Thursday, July 15, 2010

The economic nonsense of corporate income tax

The share of corporate income tax in tax revenue has been growing in the last two decades in the majority of countries. Beginning in 1990s, policymakers in developed countries have trimmed corporate income tax rates in the hope of fewer distortions to saving and investment. As a consequence, tax revenues from this particular tax have increased as a share of the GDP. Surprisingly, leaders in corporate income tax reduction were high-tax European countries such as Sweden, Austria and Germany. Today, the lowest corporate income tax rates in developed world are found in European countries such as Cyprus and Ireland.

What is the economic feasibility of corporate income tax? In fiscal theory, the rationale for this particular tax lies in the existence of benefits from legal protection enjoyed by the corporations and private limited companies. Joseph Stiglitz has argued that this particular tax is a tax on entrepreneurship as it discourages new capital formation. Corporation's tax base depends on the amount of revenues minus expenditures for labor, materials and capital goods. The real paradox of corporate income tax is that it is preferable for the corporation to create new debt than to issue equity. In fact, the debt is considered as a deduction from corporation's tax base. Thus, it is difficult for start-ups to get the loan from the banks as the bank is not willing to take on the risk involved with the repayment of the loan since start-ups' success is uncertain. Therefore, the existence of corporate income tax hinders business investments and entrepreneurial activity in general.

The abolition of corporate income tax would be an important boost to capital formation and new business investment. In addition, many economic distortions would disappear. It should not be neglected that tax incidence in corporate income tax is not shifted to the corporation. The ultimate payers of this tax are workers, customers, suppliers and shareholders. The tax is shifted in lower wages, higher prices and lower dividends. At last, the tax also creates perverse incentives that discourage investment and, nevertheless, job creation.

Source: OECD Tax Database (link)

2 comments:

  1. A very good post discussing a truly important issue. A brief overview of corporate tax rates around the world reveals that the U.S and Japanese corporate tax rates are the highest in the industrial world. While the lowering of corporate tax rates has captured the entire globe, it seems that the U.S is sadly quite exempt from international tax competition.

    It's welcome that policymakers realized the distortionary effects of corporate income taxation since the this form of taxation is the largest source of tax avoidance and capital flight. The recent data from Tax Policy Center suggest that corporate income tax represents cca. 12 percent of federal tax revenue (http://www.taxpolicycenter.org/briefing-book/background/numbers/revenue.cfm) and its share has decreased since 1950. In addition, it should be emphasized that corporate income taxation is a substantial source of displacement effect since, in the U.S, it diverts almost 40 percent of corporate income from business investment into the government sector.

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