How To Decide On Taxing Corporations and The Rich?
Context
An important public policy issue… Income inequality has increased in many industrialized countries since the 1990s. This has spurred much debate and ideological positioning on the causes and consequences of this phenomenon. One of the main drivers of public debate lately is related to the taxation of corporations and high-income individuals.
Since decisions about taxation have important consequences for growth, jobs, prosperity, freedom of choice, public well-being, public finances, and public services in the long run, it is important to set a few things straight in the public debate to reduce the amount of nonsense and increase the quality of the debate and exchanges. This is a very important post, so please read on, even if you only care about forex and stock markets — it is good “brain training”! Let’s go!
Increasing income inequality within industrialized countries
Although the global poverty rate has decreased at a record pace since the 1990s (yes this is true and documented, so stop frowning), it is indeed a fact that income inequality has increased within most industrialized countries. The source of income varies depending on income levels.
High-income individuals tend to get more of their annual income in the form of capital gains and business income than other people. In other words, high-income individuals get proportionally less income from standard salaries and more of their incomes on other types of income, like capital gains.
The reasons for this phenomenon of increasing inequality are quite complex and much harder to properly identify rigorously than most people think. Globalization, global supply of labor from low-income countries impacting the middle class, automation enabled by technology, increasing transport efficiency allowing more globalized supply chains, technology and mass media that increase the marginal value of stars and other types of people, tax rates, financial market dynamics, and MANY other developments are potential causes of the observed phenomenon. I don’t want to analyze the causes of the increase of inequality within industrialized countries in this blog post…
In this post, I want to discuss the debate over the taxation of corporations and of high-income individuals.
Taxing corporations
Any form of “institution” like a company, corporation, etc., is a legal entity that is not an individual person. Most important companies have much more than 10 or 100 employees, often hundreds, thousands, millions, and even billions (facebook!) of users/consumers, and a complex setup of suppliers and associates.
Here is the simple reality of an institution that is not a person:
Note that “profits” are taxed 2–3 times or more:
- At the firm level: the difference between all income and expenditures is taxed… this gives you the net profit
- The net profit is then distributed in the form of dividends, which is ALSO taxed
- Increasing profits makes the price of the stock increase, which gives capital gains to shareholders, and these capital gains are also taxed
Who “really” pays corporate taxes? So. I ask you a simple question: if you charge any amount to be paid to a legal institution (call the amount to be paid whatever you want: taxes, social charges, social contribution, payroll taxes, employer contribution, etc), who actually pays the amount to be paid? Let this question sink in very deep before you answer.
When an institution that is not an individual must pay some amount to a government (or to anyone else, actually), here are the options:
- Reduce profits paid to shareholders relative to what otherwise would have been
- Reduce salaries, bonuses, and other payments to Upper Management relative to what otherwise would have been
- Beg the bank and other lenders to decrease payments on loans (good luck!)
- Decrease the cost of supplies of all types
- Decrease total employment volume to save on total payroll costs
- Close down and go produce elsewhere (equivalent to a layoff of 100% of workers)
- Decrease wages relative to what they otherwise would have been (ex: increase by 1% instead of by 3%)
- Increase prices for consumers
In the short run (1–2 years), profits will typically drop and shareholders/owners will take a hit… including your private pension fund and all public pension funds… What happens in the LONG RUN depends on “elasticities” of various markets: the sensitivity of markets to changes in prices, profits, costs, etc. Generally speaking, if profits are overly burdened, companies will leave the territory or find a way to avoid the taxes.
Although there are some nuances and case-by-case, sector-by-sector estimations to do, the typical case is that it is ordinary people who actually pay corporate taxes in the end with 1) higher prices; 2) lower employment volume (and higher unemployment); 3) lower wages or generally worse working conditions than otherwise would have been. That is reality: most corporate taxes and other such charges are actually paid by “ordinary people” in the end, by lower job creation, lower wages, and higher prices. WOW! That is a hell of a “progressive agenda”… This is NOT “neoliberal” ideology or some capitalist plot to manipulate people — it is like reality. Period.
Sorry if you don’t like it. I insist: if you are hungry for “social justice” and you want ordinary workers to be better off, the LAST thing to fight for is for increased taxes to companies! In fact, a smart progressive agenda would seek to decrease all forms of taxes paid by companies to allow job creation, a higher employment rate, and a lower unemployment rate — in short, prosperity! That will help ordinary people.
Would a fast decrease in all “taxes” charged to corporations actually increase wages for workers? Not in the short run, no. It’s not that simple. But in the long run, lower taxes will encourage production and employment, which will make labor scarce… and THAT will benefit ordinary people and their wages in the long run! Never forget this: any payment to be made is ultimately ALWAYS paid by individuals.
A company is NOT an individual — it is a collection of individuals: managers, owners, workers, consumers, etc. It makes NO intellectual sense to say something like “we should increase taxes to big companies who make millions and billions.” Literally. I say this even to you communists out there who hate corporations with all your guts: when you talk about firms paying stuff to the government, what you should really be saying is “we should make consumers and workers pay taxes indirectly via taxing companies.”
Make it impossible to layoff workers or to freeze wages?
After reading this highly uncomfortable truth, the typical reaction (especially in France and Latin countries) is to say that we will simply make it very hard for companies to 1) fire workers; 2) cut wages or working conditons; 3) close down. This seems like a magical solution: tax companies to increase government income and allow social spending like education and healthcare, AND prevent all companies from making workers and consumers pay for those taxes with strict regulations and laws. COOL!
OUF! Broken thinking that gives birth to broken policies and broken prosperity. This gives birth to what I like to call “spaghetti policies”, with a patchwork of broken policies one on top of the other, which only creates fiscal complexity, inefficiencies, and stagnation. Is France doing well now with the approach of crushing firms under fiscal burden? … Look at countries that are doing well and look at the effective corporate tax rates (including Scandinavian countries by the way) and you will find both correlation and some grounds for causation… Have a beer and think about this a bit before your next “call for revolution…” Saying that corporations pay taxes is as devoid of meaning as saying that the building I own pays for my real estate taxes for me… of COURSE it doesn’t! Either I pay those taxes or people who rent space in the building I own will pay! Or I will cut on repairs and upgrades… either way, individuals always ultimately carry the burden of taxes. Always.
Taxing the rich
Taxing legal organizations that are a collection of individuals makes no sense. However, taxing invidivuals DOES. There are various taxes to high earners, but they mostly take the form of 1) income taxes; 2) taxes on non-salary income such as capital gains taxes, dividend and interest income taxes, etc.; 3) taxes on total wealth; 4) luxury taxes: taxes on goods or services that only high-income individuals purchase (Ferrari, private jet, million dollar watch, etc).
Freedom considerations put completely aside, there are still pragmatic considerations even when talking about taxing high-income individuals:
- Where do they declare their income?
- Where does their income come from in global markets?
- What is the sensitivity of taxable high-earner income to tax rates?
- What do geographically close neighbours do? (fiscal competition).
There are MANY pragmatic considerations even when discussing the taxation of high earners, and these are ignored by simple-minded-yet-well-intentioned-people who are clueless about economics and improvise themselves as economists after reading 3 books and a few articles. One must also remember that capital is much more mobile than physical workers, which means that the forms capital takes will move around, partly due to fiscal incentives. But at LEAST yelling out for higher taxes to the rich and wealthy has SOME intellectual grounds, which is NOT the case when calling for higher corporate taxes. So at least there is place to debate with a somewhat OK starting point!
Concluding remarks
Asking for higher corporate taxes simply makes no sense, because corporations are not individuals, and ultimately the ONLY “entity” that actually pays and receives sums of money are individuals. Corporate taxes ultimately hurt the very people you want to save: ordinary people, workers, and consumers. Stop that now. Asking for higher taxes to the rich and wealthy at least makes some intellectual sense, although even that has complexities that could be the subject of a whole book, or certainly the subject of a blog post… maybe later… click the heart to show you like the insights. Many thanks. Be well.
pbedard@YourPersonalEconomist.com
