The recent tax bill signed by President Trump reduces the corporate income tax rate from 35% to 21%. This was a positive change, but really, just a step in the right direction. The corporate income tax rate should be zero.
All corporate income belongs to people and it is the people that matter. My point here is different from the economic theory of tax incidence. To the degree people change what they do to reduce their tax burden, part of that burden is shifted to other people. Usually, total income and welfare is also reduced. When a tax is reduced, the reverse of that logic is that effort to reduce the burden is curtailed and part of what was shifted disappears. This benefits someone against whom the tax was not directly assessed while increasing total income and welfare.
There is almost certainly some shift in the incidence of the corporate income tax, but the first step is to understand that the immediate burden of the corporate income tax is on the owners of the corporation--that is, the stockholders. There is little reason to have a special tax on the income stockholders earn from businesses organized using the corporate form and certainly no reason for a high tax of 21% much less 35% or even more.
While the average income of those owning shares of stock is relatively high, there are many stockholders who have quite modest incomes. Most obviously, many with defined contribution retirement plans use savings to purchase stock, sometimes indirectly through stock index funds. The corporate income tax reduces the return on these stock investments and so the income available to working people when they retire. Since this impacts the amount of saving necessary to generate an acceptable retirement income, it adversely impacts the consumption and welfare of average working people in the present. To avoid imposing unfair and unreasonable tax rates on people of modest means it is necessary to stop taxing corporations and instead tax the people who own the corporations. Those with lower incomes can then be taxed at a more modest rate.
Suppose a corporation pays out its profit as a dividend to its stockholders. Assume the share of the profit due to a stockholder is $100 The tax paid by the corporation was $35, leaving $65 for the stockholder's dividend. A individual with an average income might be in a 15% personal income tax bracket, leaving about $56. The government has taken nearly half of the share of the profit belonging to this taxpayer. After the recent decrease in the corporate tax rate, this would instead be $79 for the dividend. After paying the 15% tax rate on personal income, that would leave $67. The government is taking about 1/3 of the original $100 profit. But why?
Why shouldn't this average worker solely pay the 15% on this $100 as he or she would pay on any other income? While for most people that is wages, it also includes interest and profit generated from other business forms such as a proprietorship or a partnership.
It would be possible to impose an especially high tax on people earning high incomes from businesses organized as corporations, but that really doesn't make any sense either. Before the reduction in the corporate tax rate, the $100 profit would allow for a $65 dividend, which after the 39.6% top tax rate would result in about $40, so that the government is taking about 60% of the earnings. After the tax cuts, with the new lower corporate tax rate and the slightly lower top tax rate on personal income, the government will take slightly more than 1/2 of the earnings.
However, why should income from corporate profit be taxed at 50% while interest from bonds (including corporate bonds) or profit from proprietorships or partnerships be taxed at 37%? While I think the new top tax rate is too high rather than too low, having an especially high tax rate for income from corporate profit is unreasonable and unfair.
There is an important complication that could result from taxing personal income at a higher rate than corporate income. With no corporate income tax and a personal income tax, there is an incentive to use the corporate form to accumulate wealth without paying any tax. Conceptually, this can be corrected by allocating all corporate profit to the stockholders whether they are distributed as dividends or held as retained earnings. An alternative approach is to continue to tax corporations but to provide a refundable tax credit against each stockholder's personal income tax.
However, there is a good case to be made for expanding the ability to accumulate wealth without paying tax. From that perspective, the problem would be that the ability to do so is limited to those who buy and hold stock in a particular corporation. It should also be possible to accumulate wealth tax free for those who shift funds between corporations or keep money in a savings account or purchase bonds. Perhaps the easiest way to accomplish this administratively would be to remove the limits on deductions for contributions to IRA accounts as well as the penalties for early withdrawal. The result would be a shift from a tax on personal income to a tax on personal consumption.
Some would complain that taxing consumption is unfair because we all must spend some of our income on consumption and those with higher incomes have more left over that can be saved and so avoid tax. I suppose the argument just takes the tax rates as given, though I think that those making this claim are typically assuming a proportional consumption tax. That would be true of a typical sales tax.
However, a personal consumption tax can be applied at different rates. I favor a digressive rate structure. That is a tax system that includes two rates-- 0% for some initial level of consumption (or income) and then some other rate that applies to the rest. Of course, it can be equally described as a single tax rate that is applied after a standard deduction. So for example, a 10% tax rate applied on all consumption greater than $20,000. Such a tax system is progressive relative to consumption, because average tax rate rises with the level of consumption. With the given example, consumption of $10,000 would be taxed at a zero rate, consumption of $25,000 would be taxed at a .1*(25,000-20,000)/25,000 = 2%, consumption of $50,000 would be taxed at .1*(50,000-20,000)/50,000 = 6%, and consumption of $100,000 = .1*(100,000-20,000)/$100,000 = 8%. As consumption rises, the average tax rate approaches in common marginal rate of 10%.
How a tax on consumption relates to the income earned by the taxpayer would depend on the saving rate. However, be increasing the zero bracket and the tax rate, the average saving rate can be offset so that the tax system is progressive relative to income as well.
While it might seem that taxing consumption biases the tax system towards saving, the conventional wisdom in economics is that instead taxing income creates an inefficient bias towards current rather than future consumption. Economics assumes that the purpose of production is consumption. Income reflects contributions to production with its purpose being consumption now or in the future. Saving and the accumulation of wealth is the mechanism by which current production is used to provide for future consumption. Basically, the notion that taxing consumption is inefficient ignores that future consumption will be taxed as well, and that taxing investment income implies an excess burden from choosing to consume in the future.
While that argument is true as far as it goes, a given tax revenue requires a a higher tax rate on consumption than income (assuming private saving is positive in aggregate.) That higher tax rate on income will tend to discourage other economic activity--like working to earn income--compared to a lower tax rate.
Still, my own view is that earning income measures contributions to society and consumption is what is taken from society. I think it is better to tax what people take than what they contribute. I don't really agree with the principle that those who contribute and take more should pay more taxes, but I do believe that it is wrong to heavily tax people who take very little, especially when that is because they are unable to contribute much.
Regardless, taxing corporations because those who mostly own them are buying yachts and limousines is a mistake. It is possible to reform the tax system to greatly reduce the resulting unreasonable and unfair burdens placed on others.