Wednesday, November 1, 2017

Corporate profits and taxes. Nothing to see here.

This is an interesting article by Matthew Klein about an idea from Dean Baker to tax corporate income through silent ownership of shares.  It may not be feasible, practically, but it does make sense in a lot of ways.  It fits with my recent posts about property taxes as a form of silent ownership and homeowner subsidies as a form of mandated annuity.

But, the article seems to ignore issues of tax incidence.  Corporations don't really pay taxes.  In the long run, after tax wages, profits, and prices should settle at some relative level of returns and incomes that reflects a complex stew of social preferences and challenges.  This is forgivable in some ways, because the tax proposal in the article seems like it would avoid a lot of the negative consequences that make corporate taxation problematic - legislated special favors, tax avoidance activities, etc.

Politics, realistically, is mostly about status moves and insider-outsider alignment.  Tax avoidance is a fundamental, universal economic issue.  In positive terms, economists would typically treat tax avoidance as a signal of dislocation.  Where there is avoidance, it is a sign that taxes might be too high or the base too narrow, and we would look for ways to pull back.  Our political postures can frequently be divined by recognizing where we invoke attribution error vs. sympathy or indifference.  For instance, few of us would think twice about, say, crossing a state border to buy a car or fill up our gas tank, if taxes across the border were lower.  We might not even recognize that we were engaging in tax arbitrage.  We might just be reacting to price signals.

Corporations are basically engaged in the same activity.  But, we attribute their tax avoidance to their soulless greed.  Much is made of foreign tax shelters, etc.  Some of that is going on, clearly.  But, most corporate behavior, just as with our own behavior, can simply be described as reactions to price signals.  But, corporations are pretty universally outside the zone of sympathy.  So, our reaction to their tax avoidance is to turn up the heat and to find ways to force the taxes onto them, in spite of their avoidance and the inevitable secondary and tertiary effects on price that inevitably mitigate some of the intended taxation.  This is ironic, since aggregate corporate after tax profits aren't that sensitive to taxes.  This is explicitly understood in markets like municipal bonds, where different tax treatments change securities prices with little effect on after-tax returns.

Here is a chart from Klein's article:

He shows declining corporate tax collections over time in the US.  He blames this mainly on foreign tax shelters.

It seems clear to me that the reasonable response to this problem is to lower corporate taxes because the foreign tax shelter problem is created by corporate taxes, and cutting corporate taxes would not really be problematic - prices, wages, and profits would adjust in the long term so that more income would be earned through wages, and more taxes would be paid through sales and income taxes.  And, as we see here, we're talking about 2% of national income. Whatever the actual proportion those taxes would actually fall on various agents, those debates are talking about a small fraction of a percent of national income.  And the benefit would be that firms wouldn't be able to gain an advantage from international tax arbitrage.

To this point, here is a graph of the share of national income of various forms of capital.  The Klein chart ignores composition.  This is a very common problem.  Economists and journalists frequently compare corporate profits over time.  Changing corporate profits over time are dominated by changing composition - using debt financing versus equity, proprietorship versus corporate organizations.  Furthermore, there is the issue of inflation premiums in interest expense.  This is accounted for as an expense to firms and income to lenders.  But, in real terms, this is an arbitrary transfer.  In real terms, the inflation portion of interest payments is like a debt buy-down.  For all of these reasons, changing corporate profits or taxes paid over time are just not that useful of a metric.


Before 1980, there was a shift into corporate forms, then that shift reversed back to proprietorship.  There has been a shift toward debt financing, and in the 1970s and 1980s, there was a significant inflation premium on interest payments.  When we stack these forms of income, they are remarkably flat over many years.  Here, I have also placed corporate taxes at the top of the stack.  When corporate taxes were higher in the early 20th century, capital incomes before tax were higher, and they were somewhat higher even after tax.  Over time, corporate taxes have fallen, yet total capital incomes after taxes have a remarkably stable mean, as a share of national income.

There is much less here than meets the eye.


  1. You are arguing for stability of after tax returns from some kind of equilibrium over time as investment behaviour changes.

    In addition, with global capital markets we are adding another quicker driver of stability: international capital mobility.

    1. Yes. I would say that high tax rates relative to alternatives induce activity out of the domestic corporate form, in general. Some of this is into proprietorships, some of it is into debt financing on corporate balance sheets, and some of it is into non-domestic corporate activity. So, certainly the international capital mobility issue is a subset of that shift. Within that subset, there is a set of activity that is a discretionary tax arbitrage in tax havens.

      If you tax something, you get less of it. We won't get at the ramifications of the broader issue if we put all the focus on a subset of a subset of a perfectly predictable shift in activity.

  2. I would be happy to see corporations taxed like REITs. The dividend recipients would then be taxed. Not that dissimilar from partnership taxation really.

    1. Makes sense. When I talk to tax experts they always have complications I didn't think about, though.

  3. > If you tax something, you get less of it.

    With the notable exception of land value taxes, obviously.

    (And the aversion of the implied value judgement for taxes on alcohol conaunption or eg carbon dioxide production or other pollution: there the distortion of supply is actively encouraged.)

    1. Yes. Property or land value taxes seem good and the decline in property taxes over the past half century has probably not been for the better.

  4. Taxing income (personal or corporate) is a losing game now. Too many dodges available.

    Probably, a migration to property, fossil fuels, Pigou, and sales taxes is advisable. Tariffs too.

    1. Tariffs are a horrible idea as is mainstream knowledge since at least Adam Smith.

      Singapore does pretty well with their personal income tax, but they have a simple system with almost no deductions and a low maximum marginal rate of 15%. It's honestly more hassle to dodge than to just pay there.

      I wonder how much auctioning off green cards (or similar) to the highest bidders could raise. Would also give the politicians in search for revenues some inventive to increase allowed legal inbound migration.