Saturday, December 04, 2004

just a little slow

Kevin Drum suggests eliminating corporate income tax, but worries about people using corporate money to pay for personal expenses. The problem isn't that corporation money would go to personal expenses, but that such a change would make it even easier for corporations to amass wealth without paying taxes. Everyone wealthy enough to do so would move their assets into privately-held corporations, making all investment income tax-free until withdrawn and spent.

To understand why corporate spending on personal expenses wouldn't become a bigger problem, consider what happens today when Joe Executive has a $100 dinner on an expense account. He pays no income tax on that dinner, and the company gets to deduct the cost from its income. Since Joe's rich (and lives in California), the company would have had to pay him about $200 for him to buy the meal with his own income. Having the company pay for it reduces the tab to $100. A 35% corporate tax reduces the net bill to the company to $65. If the corporate tax were eliminated, it would still be attractive for companies to pay for personal expenses, but less attractive than it is today.

Making corporate income tax-free, on the other hand, creates a large incentive to keep assets in the corporation as long as possible. With a 35% marginal tax rate, a taxable investment of $100 with a 5% return over thirty years grows to $260. The same investment allowed to compound tax free, then taxed at 35% grows to $320.

Some people would claim that's a good thing, that letting investments like that grow will put more money in peoples' hands rather than the government's, but that's not really the question. If we assume government spending and tax revenue are connected (an assumption that seems weaker with every passing budget), then the overall tax rate will approximately match government spending, no matter the details. If we cease taxing investment income, we'll have to raise taxes on something else: wages, consumption, value-add, carbon dioxide production. Eliminating taxes on investment return favors those able to save a large portion of their earnings over those who can't or won't. A justice argument might be tenable against those who won't, but not against those who can't.

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