The President made a big deal about and frequently referred to “Invest[ing]” during his State of the Union speech (or so I heard, since I didn’t watch it). Lots of “investing” in more government programs and top-down, centralized economic planning. Lots of “investing” in social safety nets. Lots of “investing” in more pet projects for politicians.
Actually, the President was talking about “spending”, but his handlers have informed him that the “S-word” doesn’t fly well with voters right now. So they did some polls and focus groups and determined a good word to use instead would be “invest”. Then they pulled up the Tools menu in Word and clicked “Replace”, changing every instance of the word “spend” to “invest” in all the President’s speeches. So the President plans to spend billions of dollars in taxpayer–okay, let’s be honest, borrowed–money on the same stuff he wanted to do before the landslide Republican victory in November. But now it’s okay because it’s “investing” instead of “spending”.
This isn’t “investing” in the future. It’s just more of the same Washington horse-hockey. The old Potomac Two Step.
If the President really wants to jump-start our economy and drive investment, he has a powerful–but politically unpopular with his base–tool in his arsenal: He can ask the Congress to eliminate the Corporate Income Tax.
The corporate income tax charges businesses for the profits they earn on their operations. The rate is as high as 35% of net profits, or the amount of money left over after the company pays its bills, its employees and its creditors.
“But those evil, greedy corporations should have to pay their Fair Share™ of taxes!” cry the Leftists.
Sure! Corporations should pay their fair share of taxes! That is, if corporations actually paid taxes. The problem is, corporations don’t pay taxes. They can’t. They’re a legal fiction. Corporations are merely an idea in our heads; an imaginary concept that explains groups of people working together toward a common goal of aggregating and using resources to make or distribute products and services. In reality, corporations don’t pay taxes because they are imaginary constructs. Corporations are made up of individuals: Owners, managers and employees. The corporate entities we talk about simply helps us understand why and how they work together.
So now that you understand that corporations don’t exist, your next question must be,
“Who pays the Corporate Income Tax if corporations are a figment of my imagination?”
Very simply: You do. The owners are ultimately responsible for payment, and they pay a portion of it, but they pass much this tax on to their employees and managers (in the form of lower wages, salaries and benefits) and to their customers (in the form of higher prices). In effect, every person who buys goods and services and every person who works for or owns part or all of a business pays the Corporate Income Tax.
“So how does eliminating the Corporate Income Tax lead to investment and stimulate the economy?”
This is a little more complex, and it first requires an understanding of what money really is: Money isn’t just money. In fact, money is another imaginary concept that we humans have made up. Money, in reality, is a place-holder for goods and services we haven’t bought. Before money, people would barter: They would trade goods and services for other goods and services. So two chickens would be traded for a spear; a goat would be traded for a measure of grain. Two people would come to an agreement on an equitable trade of resources they needed to survive and prosper.
Barter works well in small, localized economies such as hunter-gatherer societies, but it’s not well suited for large or expanding economies. So our ancestors invented this concept that they called “money”, usually making it from precious metals or other materials, later by printing special designs on paper and still later by entering ones and zeroes into a computer.
Money allowed people to split up the resources that they had previously bartered. Perhaps a family of cattle ranchers needed some thatch in their roof. Now, a cow was far more valuable than thatch, so the thatcher would have to barter for several weeks worth of a dairy cow’s milk, or he would have to give up something else of value in addition to the thatch in exchange for a whole cow. It could become very difficult for people to arrive at an equitable bargain simply because of the significant difference in the value of the bartered goods.
So one day, an enterprising individual decided to trade something in place of a valuable resource, and the person he offered it to accepted. It may have been a piece of volcanic glass, a decorative shard of bone or a small nugget of gold or silver. It doesn’t matter what it was, but at some point two people agreed to trade something other than the resources they actually needed, and money was born. So remember what money is: It’s a placeholder for resources.
“But what about gold and silver? Aren’t these precious metals real money?”
Again, gold and silver are just placeholders. They have no intrinsic value outside of being electrically conductive, maleable and pleasing to look at. If an asteroid struck the Earth tomorrow and wiped out all the plants and animals, the survivors wouldn’t be clamoring to get into Fort Knox to take the gold reserves. They’d happily trade whole ingots of gold for a loaf of bread.
“Fine. Money is another legal fiction. It’s a place-holder for resources and goods and services I haven’t bought yet. You still haven’t explained how cutting the corporate income tax helps our economy.”
Economic and financial experts have a special name for money. They call it “capital”, and that’s why our economic system is called “capitalism”. In fact, “capital” is an all-encompassing term meaning both money and the resources we have or obtain in order to make goods and services. We use capital (money) to regulate the flow of goods and services in our economy, and the amount of money required to obtain a good or service communicates its overall value of that good or service. If a chocolate bar is one dollar and a television is $1,000, we instantly understand that the television is 1,000 times more valuable–that is, requires 1,000 times the traded compensation–than the chocolate bar.
So when a business goes looking for resources, it has a certain amount of capital it can use to obtain them. Resources could mean available labor, machinery or raw materials. It could be the building where the business is housed or the telephone and internet connections it uses to communicate. It’s all capital. So when the government taxes a corporation or other business, what it’s really doing is taking away that business’ ability to obtain new raw material, new or better labor, and new physical plant and equipment. By removing money from the business, it removes capital from the capitalist system and places it elsewhere. And ineffective at doing that.
By acting together as a corporation (or partnership or sole proprietorship, for that matter), the owners, managers and employees can do things together–and obtain resources–that a single individual cannot. The vast majority of people can’t buy a nuclear reactor or a jumbo jet airliner or an aluminum smelter or an oil refinery on their own; however people acting together as a corporation, with all the combined resources and aggregated individual talent, can. Even if an individual could afford to purchase a jumbo jet and knew how to fly it, he’d still need someone to load the fuel, cargo, bags and the passengers and maintain the machine. He doesn’t have the time to do it all on his own. So again, people act together as a corporation to get the job done. And all that cooperation wouldn’t happen without the money to buy the resources the individuals need.
“But that owner needs to pay his Fair Share™ of taxes! If we don’t tax the corporation, how do we get revenue for the government?”
Simple answer: He is taxed. He pays income, payroll and/or capital gains taxes on his personal earnings as the corporation’s owner. By taxing the corporation, he is double-taxed. You see, ultimately the income of the corporation is his (and any other shareholders, if they exist). The profits of the business are taxed, then the business distributes part or all of the rest to the owners, then that income is then taxed as capital gains. If the corporation weren’t being double-taxed, it could send more money to its owners, pay its employees more, reduce its prices to its customers or buy more capital resources that they will need to hire new employees to maintain and operate (or any combination of those actions).
In effect, eliminating the corporate income tax becomes a pay raise for everybody. Whether it’s by lower prices, higher wages or increased employment as more capital is required, the net result is a growing economy. After all, if a company buys more capital equipment, somebody has to build it, and that “somebody” is probably another business. Somebody has to operate it, and many of those operators will be people who are currently unemployed.
“But won’t government revenues suffer?!”
In the short-term, they undoubtedly will decline somewhat. This is where the Laffer Curve comes into play: By reducing the tax burden and allowing money to flow more freely within the economy, the economy grows more quickly. By re-investing the money they save, corporations buy new capital goods (distributing that money eventually to somebody who will pay taxes) and hire new employees (who pay income taxes) to maintain and operate them. Even if they choose to keep the money for themselves, the corporation’s owners end up paying additional capital gains tax.
Employment grows, incomes rise and capital gains are larger. The regular income tax revenue grows over time and eventually the economic stimulus increases tax revenues until they reach and overtake the missing Corporate tax component.
“Why not eliminate some other tax, like Capital Gains?”
Eliminating another tax system wouldn’t be a bad thing. But eliminating capital gains tax isn’t as immediate a shot-in-the-arm. Besides, that the money was already taxed at the Corporate Tax rate, which once again is paid by everybody who works or who buys goods and services. Eliminating capital gains would certainly spur investment, but it only directly benefits one class of people. Eliminating corporate taxes benefits everybody.
“How do you know it will work?”
Imagine you’re a business owner. Your business no longer has to pay corporate income taxes! You have a couple of choices: You can increase your dividends and keep more money for yourself, or you can invest it to grow your business by hiring new workers and/or buying new plant and equipment. If you keep it, you pay more capital gains tax. If you re-invest it, you don’t pay any tax! Or you can keep part of it and re-invest the rest. It all depends on your personal needs and the needs of your business.
The only other option is to sit on the money and do nothing. While that’s a possibility, it serves no long-term purpose other than to defend against uncertainty. Uncertainty is what we’re dealing with now, as business owners and managers try to decifer how tax rates will change, what new regulations will be added and what the actual cost of the Health Care Takeover will be. As long as uncertainty is high, business owners won’t want to invest too much into their business, but will instead will hoard their cash as a hedge against the uncertain economic outcomes. Eliminating the Corporate Tax Rate will signal a change in how Washington views business and the economy and go a long way toward helping reduce uncertainty.