Taxing corporations

I will ease the pain from this early morning (when GOP senate slashed corporate taxes) by escaping into fantasy, I mean theory, but I repeat myself.

A key theoretical argument about taxing profits (due to Diamond and Mirrlees I think) is that the tax can be very very high if firms maximize profits, because maximizing 0.5X is just the same problem as maximizing X. This is a tax on pure profits (profits minus capital times the cost of capital) .

The practical implication is that we should figure out what corporations maximize and apply a high flat tax rate on it, because maximizing 0.1X is the same problem as maximizing X.

Theory then goes crazy and assume that firms maximize shareholder value equal to the present discounted stream of dividends. If so, we should tax dividends. This is roughly similar to the new law in which investment is treated as an expense, so profits minus investment is taxed.

There are lots of problems (aside from the fact that only in shareholders’ dreams do manager maximize shareholder value). We would have to tax stock buybacks too (just another way to get money to shareholders). Taxing dividends but not interest paid encourages high leverage (for example through leveraged buyouts). Here again a tax on buying and retiring shares would be useful (not politically possible but useful). A really heavy tax on dividends would make initial public offerings unattractive — I think a subsidy for new share issue would be nice (reallly politically impossible).
But the idea is just tax money going to shareholders and it is based on the assumption that getting money to shareholders is the whole point and maximizing 0.01X is the same problem as maximizing X.

The assumption is crazy.

I think top management of corporations maximizes compensation of top management subject to a limit that, if they go too far, it will be very profitable to take over the coporation and fire them. This means that, if the aim is to generate compensation for top management, we should tax compensation of top management. Highly. I am quite sure that if the tax were 99% it would raise a lot of money (provided all compensation could be detected). They *will* pay themselves no matter how much it costs the shareholders.

Now this strikes me as a pretty good idea. I think top management has to be defined as those with the top total compensation not any title (otherwise the CEO will call himself his secretaries secretary). Now this does encourage taking corporations private. But really, CEO compensation is obscene and is just begging to be taxed.