Response to McCardle

Megan McCardle argued today that we should eliminate corporate income taxes. It’s an old position for her, but she still does a poor job of presenting the case. I’d like to rebut some critical points.

Actually, I’m going to rebut the entire thing. Before I do, however, I want to hit one point because it exemplifies the idiocy of the whole.

The corporate income tax doesn’t raise that much money It’s not nothing–about $300 billion. But we could recoup a whole lot of that simply by taxing dividends and capital gains as ordinary income, and perhaps tweaking top rates. That might be a bargain conservatives would go for.

Let’s make this simple. In 2008, individual income taxes would have had to increase by 25% to make up for removal of corporate income taxes. In that year, IIT was about 46% of total revenues and CIT was about 12%. 12/46 is 26.1%. Ms. McCardle thinks conservatives would go for this. I think Ms. McCardle’s world looks nothing like the world the rest of us live in.

For those who want the play by play, continue, but realize it’s pretty much more of the same. I’ll just quote the key sentence of each argument for you — feel free to follow the link above to see the entirety to which I’m responding.

“You can’t tax a corporation; you can only tax a person.” First and with some snark, according to the courts corporations ARE persons. More seriously, “can’t” flies in the face of the fact that we, and pretty much every other nation in the world, DOES tax corporations.

“The incidence of “corporate” taxes is not necessarily progressive.” In this paragraph McCardle does a double dose of dishonest argument. First, she shifts from corporate income taxes to payroll taxes, and then argues that they’re the same for the worker and the heiress. If we’re speaking of payroll taxes, she’s right about not being progressive. In fact they are highly beneficial to her heiress as the majority of the heiress’s income is not subject to those taxes. But in the middle of the paragraph she suddenly talks of taxes on 401(k)s as though they are exactly the same as payroll taxes. Umm, Megan? Taxes on 410(k)s are not corporate taxes.

“The corporate income tax encourages firms to use debt finance, rather than equity.” For those who didn’t follow this paragraph of hers, let me restate it in plainer English. [paraphrase] “Companies that need money borrow it instead of selling more shares because borrowing is tax deductible.” This simplistic statement runs into a little-known principle called “diluted share value” which is a result of another mystery called “supply and demand”. You see, if the company creates and sells more stock shares, the price per share will decrease – to about the point where the gross amount borrowed is about the same. Oh, it’s not a perfect balance, and provided your company is more-or-less ‘worth’ it you can make money off the equity sale, but it’s slow and it’s a gamble.
Debt financing, on the other hand, gives immediate money to spend that can be forecast. Even better, it does not risk or require diluting the control of the stockholders.

“You can’t eliminate all the loopholes.” In a word, so? But then she changes the argument by referring to the previous, with, “I know what you’re thinking: why don’t we end the deductibility of corporate debt payments?” No, Megan, I wasn’t. And since the remainder of this paragraph is solely about this strawman it’s almost worthless to continue – except to deconstruct her argument by revealing the second strawman. You see, she creates it by pretending her example corporation is representative of strong corporations. It’s a corporation with $1 million EBIT and $500K in Interest. This corporation gets hammered for 60% of its EBIT in a recession which means it’s facing going down the tubes due to the $100K loss. The problem is that a company with a TIE (Times Interest Earned = EBIT/Interest) with 2 is one that is in a worrisome state already. It is not a surprise that it’s hit so hard in a recession. Straw, plain and simple. Let’s move on.

“The corporate income tax encourages firms to waste resources on tax avoidance.” Actually, there’s a point here. They do waste a lot of resources on tax avoidance. They also waste resources, as Ms. McCardle notes, on influencing laws and regulations to give them more loopholes. However, to use that as a reason to not to bother is… I need to do a comparison. “Because criminals will work so hard not to be caught, we should just eliminate criminal laws.” Yes, that’s a touch absurd. It also carries the tenor of my point. The effort those we wish to touch will use to avoid being touched should rarely be considered as a reason not to touch them.

She then compounds this by saying essentially that tax codes are hard so we should get rid of them. The reason they’re hard is because of the long lists of loopholes, both valid and otherwise. Look, back when I was first taking income tax classes, my professor opened with the statement that tax attorneys would never go out of business because we insisted on cluttering out taxes with the desire to be “fair”. That we also like to use them to influence behavior is just a bonus for the Tax Accountant. The point is there will never be an acceptable simple tax, and every proposal – even my own – that may be installed will rapidly be modified if adopted. So taxes will inevitably be hard, and that should not be an excuse to not bother having them.

“If we get rid of the corporate income tax, we could eliminate the special treatment for dividends and capital gains.” Oh, sneaky, Ms. McCardle. You see, we didn’t used to have special treatment even though we had corporate income tax. Dividends and capital gains were one of those “it’s not fair” adjustments made to the code. It also turns out to be a false claim. As near as I could tell when running numbers, the creation and later adjustment of those special taxes did not change the number of investors nor how much they put into the companies. Further, the vast majority of stock is held not for development of the company (dividends) but for its eventual saleability (capital gains). Thus I think they should be treated like the profits from sales of any other goods and become simple income. Regardless, special taxes are not tied to corporate taxes.

“There are already substantial disincentives to shelter your income in a corporation.” This is a pre-emptive argument made in anticipation and in claimed response to earlier pushes on the subject of eliminating corporate taxes. “They do it already, this would make no difference,” she says. She’s correct. It’s also yet another strawman, a false and easily dismissed argument she created solely to be able to knock it down. It’s a rhetorical trick most of us use at one time or another, but which adds nothing to the position’s strength.

“The corporate income tax doesn’t raise that much money.” Yes, I already hit this, but here we are again. Ms. McCardle, the corporate income tax accounted for approximately 12% of total US revenues in 2008. In that same year individual income taxes accounted for approximately 46% of total revenues. If there’d been no corporate income taxes, the individual tax collection would have had to increase by approximately 25% to make up the difference. Let me make that plainer. Everyone would have had to pay 25% more in their income tax to make up for no corporate income taxes. You say conservatives might go for the argument. I then laugh myself silly.

“Without the corporate income tax, a lot of the incentive for lobbying would go away.” Again, wishfulness in the extreme. In addition to corporate income tax we’ve got things like environmental and customer protection regulations. We’ve got regulations limiting what can be done to competitors, and what can be shipped with what labeling. The list is actually quite long, and while tax is a large thing it’s not the majority, much less almost all the source of lobbying.

I think a valid case can be made for eliminating the corporate income tax in favor of other revenue sources. Megan McCardle did not make that case.

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