People Pay Corporate Income Taxes

Question: when a corporation earns a profit and pays its annual income tax, who actually foots the tax bill? Does the corporation pay it, or does someone else?

To answer this let's analyze what a corporation can do with its profits in lieu of paying income taxes:

1. Distribute bonuses to existing employees or dole out raises
2. Hire new employees
3. Invest in new capital
4. Distribute profits via dividends
5. Lower prices to increase demand

It is clear to me that the opportunity costs of corporate income taxes are: less bonuses and raises for people, less hiring of people, less investment in other’s peoples goods and services, less dividends for people, and higher prices for people. Corporate income taxes are effectively indirect taxes on human beings—taxes on you and me. These taxes are an inefficient way of collecting government revenue because of their indirect nature. With most things in life, I prefer to be more direct than indirect, and more efficient than less efficient. The real question should be, is there a better way?

I believe there is. Here is why:

Any income tax contains an inherent flaw, namely they do a poor job of aligning the costs of government services with the benefits received from these services. Why is this alignment so important? Because the more costs and benefits are aligned, the easier it is for consumers (i.e. taxpayers) to evaluate whether they are getting their money's worth.

Take the example of shopping at a grocery store. I like to survey the aisles and choose what groceries best fit my tastes, preferences and income. Before walking up to the register I have a good idea of how much everything costs, and after paying I receive a receipt that clearly displays how much each item cost. If I don’t like any of the items, I can do an exchange or receive a refund.

The way income taxes work is quite different than the above…it’s like going to the grocery store but instead of surveying the aisles, you’re handed a box of groceries. You don’t know what’s inside the box. You don’t know if you want or need whatever is inside the box. You don’t know what each items costs. All you know is that you must pay the bill or go to jail. And you most certainly cannot ask for any exchanges or refunds.

I’m sure we all prefer the normal way of paying for groceries. Of course in practice it would be politically difficult to adopt the normal approach, nonetheless it’s important to understand this inherent flaw so we can improve upon our existing tax code.

The indirect nature of corporate income taxes–which take money away from workers, investors and consumers–and inherent flaws of income taxes make it harder for society to analyze the costs and benefits of government services. The alignment between costs and benefits is important in order for any market–even a market for government services–to function efficiently.

So are corporate income taxes necessary? I think not. My two-step solution to fixing this mess would look something like this:

1. Make the federal corporate tax rate 0%. Corporate taxes create unnecessary complexity and further muddy the cost/benefit alignment necessary for a more efficient government.
• This simultaneously eliminates all corporate tax loopholes and levels the playing field between big businesses–that can lobby and lawyer their way around the statutory tax rate–and smaller businesses that don’t have the resources to game our inefficient tax code.
2. Eliminate taxes on capital gains, dividends and interest and tax all investment income as ordinary income. This means Warren Buffet and Mitt Romney will pay the same tax rates as their secretaries (we don't need to further complicate our tax code with a "Buffet Rule").
• The government currently taxes corporate profits, and then taxes the dividends paid out after taxes, which is effectively a double tax on the same profit stream. My solution would end this inefficiency and tax all income at the higher ordinary rate.