How Capitalism Will Save Us (33 page)

P
opulist politicians traditionally score points by bashing the idea of tax cuts for corporations. In the 2008 presidential campaign, then-candidate Barack Obama said of himself and John McCain, “We both want to cut taxes, the difference is who we want to cut taxes for.” Obama said he wanted to cut taxes for the “middle class,” while McCain wanted to reduce rates for “some of the wealthiest corporations in America” including the big oil companies. The implication was that McCain was out of touch and cared little for the needs of the average citizen.
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However, had McCain been elected and been able to carry out his promise to lower the corporate tax rate to 25 percent, he would likely have delivered a charge to the economy that might have helped to lift it out of the recession brought on by the 2008 financial crisis.

That’s because high corporate taxes, like other levies, destroy economic activity. As Thomas Sowell explains so aptly, taxes make transactions more expensive. Thus, fewer take place. In the case of corporate taxes, they leave businesses with less capital to invest. Taxes also lower the net return on investments. Consequently, companies become reluctant to take risks and less likely to expand. High tax rates also increase the mortality rate of small businesses because they have less access to capital. They’re less likely to grow large enough to attract outside investment.

American corporate taxes are the second highest in the developed world. According to the Tax Foundation, the total American corporate tax rate—including state taxes—exceeds 39 percent, second only to that
of Japan among developed countries. The top statutory corporate tax rate in the United States reaches as much as 47 percent in some states, such as high-tax Iowa.
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That’s a stark, ironic contrast to the nations of Europe, which, despite high personal income taxes, have lower corporate rates. Even semisocialist countries such as Sweden, for example, have more reasonable business taxes. They understand that allowing companies to generate profits helps maintain a healthy economy better able to afford government social schemes. Sweden’s corporate tax is a moderate 28 percent. Even France’s rate is lower than the U.S. statutory rate. In recent years these nations have actually lowered rates to attract business investment.

The consequence? Businesses that might have located or invested here are going elsewhere. After all, why would any intelligent CEO decide to invest here if his corporation will only end up paying taxes that are 5 percent or 10 percent higher than in other countries?

Little wonder companies are moving to places like Ireland, with its corporate tax rate of 12.5 percent. Once the poorest country in Western Europe, that tiny nation has been able to transform itself in barely two generations into an economic miracle. Though it has been hard hit by the recession, Ireland’s per-capita income has surpassed that of Britain, France, and Germany.

High corporate tax rates drain businesses not only of capital but of productivity. They divert resources from business development and expansion into tax-avoidance efforts. These include so-called abusive tax shelters—elaborate, often convoluted strategies and transactions created for the sole purpose of avoiding taxes. The Enron fraud was in large part a huge tax-avoidance scheme. The
New York Times
reported that the energy company created 881 subsidiaries abroad, almost all located in tax havens. The strategy enabled the company to evade some $2 billion in federal income tax—and thus report false profits.
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In contrast, when corporate taxes are cut, businesses become more productive. More of them spring up. The result: increased tax collections. Cato Institute fellow Alan Reynolds has noted, “countries with corporate tax rates from 12.5% to 25%, such as Ireland, Switzerland, Austria and Denmark, routinely collect more corporate tax revenue as a share of GDP than the anemic 2.1% figure the Congressional Budget Office projects for the U.S.”
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Politicians like to imply that taxing corporations is “fairer” and will somehow leave individuals with a lighter burden. The reverse is actually the case: higher corporate taxes end up increasing the financial burden on consumers. After all, where do businesses get money to pay those corporate taxes? Where else? From their customers.

When you buy a tie or a blouse, you’re not just paying for the fabric and the labor. You’re indirectly paying the manufacturer’s—and the retailer’s—payroll taxes, Medicare taxes, excise taxes, fuel taxes, and the like that are passed on as part of “the cost of doing business.”

What does this mean in Real World economic terms? According to the Tax Foundation, the $370 billion in federal corporate income taxes collected in 2007 by Uncle Sam translated into an annual tax burden of $3,190 per family—more than the average household spends on restaurant food, gasoline, or home electricity in a year.
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Furthermore, the Tax Foundation’s Scott Hodge and Gerald Prante believe that supposedly “invisible” corporate income taxes impose the greatest burden on lower-income households. These low-wage earners have a lower disposable income. They are most sensitive to these pass-along levies. Hodge and Prante conclude:

A general cut in corporate income tax rates (or other taxes on capital) would provide a greater benefit to low-income households than would further rate cuts in individual taxes. Indeed, there are 43 million Americans who already have no income tax liability after they take advantage of their credits and deductions. Those households would benefit most from a cut in corporate taxes.
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Harvard economist Gregory Mankiw predicts that cutting the rate to 25 percent would unleash enough economic activity to generate revenues through other taxes to cover a major part of the $100 billion cost of the reduction. Other experts believe the cut would be self-financing.
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Capitalism bashers like to insist that only faceless corporations pay corporate taxes. But in the end, everybody pays.

S
teve Forbes’s book,
The Flat Tax Revolution
, outlines the plan for the Forbes Flat Tax: a single-rate federal income tax and corporate tax of 17 percent. Income is taxed once and only once. The flat tax eliminates all double taxation of dividends, as well as taxes on personal savings and capital gains. The tax for individuals and families would apply only after generous exemptions for adults and children. A family of four, for example, would pay no federal income tax on their first $46,165 of income.

Adults would be able to take a $13,200 standard exemption. Single people who make less than that would not be on the tax rolls. Married couples would receive a $26,400 deduction. Heads of single-parent households would have a 30 percent higher exemption of $17,160 to compensate for the additional burden of raising a child alone. Families would receive a $4,000 exemption for each dependent and a refundable tax credit of $1,000 per child age sixteen or younger, as under the current system.

In contrast, the current system is based on a tangle of tax rates: personal rates range from 10 percent for lower-income earners to 35 percent for top earners. There’s a 15 percent tax on capital gains and a 35 percent federal corporate income tax. On top of this are piled city, state, and local taxes.

People get concerned that the flat tax would eliminate favorite deductions, such as those for mortgages and charitable contributions. That’s why individuals should have a choice between going to the new system or staying with the old. Most people would quickly realize that a simple, low flat tax would give them more resources for housing and charitable contributions.

Why is the flat tax better than the current system? Simplicity, for starters. Lincoln’s Gettysburg Address, which defined the character of the American nation, is 272 words in length; the Declaration of Independence, 1,300 words; the Constitution, nearly 5,000 words. The Holy Bible, which took centuries to produce, 773,000 words. The federal income tax code and all of its attendant rules and regulations come to more than
nine million words
. And nobody truly knows what’s in the code
and what it means. That’s why the IRS gives taxpayers on its hotline wrong information at least 25 percent of the time.

The complexity of the code was illustrated several years ago by a
Money
magazine survey. It took a hypothetical family’s finances and gave the numbers to forty-six expert tax preparers, the best in the field. What the magazine got back was a shocker: no two preparers could agree on what the family owed. Each had a different estimate, and the differences came to thousands of dollars.
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Just about everyone would pay less under the flat tax than they do now. This is true regardless of the deductions they have taken under the old system. This substantial tax cut would unleash economic growth and boost tax collections. Fiscal Associates, a consulting firm specializing in quantitative analysis, estimates that a flat tax imposed in 2005 would have generated some $56 billion more in net government tax revenue by 2015 than the existing progressive code.
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The flat tax also eliminates a hidden tax we all currently pay—the enormous cost of compliance, the immense amount of money and man-hours that we spend filling out returns and working to reduce our taxes. As we mentioned, the nation’s total compliance cost has been estimated by the Office of Management and Budget to be around $200 billion.

With a flat tax, you’d file your return by filling out a single card. No more filling out page after page of tax returns. No more anguished hours spent with your accountant worrying whether you took the right deductions. The flat tax would reduce the need for the armies of accountants and bureaucrats who are part of the public- and private-sector effort of producing and processing tax returns.