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June 9, 2004
Raising the Issue: In the Name of Honesty and Economic Efficiency, Cut Business Taxes
Posted by Dr. Roy Cordato at 2:00 PM
Should the NC legislature reduce “business taxes” this year? The answer is clearly yes. But more specifically, these reductions, which
should target all business taxes including the personal income tax, should be made with an eye toward ultimately abolishing the misnamed corporate
income tax. This tax violates not only the basic principles of efficient tax policy, but more importantly it is dishonest and unfair. Anyone who
values transparency in government should advocate the ultimate abolition of this tax.
Corporations and other types of businesses do not and cannot pay taxes. The reality is that all taxes, business or otherwise, must come out of some
real human being’s pocket. “Business taxes” are hidden taxes and the so-called corporate income tax, currently at 6.9 percent
in N.C., is the most egregiously dishonest.
Corporations are legal and accounting constructs, and as such cannot pay taxes. All revenues received by a corporation accrue to the benefit of
some real human beings. Therefore, all taxes that are paid out of this revenue must come from someone’s income. These people can be broken
into three broad categories—the corporation’s employees, customers, and owners, i.e. shareholders. All corporate income taxes are paid
by some combination of these three groups. Workers pay in the form of lower wages or fewer jobs; customers pay in the form of higher prices; and
shareholders pay in the form of smaller dividends or capital gains. This last group—the capitalist class who is usually the rhetorical target
of those who advocate high corporate taxes—are not only made up of the “fat cat” corporate board members, but millions of small
investors whose pensions and other retirement funds are tied to the fate of corporate earnings.
For unincorporated business—i.e. sole proprietorships, partnerships, etc.-- the story is the same, except that the proprietors, partners,
and other entrepreneurs who own the firms replace shareholders. Here the owners’ pay directly through the personal income tax, most likely
at the top marginal rate of 8.25%. But even in this case, the taxes raise the cost of doing business and contribute to higher prices and lower wages.
In reality, when we talk about the “business taxes” in North Carolina we are invoking a euphemism for taxes on workers, consumers, shareholders,
and independent entrepreneurs at all income levels.
The economic analysis ties into this point. An economically efficient
tax system, one that does not distort investment and consumption decisions, should tax all income once and only once. The corporate income tax
introduces double and in some cases triple taxation into the system. A worker at Wal-Mart who is paying personal income tax is being taxed on a
salary that has already been reduced by the corporate income tax. A shareholder in the company faces triple taxation. First, when any income is
taxed, by definition the tax reduces the potential income stream, i.e., interest, dividends and capital gains, that that income can generate. This
is the first level of taxation. Dividends and capital gains are reduced further by the corporate income tax, and when they are finally earned, they
are taxed as part of the investor’s personal income.
Every layer of taxation on any form of income represents a tax penalty on the activity that generated it. Investors, entrepreneurs, and workers
are the engines of economic growth and prosperity. Corporate and business taxes add layer upon layer of penalties on the very activities that we
should be encouraging to flourish; investment, entrepreneurship, and work effort.
Linkable Entry
Raising the Issue: Should state lawmakers work to reduce the state's business tax burden as they craft the 2004-'05 budget?
Posted by Elaine Mejia at 2:15 PM
As they deliberate adjustments to next year’s state budget, state lawmakers are hearing renewed calls from a small but vocal section of
the state's business community to reduce the state's business taxes. These tax cut proponents are attempting to prey on the common sentiment that
the state must do something to stimulate the economy. Unfortunately, a close look at the facts shows that cutting business taxes will do little,
if anything, to improve the outlook for working families in our state. Indeed, there is far more evidence that business taxes are already low and
in serious need of reform in North Carolina than there is evidence that corporate taxes need to be reduced.
The most oft-cited evidence of North Carolina’s “high” tax burden on businesses is the fact that we have the second highest top
corporate income tax rate in the southeast. What is almost never mentioned is the fact that North Carolina's current corporate income tax rate of
6.9 percent ranks 29th in the nation, hardly sticking out like a “sore thumb” deterrent to business investment as some claim. Furthermore,
the state's corporate income tax rate is only one of many measures of the overall business tax burden in North Carolina. According to two recent
studies that account for a broad range of state and local taxes paid by businesses (including our relatively low property taxes), North Carolina's
overall business tax burden is comparatively low. A study conducted by the Public Affairs Research
Council of Louisiana in 2002 ranks North Carolina's total state and local tax liability on an average manufacturing firm as 9th (rural) and
10th (urban) out of the twelve states in the South. Another comprehensive study published in 2003 by the Council
on State Taxation ranks North Carolina between 47th and 49th in the nation on all four of its measures of business tax burden.
In addition to being comparatively low, there is growing evidence that the state corporate income tax is in dire need of major reform. In 2003,
the non-partisan Multistate Tax Commission released a study showing that North Carolina lost an
estimated $300 million due to tax shelters and loopholes in fiscal year 2001 – 65 percent of the total corporate income tax revenues received
that year. The share of state tax revenues from corporate income taxes in North Carolina has been falling steadily for the last fifty-plus years
and now stands at only 6%, begging the question “what is the fair share of tax revenues that should be paid by corporations?”
One of the most basic principles of economics is that the true cost of any decision is not the cost in dollars and cents of the immediate decision – in
this case the revenue lost by any cut in the tax. The true cost, rather, lies in the benefits that would accrue from making a different choice,
i.e. the “opportunity cost.” Consider that in 2003 North Carolina was ranked #1 in business climate by Site
Selection magazine for the third year in a row. Now consider that just last week we learned that North Carolina has slipped to 41st among all
states in a new state-by-state study that reports on the well being of America’s
children. During the current fiscal crisis, lawmakers have, in fact, cut programs such as adolescent pregnancy prevention and nutrition programs
for pregnant women and infants that would help improve child well being. Which of these rankings is truly calling out for the state’s attention?
Linkable Entry
Raising the Issue
Posted by Dr. Roy Cordato at 2:55 PM
I would like to start by addressing Elaine’s question toward the end of her statement. “What is the fair share of tax revenues that
should be paid by corporations?” In light of the fact that corporations do not and cannot pay taxes, this is a meaningless question. The question
that is actually being asked is how much of the tax burden should be borne by workers, consumers, and shareholders in the form hidden taxation imposed
by the corporate income tax? My answer is that these groups are already paying too much in taxes and they shouldn’t be deceived into thinking
that they can pass some of that burden onto someone else vis a vis the corporate income tax.
As far as the studies that Elaine cites, it is difficult for me to investigate them in this setting, (the studies themselves are not apparent on
the links). The point that needs to be made is that these studies, unlike the one often cited by the Governor conducted by Ernst
and Young, would need to include all taxes paid by business. Most importantly they would have to include all personal income taxes paid by independent
unincorporated businesses and they would need to allocate a portion of the sales tax to business. The Earnst and Young study that shows NC as having
the 5th most favorable tax burden is irreparably flawed because it does none of this. NC’s personal income tax has one of the highest top
marginal rates in the country and the vast majority of businesses in the state are unincorporated and their owners pay their business tax at the
top 8.25 percent rate. Also, The simplest excise tax analysis learned in every econ 101 class can demonstrate that sales taxes are borne by both
the seller and the buyer. So part of the sales tax should be included in the business tax burden.
Finally, so long as we are citing studies, reports done by the Tax Foundation and the Small Business Survival Committee cast North Carolina as having
a relatively poor tax climate for business. The Tax Foundation ranks states according to their “business tax climate” and they include
retail sales and personal income taxes. They ranked NC as among the worst in the region and right at the average for the nation for 2003. The SBSC
looked at fiscal policies effecting entrepreneurs and small business, focusing on marginal tax rates and capital gains. NC had the 15th least congenial
business atmosphere in the country.
Linkable Entry
Raising the Issue
Posted by Elaine Mejia at 3:37 PM
Roy - The basic point remains that the objective of any tax system is to progressively distribute the burden of paying for government services.
The tax on corporate profits is one of many tools that we use to distribute this burden.
When I buy a shirt, I'm taxed. When I get the shirt dry-cleaned, I'm taxed. The low- and moderate- income earners are the one's being taken to the
cleaners by our tax code due to its regressivity. Double-taxation can be argued for any taxpayer, businesses are no exception. Our tax structure
exists so that the tax burden is spread among taxpayers. Eliminating the corporate income tax would create massive inequity and further accelerate
the trend to overtax working families.
In a perfect world, we would find a way to maintain a progressive tax system and eliminate the evils of "double taxation." And you‚re right
that individuals shoulder the ultimate burden of any tax on business. In the case of the corporate income tax, those individuals are shareholders
- the very group that has seen its federal tax bill plummet under the 2001 and
2003 rounds of tax cutting.
"Double taxation," although not desirable, is rampant in the tax code and it's not always wealthy shareholders who are "hurt" by it. You might say that
the solution is to move to some sort of national consumption tax, but to make this debate meaningful, we need to stick to today's political realities -
like the reality that even after you apportion all of state and local taxes to individuals, it is low- and middle-income families in North Carolina that
pay the greatest share of their income in taxes.
As the Budget and Tax Center demonstrated in a recent Tax Brief,
the Small Business Survival Committee's state comparison report that you cite is a badly flawed analysis of our small business climate. The study's
measures are arbitrarily chosen (such as the "number of bureaucrats per 1000 residents") and have no predictive value of small business success
whatsoever. Not surprisingly, a recent report by the US Small Business Association
directly contradicts the validity of the so-called Small Business Survival Index. The fact is that while North Carolina has ranked 37th in the nation
for the past two years on the Survival Index, the survivability of actual
businesses in North Carolina is quite strong. From 1990-2002, North Carolina ranked 6th in the nation on the total number of employer firms, 11th
on the number of employer firm formations, and 38th on the number of firm terminations. In addition, North Carolina performed better in each ranking
than every neighbor state.
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Raising the Issue Debate to be Continued
Posted by Dr. Roy Cordato at 5:32 PM
The last two entries in our Raising the Issue Debate will be posted in the morning. Thanks to Elaine for her patience.
Linkable Entry
June 10, 2004
Raising the Issue: Closing Argument
Posted by Dr. Roy Cordato at 08:21 AM
Yes, the purpose of taxation is to raise money to pay for government services, but we clearly disagree on progresivity. Taxation coercively denies
everyone their right to the fruits of their labor. This is a right that is specifically recognized in the NC
Constitution and that is endowed in each one of us equally by our Creator. Progressivity denies this equality of rights and assumes that the
more income you have the fewer rights to that income you posses.
But even if progressivity is desired, it should be achieved with large zero rate brackets at the bottom, making the average rate progressive, rather
than with increasing marginal rates. Progessive marginal rates make no sense from an economics perspective. They penalize and therefore discourage
work effort, investment, and entrepreneurship and they punish economic success. This is no way to encourage economic growth.
You are right there is double taxation everywhere and the “corporate income tax” makes sure that that double taxation is felt, not only
by corporate shareholders but by workers and customers. It is difficult for me to see how a corporate tax on Wal-Mart that reduces the wages of
its low skilled and low-income workers and raises prices to its mostly low income customers could be considered progressive. But the main point
is still that none of the corporate tax is paid by the corporation, not because of loopholes or tax shelters, but because it can’t be, and
it is misleading at best to talk about corporations paying their fair share.
Clearly, we can both point to studies ranking NC’s “business climate” according to one set of criteria or another, but the fact
is that North Carolina had unemployment rates well above the national average during the recent recession and has had a recovery that is lagging
behind much of the rest of the nation. The most important way that state government affects the cost of business expansion and therefore job creation
is through taxation. Therefore, taxation is the most important policy tool that the state has at its disposal for stimulating economic growth. There
is probably no more agreed upon proposition in economics than the idea that the more you tax productive activities the less likely it is that those
activities will be pursued. By reducing income tax rates across the board and by, for now, dramatically reducing the corporate rate, the state has
the power to increase the rewards for investment and work effort thereby providing an incentive for economic growth and job creation. In addition,
this reduction in the corporate tax would have the happy effect of reducing the hidden tax burden on workers and consumers.
Linkable Entry
Raising the Issue: Closing Argument
Posted by Elaine Mejia at 09:14 AM
Well, we could debate for days on exactly who bears the burden of the tax on corporate profits, shareholders or workers, but we’d probably
bore our readers to tears. Certainly, some level of fair tax rate competition between states is beneficial because it encourages efficiency and
innovation as states try to maintain and enhance the quality of public services and keep costs in check. But cutting business taxes under current
conditions fails the following two basic tests of good public policy.
One, it is not likely to improve the state’s long-term economic outlook. For more than twenty years, researchers have been studying the influence
of state and local tax policy on the level and distribution of employment and investment. The majority of this research has demonstrated that taxes
do not have a substantial effect on economic activity among states. The studies that have shown a statistically significant impact of taxes on economic
performance generally hold other critical variables constant. Those other variables, such as the quality of public services, the availability of
an adequately-trained labor force, and the cost of energy are often more influential than differences in tax burdens.
Two, it is not worth the tradeoffs – tradeoffs like shifting the tax burden to lower-income families or forcing even more budget cuts than
state services have already endured. The fiscal crisis of the last three years has forced state government to scale back dramatically. In fact,
state general fund spending is $272 less per capita after adjusting for inflation than it was in 2000-01. If the state’s general fund had
kept pace with inflation and population growth during this period, the general fund budget would be $2.3 billion larger that it is today. Furthermore,
the tax increases enacted since the fiscal crisis began have fallen disproportionately on low- and moderate-income families. Approximately 90% of
the revenues from the tax increases enacted during the fiscal crisis comes from the two _ cent sales tax increases (one state and one local). Less
than $100 million per year is being generated by the one progressive tax increase during the period – the creation of the new 8.25% income
tax bracket on the state’s highest income earners.
Finally, Roy, I would take issue with your rather pessimistic (fatalistic?) argument that tax policy is the only way that government can impact
long-term economic development and job creation. Such an argument wrongly discounts the power and efficacy of public investments in workforce (through
enhanced public education, job training, health care and other core services) and infrastructure (through enhanced transportation, communication,
public utilities, etc.).
As North Carolina moves forward, restoring the solvency of the state budget and making crucial public investments in our future, and/ or lowering
the tax burden on working families should both take precedence over any reductions in business taxes.
Thanks to the John Locke Foundation for hosting this debate and to Roy Cordato for being such an able sparring partner.
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