At bottom a corporation is simply a legal fiction that allows a business or other concern to be treated as if it were a person. Since it is a fictional person, the taxman treats it like a real person when it comes time to pay taxes, and charges it a tax rate similar to the rate charged real people.
Is this a good idea?
Corporations are employers, buyers of raw goods, producers of finished goods, convenient holding companies for capital goods, and when times are good also sources of returns for investors. If the cost of raw goods plus the cost of production and sales is less than the sales price then the corporation makes a gross profit. Out of this gross profit come the wages of the workers and managers, further capital investments to improve the productivity of workers, and returns for investors. What happens when government reaches into a corporation and takes out a tax? Specifically, who actually pays corporate taxes with his or her reduced take-home pay?
When taxes increase to a business several things happen.
- First, it cuts wages by reducing worker hours, giving pay cuts, or denying pay raises. This is almost always the first recourse, because variable costs like labor are the easiest expenses for any business concern to cut. The Washington Post reports that 70-92% of corporate taxes are paid by reducing employees’ pay.
- Second, the corporation hires tax accountants, lawyers, consultants, and even lobbyists to cut its tax load.
- Third, the corporation reduces maintenance and capital investment, which will slow down the corporation’s future growth and may cause it to fail at some future time if its competitors do business from places where their taxes are lower and they can increase their productivity faster.
- Fourth, it tries to charge customers more.
- Fifth, it tries to replace its raw materials with cheaper alternatives.
- Sixth, it may engage in cost cutting measures on peripheral activities to do things like save energy, replace computers over a longer cycle, or reduce paperwork costs. These typically only produce minor savings as competent businesses are already cheap about peripheral activities.
- Seventh, it may lower returns to investors, making its stock less valuable
Are any of these results of corporate taxes good things, or do they all damage workers, investors, and other businesses? Since corporate taxes mostly work by taking money out of the pockets of employees, with less impact on highly valued employees and greater impact on employees as their value to the company decreases, aren’t corporate taxes simply an extremely regressive tax that has disparate impact on entry level, unskilled, and disabled workers?
Let’s talk about this in a way that everyone can understand. The average employed married American worker makes about $50K and pays taxes at the 15% marginal rate. If he or she works for a for-profit corporation, then the impact of the corporate tax is to reduce his or her gross salary by 70% of 34%, or 23.8% (assuming a fairly successful small business). I’m choosing the lowest impacts I can find in the tax tables and I’m playing a little loose with adding and subtracting percentages, but the result is that I’m understating what happens, not overstating it. The average may be higher. That means the average worker would make 23.8% more money if there weren’t any corporate tax. It also at least doubles the federal tax that the average worker pays. For a worker making $50,000 that is a $12,000 raise that won’t happen because the government stole it away in the dark of night! Does the average worker making $50K receive more value from the government than he or she would get from that $12,000 that was cunningly taken out of his pocket? Or is it simply a sneaky way for the government to siphon money out of the economy with a “corporate tax” without workers realizing they are the ones who are being robbed?
Who pays corporate taxes? The answer is: if you work for a corporation, you do.
Update: revivefederalism has an excellent piece on how Corporate Taxes and high Dividend Taxes tempted companies to become highly leveraged in order to reduce their tax load. This in turn destabilized the companies and led some of them into bankruptcy last year. The causal link from high corporate taxes to the financial collapse is clear.