President Obama has proposed reducing corporate income tax rates from 35% to 28% while eliminating some loopholes to make up the lost revenue. I think it would be interesting to consider a more controversial change:

What would happen if we eliminated corporate income taxes?

This kind of suggestion would be greeted with elation from libertarians and some Republicans, and generally derided by liberal Democrats like me, but if done correctly, it might actually turn out to be a pretty good idea.

We have to recognize first that any tax levied will result in some amount of tax avoidance behavior.  Some of this we want, like charitable contributions and reinvesting in the. But the behavior we don’t want, like off-shoring and spending millions on accountants and lobbyists to create and exploit loopholes, can be really costly to economic efficiency. What you get is really huge companies that pay no income taxes, and due to various tax credits, actually get money back from the government after making billions in profits.

Corporate income taxes, in spite of the fact that many large corporations pay little or no income taxes, are also used as an excuse for having a regressive 15% tax rate on capital gains, the notion being that dividends are being taxed twice, once as corporate profit and once again as capital gains to share holders.

I think we would potentially capture more revenue if we eliminate corporate income taxes altogether, but tax all capital gains as ordinary income.  This would eliminate the “double taxation” argument, and eliminate a lot of inefficiency involved in off-shoring.

If we just say that all corporate income is tax free there would be new kinds of tax avoidance behavior. If it is all business profit, then I can just quit my job and work as an independent contractor and suddenly I pay no taxes.  So I think the first rule is that for this to apply you must pay dividends at a certain level relative to profits.  We would also need protections against CEOs simply living off the company bank account. Some other rules would be needed to get back the behavior we do want that corporate taxes drive. For example, for a corporation to be tax free it must also give no money to lobbyists or political campaigns. Violations of regulatory rules, instead of resulting in one time fines that large corporations are more than willing to pay, result in revocation of tax free status until the company passes a review demonstrating that they have cleaned up their act and paid restitution. There would be no tax loopholes for corporations outside of this policy, so if you get caught and are forced to pay taxes, you pay the full amount, no exceptions. There should also be some level of profit as a percentage of revenue above which you go back to paying income tax, to continue to encourage reinvestment and hiring.

I would love to have real economists look at this idea and run the numbers to see how it would affect income tax receipts. Perhaps they have, but I don’t think I’ve ever seen it addressed in quite this way. Part of the reason for that is likely that conservatives would only look at eliminating corporate taxes and not doing any of the other mitigating things I’ve mentioned, while liberals scorn the very notion without considering that it could be a more practical means of attaining very liberal goals. My personal guess is that we would not see much decrease in tax receipts, and maybe even an increase. All dividends would be taxed as normal income, and hedge fund managers who currently pay 15% would suddenly be paying 38% on their millions in annual income. That’s a lot of money.

At the same time, businesses should save money by not having to work as hard at avoiding taxes. Not to mention we would move at least some jobs back to America. We’ll never be able to compete with offshore locations in terms of labor costs, lax environmental regulation, and cheap transportation, but some kinds of businesses are less affected by these costs and would move back. Financial services companies would be delighted to move back to the U.S. so there would be plenty of money and jobs coming back to America. States like Florida and Texas that have no state income tax could become new centers of finance.

Nevertheless, I’m not foolish enough to think that I’ve just solved a huge problem with a simple solution that no one ever thought of before. I expect there are holes in my idea, but I just can’t think of any that would be insurmountable, except for the political ones.