Corporate Income Taxes: An Economics Perspective

1
Corporate Income Taxes An Economics Perspective

• Presentation to the Presidents Advisory Panel on
  Federal Tax Reform
• March 8, 2005
• William M. Gentry
• Williams College

2
Overview

• Incidence of the Corporate Tax
• Tax shifting who bears the burden of the
  corporate tax?
• Distortions from the Corporate Tax
• Organizational form choices
• Investment decisions
• Financing decisions

3
Views of the Corporate Tax

• A tax on capital used by corporations
• Tax base includes investors required return
• Applies to returns to shareholders, but not to
  returns to creditors
• A tax on pure profits of corporations
• Returns above the ordinary risk-adjusted return

4
Tax Incidence

• Allocating tax burden across people
• 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

5
Avenues for Shifting the Corporate Tax

• Tax on capital used by corporations
• 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

6
Best Estimates of CIT Incidence

• Empirical evidence is relatively scarce
• Agreement that
• CIT is not just a tax on pure profit
• There is shifting of the burden from shareholders
  to all capital
• Less agreement on
• Amount shifted to workers
• Amount shifted to consumers
• Distribution tables either ignore the CIT or
  allocate it to all capital owners

7
Distortions Overview

• Organizational Form
• Investment
• Financing
• Debt vs. Equity
• Dividends
• Multinational Effects
• Tax Shelters

8
Organizational Form

• Corporate tax applies to C-corporations
• Alternative business forms avoid the CIT
• 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

9
Investment

• Taxes can affect investment through
• 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

10
Financing Debt vs. Equity

• General wisdom the double taxation of corporate
  equity favors debt over equity
• Some offset due to investor-level taxation
• Evidence on taxes and over-leverage
• Relatively modest effects
• Other effects of distinguishing debt vs. equity
• The tax system favors industries or firms that
  have more access to debt
• A fault line for tax planning and tax sheltering

11
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

12
Summary of Distortions

• Corporate taxation creates a wide-range of
  economic distortions
• Organizational form
• Investment levels and type
• Financing and capital structure choices

13
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