Friday, February 19, 2010

Why isn't the corporate income tax progressive?

The equity principle that underlies most tax system suggests that those who have a higher income should pay a greater proportion of their income in tax.

This progressivity is clear if we consider income tax, but absent for corporation tax.  Using data from the Revenue Commissioners 2008 Statistical Report we can draw the following graph.

Tax Rates

This gives the effective tax rate on labour on wages up to €200,000 (lower axis) and the effective tax rate on corporations on profits up to €10,000,000 (upper axis).  We see that the tax rate on labour rises with income, from 0% up to about 28%, while the tax rate on corporations is around 11% for all profit levels.

Why should a company that earns a profit of ten thousand pay the same rate of tax as a company that earns a profit of ten million?  Why is the corporation tax not progressive?

Andrew Chamberlain provides the answer:
So here's a question. If graduated tax rates on people are fair, are they also fair for corporations?  Even if we enthusiastically embrace progressive income taxes on people, progressive taxes on corporations don't follow at all.
Let's start with a simple example. Imagine two companies. One is a start-up that makes high-tech satellites. Like most start-ups, it's well-financed but earns no profits. It has rich customers, highly-paid employees, and very rich venture-capitalist shareholders.
Now consider a second company. It's a large big-box retailer. Like most big companies, it earns handsome profits. Most of its thousands of employees earn low wages, and so do its customers. Its stock is publicly traded, and shares are mostly held by mutual funds feeding 401(k) retirement plans of workers, many of whom fall in the middle of the nation's income distribution.
Question: which of these two companies should pay a higher corporate tax rate, given their ability to pay?
At first this seems easy. The one with higher profits should pay higher rates. But look closer. What do you mean by the company's ability to pay?
Every freshman economics class teaches companies can't bear taxes, only people can. Companies are just legal fictions that shove off taxes onto customers, employees and shareholders. The firm itself pays nothing. And so the age-old notion that we should hammer rich companies because "they can afford it" is really based on a simple misunderstanding.
Back in our two-company example, one earns zero profits but has well-paid workers, rich shareholders and wealthy customers. The other earns huge profits but has low-wage workers, poor customers and middle-income shareholders. How can a progressive corporate tax be fairly applied here? What's the logic in taxing poor folks who work and shop at profitable companies with a 39 percent rate, while rewarding wealthy employees and customers of unprofitable start-ups with a 15 percent rate?
So progressive corporate tax rates that treat companies like people aren't just silly, they're unfair. And unfair in an especially capricious way that should infuriate people who really care about tax fairness.
Sam Walton was rich. But the poor families who bought jeans at Wal-Mart this morning aren't. Why soak them for shopping at a profitable company? Why not tax the Waltons directly, and forget the rococo con game of corporate taxes altogether?

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