not advocate a full elimination either - far, far too many unintended consequences.

The amount of waste we put into compliance with the corporate tax is absurd.
Please tax me more so that I don't have to spend my energies on tax compliance and avoidance.

I have no worthwhile opinion on the initiative itself, but it's interesting that the question "can we make it stick?" seems to be central to a policy question. Didn't someone say that "you can't write down a tax policy that I can't avoid"?

To me, the vagueness of the Occupy movements demands is entirely appropriate, because defeating inequality will require a change in norms. Only then will a tax policy, whatever it is, be implementable.

There are two problems with reducing corporate taxes to zero. The first is that nobody but the corporations benefit from reducing corporate taxes. I know economic theory says employees and consumers should benefit but in the real world neither do.

The second problem that arises is that governments would no longer be able to use tax breaks to lure jobs. So they'd end up giving out real money instead. There was a case in the US I read about recently where a corporation wasn't paying any taxes so in order to keep them from moving the government was allowing the corporation to collect and keep certain payroll taxes. While I understand you are against corporate welfare and your reasons for it, the reality is that it isn't going away; in fact I'd wager it has gotten worse since the Conservatives took office despite their claims to be against it also.

I haven't seen any attempts to quantify it, but I suspect corporate welfare has gotten worse in the last few years. Surely the Fraser Institute would have these numbers - I will have to check.

Quebec reality = you are wrong (sorry)

Quebec is a small entreprise country, meaning,: you reduce corporate taxes and the owner buy a bigger boat, built in Argentina.

Then, no benefit for the Province oer the Country (Canada)

Compliance is indeed a f... big burden

Marc, if the owner buys a bigger boat, they pay more income tax (first to distribute the corporate profit to the individual) and then GST/QST to buy a more expensive boat.

To Andrew,

Check the TAX code... AND surprise!!! Very little income tax

Except Republicans would insist replacing the "over $100k" with "under $100k".

Why does nobody ever talk about Milton Friedman's brilliant proposal (note that that adjective is beinfg written here by a wild-eyed liberal...):

Eradicate the corporate tax, and tax all corporate profits like S-Corp profits -- on individual returns of shareholders, whether or not those profits are distributed.

Capitalism and Freedom page 174

Because corporations are not perfectly profit-maximizing toward the interests of their shareholders, but like any human institution spend nontrivial amounts of their resources on the welfare (i.e., income) of their management, without this showing up on tax returns. In short, the corporation spends on certain things but the gain neither shows up on management tax returns nor shareholder dividend/capital-gains returns.

e.g. fancy office buildings cost a pretty penny, and exist to attract a given class of management, but don't show up as management income (instead they reduce the taxable management compensation!). They generally occur to the detriment of shareholder value, and don't show up there either.

How do you tell, for tax purposes, whether a corporation is spending on a building necessary for its operation vs. a building desired through the individuals in senior positions consuming under the corporate veil?

Scott is right to focus on the payroll tax. Raising the general income tax while lowering the corporate rate does not make sense.

The reason is that most small businesses in the US are not incorporated or are incorporated as S-corps. That means that business income is passed through and taxed at the individual level as general income. So war your scheme does is increase the distortions in favor of C corp structures.

This about half of nonfarm GDP.

So I think you are confused. You think there is a business tax in the US. There isn't. There is a generic income tax and a payroll tax. Somewhat perversely, wage income is credited from the general income tax via the earned income tax credit.

But regardless, when Scott proposes raising payroll taxes, he was speaking precisely right and your proposal to raise general income taxes is precisely wrong.

100% for the last post from David

100% to Jon too

Steve Roth:

The compliance costs to track individual shareholders and credit them with corporate profits would be very high. It also doesn't work on a cash basis since you are accruing income stored in the corporation but do not actually have control of the funds to disburse to the government to pay the tax liability. A non-trivial number of people can be stock-rich and cash-poor.

Due to signing authority issues the only way to undisbursed tax corporate income is to tax the corporation.

This proposal also concerns me in that it assumes that those who make over $100,000 are connected with a corporation through ownership. Therefore removing corporate tax and placing it on high-income individuals is a perfect substitute or at least a close one. I don't agree. There are many people who are either sole proprietors, partners, regular employees without ownership or employees in the public sector who do not have a corporate ownership relationship which drives their income.

For this large group it is simply a tax increase. OK by my politics but why this group has to pay to relieve corporations of their tax burden is a point that escapes me.

Whoops - I was trying to think through what it would look like in Canadian context. Should have made that clearer.

The Friedman proposal wouls align management behavior with shareholders interest. Once they get taxed while not receiving dividends, retained earnings are out and you can't escape taxes by accumulating them and cashing out as capital gain.

Steve Roth,

I think the problem with both your and Mike's proposal is a very real political/policy one. Taxing corporations enables governments to tax income that would otherwise be derived by shareholders who are not subject to tax, namely non-residents and non-taxables (RRSPs, pension plans, etc.). From a policy perspective, not taxing income derived by non-taxables may not be problematic, but not-taxing non-residents is a significant problem (and, in practice, without rewriting most of the world's tax laws and the web of tax treaties, such taxation would either result in double taxation or be in violation of most Canadian and US tax treaties). Moreover, from a political perspective increasing tax on voters in order to reduce the tax burden on non-residents is politically suicidal. If you were starting from scratch, you might be able to make something this work, but we have to deal with the world in which we live.

In terms of economic incidence, for a small open economy like Canada, if (like me) you think that corporate income tax is borne by workers, this sort of proposal may make sense. On the other hand, for a large open economy like the US, were there is at least some evidence that the incidence of corporate income tax is borne by foreign investors (including foreign investors who don't invest in the US), this proposal makes little sense (that may be why the US is the last high corporate income tax country).

Determinant,

I agree with you on the compliance cost of Steve's proposal. They'd be painful for companies with a large number of shareholders or with unsophisticated shareholders (in contrast, S-corporations can generally have a relatively small number of shareholders, and of course, they tend to be relatively sophisticated). It would be a mess. Curt Doolittle is right that corporate tax compliance is a pain in the butt, but Steve's proposal doesn't reduce it (the corporation still has to compute its income for tax purposes so that shareholders can compute their own income), it just creates additional tax compliance at the shareholder level.

But the cash-flow issue could probably be managed. What I'd expect you'd see is that, if the tax law were to chance in the manner suggested by Steve, you'd see an evolution in the relevant corporate laws, i.e., amendments to Canada's various corporate statutes to mandate minimum annual distributions to cover at least some of the tax liabilities of their shareholders (subject to the usual corporate solvency rules). We don't see those rules now, because there's no need for them, if the tax law were to change in such a manner, I'd expect to see the corporate law follow-it. At the very least, you'd see such provisions added to corporate articles or unanimous shareholders' agreements. It is a real issue for partnerships and many trusts, such as mutual fund trusts, whose income is taxed in the hands of partners/beneficiaries. For the most part they manage the issue, although there is always a risk (every mutual fund prospectus has a section where they tell you they might make non-cash distributions (i.e., issue new units) which would trigger a tax liability without providing you with cash to fund it).

Jacques: "The Friedman proposal wouls align management behavior with shareholders interest. Once they get taxed while not receiving dividends, retained earnings are out and you can't escape taxes by accumulating them and cashing out as capital gain."

Would it? Don't get me wrong, I've a firm fan of dividend investing because I think that regular dividends impose a certain degree of discipline on corporate managemen. But you still have a disconnect between shareholder and management interest, since management could still divert corporate profit to their pockets, since management compensation tends to be tax deductible. Moreover, query whether pushing out retained earnings is always in the best interest of shareholders (these days, for examples, corporations sitting on big piles of cash have all sort of opportunities that would be hard, or at least expensive, to exploit if they had to raise cash in the market). I can think of a few former income trusts who have gotten themselves into a world of trouble because they funded their operations with debt while pushing out cash to their unitholders.

Thinking a bit more about it, this proposal assumes a direct path such that accrual of income in a corporation accrues directly to the shareholder. Not so fast, for a few reasons.

First, most shares are held in "street name", the name of the brokerage through whom the shares were bought. This is the name on file at the Canadian Depository for Securities and which exercised the legal proxy. The broker holds the shares on deposit for the account owner but can lend them out for shorting purposes and otherwise trade in them. So the corporation doesn't actually have a record of who its owners are for communications purposes. This proposal assumes there is a direct link, which is reasonable for a small incorporated non-public company with one location and five owners, but it is ludicrous for something like the Bank of Montreal.

Second, how exactly are the accruals to be credited? Again, the owners of my posited five-owner company will likely be there for a number of years. However the period of ownership for those who hold BMO shares can be measured in days if not minutes. Does the BMO have to provide a daily income statement to properly credit shareholders for tax purposes? What if it has a loss in one quarter but three profitable ones?

Right now accrual of capital gain income or dividends occurs on date of sale or distribution. That is an easy transaction. But for a single share that has been traded 100 times over the course of a year? That is a nightmare.

"the TAX code... AND surprise!!! Very little income tax"

Marc,

I can only speak about the Canadian Income Tax Act (our Yankee friends have a tax code), but the effective tax rate on dividend income from small businesses is something like 32% (at the top income bracket in Ontario, off the top of my head I couldn't tell you what the Quebec rate is, but it would be the same order of magnitude). Hardly small, and that's after corporate level tax (in practice, Canada have pretty effective integration of corporate and individual tax). And ironically, that tax rate on corporate dividends has gone up over the past couple of years to reflect decreases in the corporate tax rate.

And for GST/HST/QST, he can build the ship anywhere he wants, if he brings it up to Canada, he'd have to pay GST/HST/QST on import.

I think your average working stiff would consider it unfair that they have to pay income taxes but corporations don't.

You'll have to graduate a lot more economics students to make such a plan fly.

I do think lower corporate tax rates are generally a good idea. Lower rates should encourage capital formation and encourage businesses to base higher margin functions in Canada. However, I would not advocating eliminating corporate taxes. Corporate organization is, aside from a means of brining many investors together to fund an enterprise, a tax deferral vehicle. The profits earned by the corporation for the shareholder are not taxed at the individual level until the profits are distributed as dividends. Corporate tax prevents individual investors from getting perpetual deferral of taxes if the corporation never pays dividends.

One tax policy that I would advocate in particular is bringing the real tax rates on dividends and capital gains into line. I don't think the tax system should bias corporations against paying dividends in this way. Plus, I think there are far too many rich people paying low marginal tax rates by getting paid with stock options.

Robillard,

Interestingly, at least with respect to public companies (or more accurately, companies which pay "eligible dividends" under the Tax Act, which generally includes public companies), there is fairly close convergeance between the effective tax rate on dividends and the effective tax rate on capital gains. It depends on the province, but in many provinces the effective tax rate (at least in the top tax bracket) on dividends is within 1 or 2% (above or below) the capital gains rate. Mind you, the big exceptions are Ontario and Quebec, so not minor exceptions (although, in part that's a recent development, as dividend tax credits have been reduced to reflect the declining corporate tax rate). Moreover, in lower tax brackets, the effective tax rate on dividends falls to zero, making divends preferable from a tax perspective.

The treatment of stock options is controversial. In effect we tax the "gain" on stock options like capital gains. From a policy perspective, that might not be entirely inappropriate. Stock options are way to give employees an exposure to the company without the cash outlay. If they bought shares, capital gains treatment would be appropriate, so a case could be made that this treatment recognizes the fact that employess often can't come up with the cash to buy shares (or exercise options) to grant the same treatment as if they did. But I'm happy to concede the equally compelling argument that, hey, employment income is employment income and should be taxed accordingly.

The one thing to keep in mind, though, is that companies generally don't get a deduction when they issue shares pursuant to stock options (there used to be a way to get around that, but it's been shut down). If they simply paid employees in cash, it would be fully taxable to the employees (say at a rate of 46%), but deductible to the company (at a rate of 25%), so it isn't clear that the current treatment of stock options (no 25% deduction, but a 23% tax rate) neccesarily results in a loss to the fisc.

Bob Smith,

Thanks for responding to my post. You're right about the effective tax rates on dividends and capital gains being relatively close, particularly with the reductions in corporate tax rates. There is still a bias in the system for capital gains though. Also, you are right to mention that companies don't get a tax deduction for stock option compensation. I personally think this is a bit of an aberration, since the U.S., and some other countries let companies claim a deduction for this. The fact that Canada doesn't allow a corporation to claim such a deduction is leading to international tax disputes. But you're right that there isn't a significant loss to the fisc from allowing income from stock options to be taxed at capital gains rates.

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