This is Taxing - September Perspective

This presidential election season seems more taxing than most. I wish there was an interesting, or even realistic, tax proposal I could dissect for you, but all we are getting is “red meat” for the bases.

The Harris proposal includes raising corporate taxes. This sounds wonderful: Let those greedy corporations pay all the taxes. The problem with this in practice is that corporations are purely legal entities. Where does the money come from? The revenue for corporations comes from the consumers. The corporations’ expenses include buildings and equipment, etc., but the largest expense in almost every corporation is payroll. Their money comes from consumers and goes primarily to workers. 

When taxes are raised on a corporation, their first impulse will be to pass on the expense to consumers. Not using the political paintbrush, prices are determined by supply and demand. Corporations can raise prices, but then will sell less product, so that doesn’t automatically lead to higher revenue. Corporations cannot just raise prices to pay the tax and stay in business, so they must cut other expenses. What is their largest expense item? Payroll. 

If you do believe that all corporations are run by greedy individuals, you have plenty of evidence to support that belief. Whose salary do you think will get cut to pay those taxes? If you guessed the rank-and-file employees, then you would be mostly correct. A good business (and they are out there) might spread it evenly, but even then, the rank and file are getting hit. Corporate tax is a tax on workers. 

When the Trump administration cut corporate taxes, two things happened that may be counterintuitive to the non-economist. First, tax revenue from corporations actually increased. As we pointed out in our Quarterly Report from the third quarter of 2010, taxes work like prices: It is certainly possible to raise rates and collect less as well as to lower rates and collect more. Secondly, we had real wage growth and for the first time this century, most economic growth benefited the middle class. Corporate tax cuts benefited the people most economists said they would, and that was the rank-and-file employee.  

The more traditional argument against the corporate tax still holds true: The corporate tax is by definition a double tax. Follow the money: Corporations get revenue from consumers who pay for the products with money that has been taxed, and they almost always have to pay an additional tax on the sale of the product. Then, the revenue is used to pay employees, each of whom must pay taxes on that money. Any money left over is often distributed to shareholders as a dividend, which is also taxed. All of this money is already taxed at least once. The corporate tax is a double dip. 

The proposals from both campaigns are so bad that it might be easier to think about what a good tax system would look like. The goal of an ideal tax system would be to fully fund the government while having the least amount of impact on the economy as a whole. This is actually what was attempted in the 1980s. The tax reform acts of 1982 and 1986 were exactly that – reform. Yes, the highest nominal rate went from 70 percent to 28 percent, but with that went a massive closure of tax shelters. This is exactly what all should want: An honest tax rate that all people actually pay, each paying their fair share. 

Politicians, on the other hand, love high rates. High rates create an incentive to find loopholes, and loopholes are paid for through political contributions. Economists refer to this as rent seeking. Restaurant owners will make significant political contributions to keep tip wages tax-free, and corporations will make significant contributions to avoid having to pay those sky-high corporate tax rates. 

One of the first taxes was proposed by Joseph to the Pharaoh. The Pharaoh had a dream there would be seven years of plenty followed by seven years of famine. Joseph suggested as at tax 20% of the harvest would be stored in grain houses so when the famine hit, Egypt could care for its people. To our knowledge there were no loopholes or exemptions; everyone paid their share. Interestingly, approximately 20% of total economic output is what governments through time have been able to sustainably collect. It hasn't mattered what the stated rates are, or the overall structure of the tax systems.

We'd love to be able to say one presidential campaign had a better overall tax policy, but that isn't clear at all. Both campaigns seem eager to use the tax system to benefit specific groups over everyone else. That is certainly the incentive of any politician.