Is it time to repeal the corporate income tax?

The argument to repeal the corporate income tax has gained a lot of steam. But what would replace it? 

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A worker counts US dollar bills at a money changer in Manila.

In case you missed it, The New York Times’ political and policy blog The Upshot published a fascinating debate throughout August on the question: Should the corporate income tax be abolished?

It’s a query that may be raised on Monday morning, when Treasury Secretary Jack Lew speaks at the Tax Policy Center on business tax reform, a presentation that will be followed by a panel of corporate tax and legal experts. You can watch online or register to attend in person here.

Talk of repeal began after my TPC colleague Eric Toder and AEI’s Alan Viard published an important new paper suggesting the corporate levy could be replaced with a direct tax on shareholders. Toder and Viard raised repeal as one of two possible solutions to the vexing problem of the corporate income tax. Unsurprisingly, this dramatic idea attracted the most attention though the other—a proposal for a new international formula for taxing corporate profits –has also generated some interesting discussion.

To replace the corporate tax, Toder and Viard would tax shareholders on the annual increase in their stock’s valuation, whether they sell their shares or not. Those returns would be taxed at ordinary income rates, not preferential capital gains rates. But because the corporate tax would disappear entirely, corporate profits would be taxed only one time rather than twice as they are today.

Times blogger Josh Barro embraced the idea, arguing, “Corporations aren’t people, so it’s a lot to ask for them to be patriotic, especially when they operate all over the world. But we can ask their American shareholders to pay American taxes on their profits.”

A few weeks later, Harvard economics professor Greg Mankiw (who advised both President George W. Bush and GOP presidential candidate Mitt Romney) also backed the idea of repealing the corporate tax.

But Greg’s idea is very different. Instead of a shareholder tax, he’d replace the corporate income tax with a broad-based consumption tax. Thus, in effect, corporate returns to capital would be exempt from tax. That idea isn’t new—back in 2007, the Bush Treasury suggested one version of such a design, which it called a Business Activities Tax.

A couple of days after Mankiw’s column, Jared Bernstein, senior fellow at the Center on Budget and Policy Priorities, weighed in. Jared, who was chief economist to Vice President Joe Biden, called abolishing the corporate tax “a bad idea.”  He wrote, “If you think we’ve got tax avoidance problems now… we’d have a much bigger problem with a zero tax rate on incorporated businesses.”

Instead, he urged, “mend” the code by ending corporate tax preferences and “closing loopholes.”

Of course, Congress is not about to do any of what Toder, Viard, Mankiw, or Bernstein suggest, at least not any time soon.  And the Obama Administration is grasping for some middle-ground—a corporate tax reform that lowers rates and eliminates some preferences but retains the basic structure of today’s law.  But which repeal plan makes the most sense?

If you buy the theory that it is easier for Congress to do relatively small things rather than big ones, you might take the Bernstein view: Give Congress a chance to address issues such as tax inversions but retain the basic corporate tax.

The downside: In effect, we’d continue the game of whack-a-mole that Congress, Treasury, and corporate tax lawyers have been playing for decades. Congress writes a law, the lawyers find a way around it, Congress eventually writes another law to block that avoidance scheme and so on. Nothing ever quite gets fixed, but the worst of the abuses are held in check—at least sometimes.

There is another view of the corporate code, however. It sees inversions as a symptom of a much larger problem: an extraordinarily inefficient corporate tax notable for both high statutory rates and abundant opportunities to minimize those rates.

This view acknowledges that roughly 10 million businesses already have engaged in self-help tax reform by organizing themselves as pass-through firms (where owners at taxed as individuals but bypass the corporate tax entirely). For all its complexity, the corporate levy generates revenue equal to only about 2 percent of Gross Domestic Product—enough to fund only about one-tenth of the federal government.

From that perspective, mending the code will never resolve its real problems. Thus, repeal looks more attractive.

But how would you replace the corporate income tax? Do you go the Mankiw route and move to a consumption tax? Or do you go down the Toder-Viard road and tax shareholders directly?

Each of these ideas comes with its own political and design challenges. And each represents the kind of major change that Congress usually (but not always) shies away from.

The good news is that while Congress dithers over whether or not to restore a bunch of expired and  largely discredited tax breaks, policy wonks are chewing over some truly ambitious ways to fix the corporate code. And who knows, maybe by the time we have a new president and Congress in 2017, one of those ideas will have gotten some traction.

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