One option President Biden has mentioned for funding his infrastructure proposal is raising corporate taxes from 21% to 28%. They stood at 35% until the Trump tax cuts were passed in 2017.
The public appears to like corporate taxes much more than personal income taxes, even if the proposed increases would affect less than 1% of our population. I suppose it’s because corporate taxes are supposed to get these wealthy corporations to pay their “fair share.” This is highly misleading.
Corporations aren’t “wealthy.” They generate wealth for their employees and shareholders. Secondly, raising corporate tax rates generally motivates corporations to raise their prices in order to maintain the desired level of after-tax earnings. This works fine when they’re competing in the U.S. against other U.S. companies. If they’re competing overseas, it becomes problematic as they must choose between being less competitive or generating lower profits.
President Biden spoke about all of the large corporations that paid no taxes at all but he didn’t mention why that was the case. Consider that when our corporate tax rate was 35%, the effective tax rate paid was 18%. To be clear, corporate taxes are on pre-tax earnings. These earnings are calculated as follows:
- Add in: Revenue, which is total sales of all products
- Subtract out: Cost of goods sold – how much it costs to make the products; expenses, the cost associated with marketing and selling the products, engineering/development of the products, the overhead of a manufacturing organization, general administrative costs like human resources and IT; other, depreciation based upon investment in facilities and capital equipment, interest expenses (less interest earned)
- Difference: Pre-tax earnings (profits)
This result is taxed at the going rate, which is currently 21%. Given that every corporation is taxed at the same rate, why was the effective rate only 18% when the corporate rate was 35%?
The answer is that over many years, Congress has provided benefits to specific industry segments, often called “loopholes,” which have acted as tax rebates for companies within these segments. If all we did was simply do away with these loopholes, then the effective tax rate would be higher now (at 21%) then it was when the corporate rate was 35%.
I have a better idea. Let’s stop taxing corporations at all and tax the wealth that they generate at higher rates. With much higher “after-tax” profits, corporations would have a number of options:
Lower prices in order to be more competitive worldwide.
Pay higher salaries to employees in order to reduce turnover.
Pay higher dividends, which benefits shareholders.
Buy-back shares of their stock, which increases earnings/share and drives up stock prices, also a benefit to shareholders.
How would we make up for the loss of tax revenue by eliminating corporate taxes?
In Case 2), those making higher salaries would pay increased income tax. Perhaps another bracket should be added on income over $1 million; how about 42%?
In Case 3), increased dividends get taxed as regular income.
Case 4) is unique because higher stock prices can be used by shareholders to create gains when they sell some or all of their shares. If they have held these shares for a year or more, the gains are taxed as long-term capital gains, which are capped at 20%. For example, if you earned $2 million in long-term capital gains, your tax would be $400,000 – 20% of the gains. That tax rate is the same as if you had taxable income of $295,000. This is a significant discrepancy that favors the very wealthy who could earn millions of dollars a year in long-term gains but be taxed at the same rate as someone who earned a salary and made roughly $300,000.
Raising corporate taxes makes no sense; it will merely cause an increase in prices and make American corporations less competitive.
Taxing the wealth created by corporations is a far more reasonable approach.