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?


  1. Good post, but perhaps you are omitting one further (major) problem with progressivity of corporate (as opposed to personal income) tax. Whilst a human being cannot (easily) split itself into two halves (to be eligible for a smaller tax rate on that those half-incomes), a corporation can do so very easily. So progressive tax would just encourage too much company-splitting, which will be economically inefficient.

  2. on the other hand a flat tax rate encourages the growth of large companies which dominate the market to such an extent that competition does not really exist. Surely it would be better to have many highly competitive but smaller companies that pay higher salaries and smaller dividends than to have little competition, and huge companies that provide low wages but good dividends to investors (who do no actual work)

  3. I agree with Anonymous. Harrrumph!

  4. apply the tax to gross income not profit. Companies paying the higher tax rate will not be able to pass on the cost of the tax to their employees because they will be competing against smaller companies paying less tax. They will have to absorb the tax out of their profits hence the incentive to split into smaller companies. This has the benefit of splitting companies that are too big to fail which in effect are reliant on taxpayers to bail them out, and providing a greater number of competitors in the market.

  5. A progressive corporate tax simply on profit size wouldn't work - I agree with the above argument that we have to tax corporations based on arguments about the people involved. Large companies may have huge profits, but they have to spread those profits over a larger organisation, meaning that they don't necessarily have a larger profit per unit factor of production as, say, a small company with small profits. This means that the comparison to income tax is not satisfactory because income tax is a tax per-person, i.e. per factor of production, whereas a progressive corporate tax would tax only the profit, regardless of how many factors of production went into making it. A progressive corporate tax based on per unit factor of production, for example profit per employee or based on profit-to-cost ratio would achieve the objective because it would tax companies more if the profit-per-person was larger. In that case, the comparison to income tax would be valid and the tax would achieve its objective.