Download Corporate Income Taxes: An Economics Perspective

Corporate Income Taxes:
An Economics Perspective
Presentation to the President’s Advisory Panel on
Federal Tax Reform
March 8, 2005
William M. Gentry
Williams College
Overview
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Incidence of the Corporate Tax
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Tax shifting: who bears the burden of the
corporate tax?
Distortions from the Corporate Tax
Organizational form choices
 Investment decisions
 Financing decisions

Views of the Corporate Tax
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A tax on capital used by corporations
Tax base includes investors’ required return
 Applies to returns to shareholders, but not
to returns to creditors
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A tax on pure profits of corporations
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Returns above the ordinary risk-adjusted
return
Tax Incidence

Allocating tax burden across people
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Critical for evaluating the fairness of taxes
Insufficient to know who “writes the
check”
 Complicated web of responses
determines who ultimately bears the
burden of the corporate tax

Avenues for Shifting the Corporate Tax

Tax on capital used by corporations
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Higher output prices may shift tax to consumers
Reduction in output affects labor demand
Substitution away from capital increases labor
demand but less capital per worker reduces
productivity
Rate of return on all forms of capital can be
reduced by the corporate tax
Tax on pure profit less likely to be shifted
Best Estimates of CIT Incidence

Empirical evidence is relatively scarce
 Agreement that
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Less agreement on
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CIT is not just a tax on pure profit
There is shifting of the burden from shareholders to
all capital
Amount shifted to workers
Amount shifted to consumers
Distribution tables either ignore the CIT or
allocate it to all capital owners
Distortions: Overview
Organizational Form
 Investment
 Financing

Debt vs. Equity
 Dividends
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Multinational Effects
 Tax Shelters

Organizational Form
Corporate tax applies to C-corporations
 Alternative business forms avoid the CIT

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Alternative forms have grown recently
Is the CIT a tax on being ‘public’?
 Distortion: if taxes discourage being a
C-Corp, then the discouraged firms miss
out on the benefits of being public

Investment

Taxes can affect investment through:
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Tax Rates
Tax Rules: e.g., depreciation rules
Higher taxes & less generous depreciation rules
increase the cost of capital
Level of investment vs. type of investment
 Bottom line: The tax system can have
substantial effects on the amount and type of
investment undertaken by corporations
Financing: Debt vs. Equity

General wisdom: the double taxation of
corporate equity favors debt over equity
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Evidence on taxes and over-leverage
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Some offset due to investor-level taxation
Relatively modest effects
Other effects of distinguishing debt vs. equity
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The tax system favors industries or firms that have
more access to debt
A fault line for tax planning and tax sheltering
Financing: Dividends

The tax system can also affect firms’
dividend decisions
Dividends vs. retained earnings
 Dividends vs. share repurchases

Evidence from 2003 tax cut: corporate
dividends increased after the tax cut
 By distorting dividend policy, taxes can
alter which firms have capital
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Summary of Distortions

Corporate taxation creates a wide-range
of economic distortions
Organizational form
 Investment: levels and type
 Financing and capital structure choices

Conclusions
Most of the burden of corporate taxation
probably falls on the owners of capital
 The economic cost – in terms of
distortions – from corporate taxation are
wide-ranging and likely to be substantial
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