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Ditching U.S. corporate income tax is a good idea

Many people, especially in Washington, have been expressing a concern about U.S. corporations merging with foreign corporations and then moving their headquarters abroad, a strategy called inversion, to take advantage of lower foreign tax rates.

For example, the average corporate tax rate in Europe is slightly less than 20 percent, while the rate in the United States is 35 percent.

However, this concern has missed an important point – the federal corporate income tax is fundamentally a terrible tax. Rather than modifying it or coming up with other regulations to discourage U.S. corporations from moving abroad, we ought to use this opportunity to end it.

Let’s consider why it is a terrible tax.


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Good taxes generate revenue with limited effects on equity and efficiency. While the corporate income tax may appear to have little effect on equity, because obviously corporations rather than people pay it, nothing could be further from the truth.

Shareholders of corporations are not willing to accept lower returns just because a corporate tax exists, so the corporations have to generate additional revenue to cover their corporate tax obligations. The tax is in effect an additional cost of being in business.

That additional revenue comes from higher prices that are imposed on all consumers regardless of their income.

While a corporate income tax is imposed on corporations, it is paid for by consumers through higher prices. Therefore, in contrast to the federal individual income tax that is progressive – higher income people tend to pay a higher percentage of their income – the impact of the corporate tax is proportional to the amount that consumers spend.

Most people would view this outcome as inequitable.

The corporate income tax is also inefficient, making it more difficult for U.S. corporations to compete abroad.

A common tax abroad is a value-added tax that is imposed on products as they move through the production and distribution process. All of the members of the European Union, for example, have a value-added tax.

Having imposed it on particular products, it can be removed when the products are sold abroad. In contrast, the corporate income tax is imposed on an entire company rather than on any particular product, so it cannot be removed when a product is sold abroad.


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This makes similar products more expensive when exported from the U. S. in contrast to most other countries.

A concern has to be the lost tax revenue to the federal government. One possibility would be to attribute all of the profits of corporations to its shareholder on a per share basis. The dividends, as well as the retained earnings, would be treated as taxable income.

Being taxed on retained earnings could be inconvenient for some taxpayers, but most corporate shares are owned by people with adequate income to pay the resulting taxes.

Then the profits could be taxed progressively as ordinary income.

Alternatively, the U. S. could introduce a value-added tax similar to that used abroad.

Because a value-added tax is a tax on consumption, it is preferred by economists because it does not discourage savings that occurs with an income tax.

With an income tax, savings are taxed twice – once when the income is earned and then when the individual receives a return on their investments. Alternatively, with a consumption tax, such as a value-added tax, savings are only taxed once – when the returns are spent.

In conclusion, the current concern about U.S. corporations merging and moving their headquarters abroad should be addressed by eliminating the U.S. corporate income tax. This would increase equity and efficiency.