Skip to content

Part 5 in a Series on the Minnesota Corporate Income Tax: President Obama’s Tax Commission Agrees with Economists on Damage of Corporate Income Tax

Over the last two months, we’ve looked at some academic literature on the corporate income tax. With the general election over (or is it?), the discussion will soon be very non-academic.  What will the people in charge of Minnesota’s tax system–the governor and the Legislature–do? The prospects for rectifying the problems with the corporate income tax are murky, at best.

Candidate Mark Dayton, likely to emerge from the recount as the state’s next governor, ran on a platform of “tax the rich.” During the last legislative session, meanwhile, the  DFL-controlled legislature passed an increase in the state’s personal income tax system (a move vetoed by Republican Gov. Tim Pawlenty). The Legislature flipped to the Republicans, who may be more inclined to address the corporate income tax, but they will be stymied by Gov. Dayton. Even if they weren’t, the budget deficit (about $6 billion if you assume normal, annual budget increases rather than decreases) means that officials will be looking for every possible dollar, regardless of the economic impact of obtaining that dollar.

When the Legislature considers budget cuts–as it certainly will have to do–we will no doubt see a parade of people who can claim harm from those cuts. That’s the nature of government spending: It often produces quite visible beneficiaries, who make it difficult, politically and otherwise, to cut spending.

With a few exceptions (user fees), every dollar spent by government requires government to acquire by taxation. The problem with tax policy is that its effects are less visible than the effects of spending. This is certainly true of the corporate income tax.

One lesson from our recent series on the corporate income tax is that the tax is one of those areas of policy where what is popular and what is economically sound are two different things. Some people mistakenly claim that corporate taxes only hurt businesses not people.  They think people can avoid taxes by making businesses pay taxes. It may seem the height of injustice for workers and families to be subject to an income tax but not corporations. Yet our brief review of some articles from leading sources in the economic literature suggests that the corporate income tax comes at a steep price—a price that effects us all.

The Obama Administration’s President’s Economic Recovery Advisory Board explains (PDF) how our corporate income tax code hurts American workers with its “deleterious economic consequences”:

Distortions in the corporate tax system have deleterious economic consequences. Because certain assets and investments are tax favored, tax considerations drive overinvestment in those assets at the expense of more economically productive investments. Because interest is deductible, corporations are induced to use more debt, and thus become more highly leveraged and take on more risk than would otherwise be the case. Because the corporate tax results in higher effective rates on corporate businesses, business activity and investment are shifted to non-corporate businesses like partnerships and S corporations, or to non-business investments like owner-occupied housing. Because MNCs [multinational corporations] do not pay income taxes on income earned by foreign subsidiaries until that income is repatriated, those firms have incentives to defer repatriation, to shift taxable profits to low-tax jurisdictions, and to engage in costly tax planning; nevertheless, the system of international taxation makes U.S. MNCs less competitive in foreign markets and even at home. Because of its complexity and its incentives for tax avoidance, the U.S. corporate tax system results in high administrative and compliance costs by firms—costs estimated to exceed $40 billion per year or more than 12 percent of the revenues collected. All of these factors act to reduce the productivity of American businesses and American workers, increase the likelihood and cost of financial distress, and drain resources away from more valuable uses. Most of these distortions also affect businesses beyond the corporate sector.  (p.65)

Perhaps the strongest case against the corporate income tax is made when President Obama’s advisory board agrees with leading economists: our current corporate tax code is hurting workers who need job-creating investments.

In case you missed it, here’s a quick wrap-up of the previous articles in this series:

In part 1, we considered one study of tax rates in 85 different countries. The conclusion: corporate income taxes have a large adverse impact on aggregate investment, [Foreign Direct Investment], and entrepreneurial activity.”

In part 2, we reviewed some more economic studies that came to a similar conclusion. These studies included snapshots of economies (the cross-sectional approach) and movies (the time-series approach). The conclusion of both types of studies is similar: investments in an economy are discouraged by higher tax rates and enticed by lower tax rates.

In part 3, we asked this important question: What does the corporate income tax do to the creation of jobs? In short, the higher the corporate income tax rate, the less incentives the economy offers for creating new businesses. Since small businesses are a key provider of new jobs, the result is fewer job opportunities.

In part 4, we found out that the higher the corporate income tax rate is, the more incentive there is for companies  to take on debt. Debt in itself can be useful, but higher tax rates encourage imprudent risk-taking. Real people are hurt when firms take on too much debt, to save on taxes, and are later forced to close when they can’t pay their bills.

(First published by the Minnesota Free Market Institute)