The history of taxation is the history of people concocting ingenious schemes to avoid their taxes. In ancient Rome, the owners of large estates would bribe the tax collector to delay payment and then lobby the government for a tax holiday that would forgive the taxes they hadn’t paid. In the 18th century, not long after American colonists broke from Britain partly over “taxation without representation,” Swiss banks offered anonymity — for a price — to French nobles looking to hide their wealth from the revolutionary authorities. And so on down to the present day, when about 40 percent of multinational profits, according to a recent economic paper, are sequestered in various tax havens.
To anyone who draws a salary and thus can’t reincorporate in Bermuda to avoid payroll taxes, this corporate tax avoidance might seem outrageous. Governments just need to get really tough, right? The problem is that rich-world governments already are, broadly speaking, pretty tough on large corporations — at least if “tough” means “deploying armies of tax collectors to extract every penny the companies legally owe.” There’s a reason that you are forever reading about companies settling tax disputes: Governments spend a great deal of time scrutinizing companies' returns, looking for places where they ought to have paid more tax than they did.
And trying to force companies to disgorge even more in taxes is an expensive proposition for companies and the public. The nonpartisan Tax Foundation estimates that the labor involved in preparing corporate tax returns takes $150 billion out of the U.S. economy annually. And that doesn’t count the distortions that the corporate tax code introduces, as companies try to structure operations to lower their tax burden even if that doesn’t make the most business sense. Nor does it include the time and money spent lobbying Congress for a more favorable tax code.
All this is very frustrating. Here's a solution: Eliminate the corporate income tax. Or lower it to some token rate, such as 1 percent, that wouldn't be worth the effort to avoid.
My friends on the left would be aghast at the notion of businesses paying no tax. But the truth is that they have never paid tax — no, not even when rates were higher and IRS agents meaner. Those who insist that companies pay their “fair share,” just as wealthy people should pay their “fair share,” misunderstand what corporations are. They’re imagining a corporation as something like a really rich person. But a corporation is just a legal fiction that temporarily holds money ultimately destined for real people. And it’s those people — shareholders, employees, customers — who end up paying any tax levied on a corporation.
Unfortunately, you can’t pick the people who will pay. Sure, a heavy corporate income tax on Walmart will cost the Walton family some money. But it will also cost retirees whose pension fund invested in the company … and people who work in Walmart stores … and people who shop there. The corporate income tax is at least somewhat progressive, but it’s probably not as progressive as its boosters imagine.
The thing is, we already have an excellent tool for taxing rich people who own stock or manage companies: the personal income tax. Yes, people do also try to avoid paying their personal taxes — but these efforts are actually aided by the corporate income tax. That’s because high corporate taxes create a problem: Government ends up taxing the same income twice, once when the corporation earns it and again when it’s paid to individuals as dividends or capital gains. To keep the combined tax rate from getting too high, and thus discouraging savings and investment, the government created a special low, flat rate for dividends and capital gains. High earners, aiming to lower their tax rate, respond by taking as much of their compensation as possible in the form of dividends or capital gains.
Why not devise a compromise package to reduce the inefficiencies created by the corporate tax code and actually make the code more progressive? Lower the corporate income tax to a token amount, just enough to generate the records the Internal Revenue Service uses to keep wealthy business owners from declaring personal consumption as business expenses. But also eliminate the special treatment for capital income, so that the wealthy no longer benefit from taking income in the form of capital gains and dividends. And if this arrangement turns out to cost the Treasury Department money, then nudge the top rate up to compensate.
We’d have a more progressive tax code, a more attractive environment for businesses making location decisions and, best of all, a horde of unemployed lobbyists and tax specialists forced to pursue a more productive line of work. Which seems infinitely better for everyone than pouring more effort into an unwinnable tax war.
Megan McArdle is a Washington Post columnist and the author of “The Up Side of Down: Why Failing Well Is the Key to Success.”