The Cactus Tax Proposal, Part 3: Corporate Tax Rates

‘d like to give my thoughts on corporate income taxes. A favorite idea on the right is that taxes on corporations should be eliminated. The reasoning is this: because the corporation pays taxes on income when it makes a profit, and the shareholders pay taxes on that income once it is distributed to them, essentially we have double taxation. In this post, I am going to argue that tax rates on corporations should at a minimum be kept where they are, if not raised. My arguments are based on fairness and the concept of moral hazard.

Taxes are fees for services, the price we pay for a civilized society, according to Oliver Wendell Holmes. These services include access to the physical and social infrastructure of the United States, use of the legal system, and even protection from the Canadian hordes.

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All of these services cost money. Many of them exist for the benefit of corporations and nobody else. For instance, there’s a whole body of law associated with corporations alone – it doesn’t directly affect you or me in any way. And corporations have legal rights separate from their owners. As an extreme example, consider that even if you just purchased 100% of the shares of a company, hostile managers could still have you arrested for trespassing if you show up at HQ before the next shareholder meeting.

So… the corporation is not its shareholders. (Yes, there are some types of corporations that are pass-throughs, but they are treated as such by the tax code anyway.) It has separate needs, and separate rights under the law. It receives services from the government separately. It should pay for those services.

How much? Well, it receives essentially the same services from the government as a person does. Sure, there are differences around the edges. As I noted, there are areas of the law that deal only with corporations, just as there are areas of the law that deal only with people. But when it comes to the big services, the expensive ones – national defense, protection of assets, etc. – the corporations use those services as much, if not more, than the rest of us.

Which means that corporations should pay taxes the way people pay taxes. At the same rates for the same level of income.

And now to the second part of this post, to note that, if anything, shareholders are getting a bargain with this “dual layer of taxation” we keep getting told about. And yes, I own a few shares here and there. I also own a small LLC, and am in negotiations with some partners to form another one. So this is not “class envy” speaking.

What I’ve learned about corporations is simple: there’s nothing that is done inside a corporation that can’t done without corporations. Sure, there are a number of economic theories about the benefits of creating a company dating back long before Ronald Coase’s seminal paper, but there is only one benefit to creating a corporation rather than a company: its the ability to reduce one’s risks. But that reduction of one’s risks is not a true reduction – its actually exporting one’s risks onto everyone else and forcing them to share in those risks.

Think of it this way: if you engage in whatever line of business, you assume any and all liabilities for that. If you can find someone to loan you $100 million to buy mortgage backed securities on a leveraged basis, and home prices collapse, you now find yourself owing well more than $100 million. On the other hand, if you buy shares of a corporation that has found someone to loan it $100 million to buy mortgage backed securities leveraged to the hilt, your maximum possible losses equal the amount you spent on buying those shares. What happens to the extra few hundred million in losses? They don’t just go away – they are absorbed by society. Society pays for those losses.

That ability, that right to export your liabilities onto society, onto everyone else, clearly has a tremendous value to individuals, and as a result, it should have a cost associated with it. That cost should also be very, very high to reduce the moral hazard associated with such behavior.

As we saw with the Bear Stearns, to name one recent a recent example, clearly the price being paid is not high enough to prevent a moral hazard when you’re dealing with the unscrupulous and the kool-aid drinkers. After all, it turns out that corporations also have other benefit over flesh and bone human beings – if a corporation gets big enough, the government and the Fed seem to feel that the shareholders shouldn’t even risk losing the entire amount they invested in the company, much less assume the negative value associated with those investments.

Eliminating the corporate income tax would not only be unfair, given the services corporations consume, it would also make moral hazard much, much more likely and much, much more common.

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Previous installments to the Cactus Tax Proposal:
Part 1: What Matters More than Anything Else
Part 2: Charities