Tax Treaties

Should Corporation Tax be Abolished?

By Daniel Mitchell, Cato Institute (24/08/2017)

The corporate income tax is a destructive levy that discourages job creation and economic growth. But it is nonetheless a popular source of revenue for politicians because voters do not understand that taxes on companies are really borne by individuals (as shareholders, workers, and consumers).

In an ideal world, there should be no corporate income tax. But in that ideal world, there would be no taxes on any income. Sound like an impossible fantasy, but it’s worth remembering that the western world made the transition from agricultural poverty to middle-class prosperity in the 1800s, when income taxes were largely nonexistent and the burden of government spending was a tiny fraction of current levels.

So what’s the right approach to corporate taxation in today’s imperfect world?
The gold standard of good tax policy is the flat tax. More specifically, it’s the Hall-Rabushka flat tax, a very simple levy which was devised by economists at Stanford University’s Hoover Institution. This system is based on the principle that the economic harm of taxation can be minimized if all income is taxed, but only one time and at one low rate.

And that means corporate income should be taxed.
That being said, most corporate income taxes in the developed world are grievously flawed.

·         Tax rates generally are too high.

·         Most nations double-tax corporate income, first with the corporate income tax and then a second time with personal income taxes on dividends.

·         Rules on ‘depreciation’ force companies to pretend that investment costs incurred today occur in the future, thus imposing a present-value tax penalty on capital formation.

·         A few nations, most notably the United States, impose ‘worldwide taxation’ on income that is earned  – and already subject to tax – in other jurisdictions.

·         There are unjustified and distortionary loopholes that result in zero tax on some types of income/activities.

That’s the bad news.
The good news is that these problems can be solved. With a flat tax, the corporate income tax would be replaced with a very simple, low-rate system that properly measures income (i.e. a cash-flow-based approach that allows companies to immediately deduct investment costs – a policy known as ‘expensing’). The flat tax also is based on the common-sense notion of territorial taxation (only income inside national borders would be taxed). And there is no double taxation since income is taxed at the business levels and there is no second layer of tax when corporate income is distributed to shareholders.

By the way, corporate income can be taxed without a corporate income tax. Lawmakers can choose to tax the income when it is distributed to shareholders (the people who own the company) instead of taxing it at the business level. The goal, of course, is to make sure it no longer gets taxed twice.

 A good business tax system isn’t a fantasy. Jurisdictions such as Estonia and Hong Kong have business tax systems that are very close to the abovementioned ideals. And it goes without saying that jurisdictions such as Bermuda, Monaco, and the Cayman Islands. are even better since they fulfill my dream of no income tax whatsoever.