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Why We Should Kill the Corporate Tax

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As we watch the turmoil in Europe, the U.S. gets closer and closer to a sovereign debt crisis of its own. Yet the most recent public uproar over whether corporations are paying their fair share of taxes distracts from the far more important question: Why are we wasting time worrying about a tax that hasn't contributed all that much to the government's coffers for decades?

Much ado about little
Last week, The Wall Street Journal raised the hackles of tax reformers everywhere by highlighting a statistic from the Congressional Budget Office. According to the CBO, corporations paid just over 12% of their profits in taxes last year -- the lowest percentage since 1972.

The resulting outcry was fast and furious. Fellow Fool Alyce Lomax pointed to a report from the Citizens for Tax Justice and the Institution on Taxation and Economic Policy that pointed to 280 profitable Fortune 500 companies that received $223 billion in tax subsidies, and paid an average effective rate of 18.5%. Thirty of those companies had negative tax rates, with Wells Fargo (NYSE: WFC  ) topping the list with $18 billion in tax breaks from the Treasury, according to the report.

Much ado about little
But amid all this turmoil is an often-forgotten point: Corporate tax revenue didn't disappear overnight. It's been an insignificant part of tax revenues for a long time. In fiscal 2010, for instance, corporate income tax represented only 6% of the total federal income for the year. But as long ago as 2003, the figure was just 7.4%. To give some sense of perspective, when you combine personal income taxes with payroll taxes like Social Security, Medicare, and unemployment, those payments added up to more than half of federal tax revenue in 2010.

This trend away from corporate tax goes back for decades. According to the Center on Budget and Policy Priorities, the percentage of federal revenue coming from corporate income taxes has fallen from a peak of 32% in 1952 to around 15% on average in the 1970s, and dropping further into the 10% range from the mid-1980s forward.

Why did corporate tax revenue largely go away? A lot of it has to do with the ease with which corporations can take advantage of tax structures that avoid it. Consider:

  • Annaly Capital (NYSE: NLY  ) doesn't have to pay corporate tax because it qualifies as a real estate investment trust. All it has to do is pay out 90% of its income every year, and it avoids corporate-level tax entirely.
  • Linn Energy (Nasdaq: LINE  ) doesn't have to pay corporate tax because its LLC structure qualifies as a master limited partnership for tax purposes. By generating 90% of its income from qualifying sources like energy production and transportation, it also frees itself from the corporate tax structure.
  • Prospect Capital (Nasdaq: PSEC  ) and Apollo Investment (Nasdaq: AINV  ) don't have to pay corporate-level tax because they qualify as business development companies. By getting at least 90% of their income from dividends, interest, capital gains, or other investment income, and then paying it out to shareholders, BDCs steer clear of corporate tax requirements. That's also how Prospect and Apollo pay such attractive yields: They have to in order to keep their favorable tax status.

But the rest of why corporate income tax revenue has fallen is simple: The government has passed laws giving corporations big tax breaks, and corporations have taken full advantage of them. The WSJ acknowledges that so-called "bonus depreciation" is likely the culprit for the current drop in corporate tax receipts, as companies have been able to write off capital expenses immediately rather than depreciating them over time.

Set your priorities
Obama administration officials have said that the president expects to announce a revenue-neutral overhaul of the corporate tax system this month, which could include a cut in the current 35% tax rate in exchange for greater taxation on profits generated overseas.

But, to borrow a page from fellow Fool Morgan Housel's playbook, we might be better off doing nothing. In fact, I think eliminating the corporate income tax entirely might well work better -- as long as we made sure that business income was fully taxed at the shareholder level, and that shareholders had to pay the higher rates of tax that are slated to take effect at the beginning of 2013. In the long run, that would not only simplify taxes but also put investments on a more even keel, allowing money to gravitate to the most valuable enterprises rather than ones that provide artificial tax benefits.

Unfortunately, for now, we have to live with the tax system we have. One way to minimize taxes is to invest using tax-favored retirement accounts, but you need the right stocks to have a rich retirement. The Motley Fool's latest special report reveals three great stock names, and it doesn't cost a dime -- but it won't be around forever, so read it today while it's still available.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.

Fool contributor Dan Caplinger is fine with paying his fair share of taxes. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Annaly Capital and Wells Fargo and has created a covered strangle position on Wells Fargo. Motley Fool newsletter services have recommended buying shares of Annaly Capital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is never taxing.


Read/Post Comments (18) | Recommend This Article (27)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 06, 2012, at 11:44 AM, dht629 wrote:

    I like the summation of corporate taxes and the part of total taxes collected by the IRS. What is frightening is that just we continually favor unearned income on individual taxation compared to income earned through wages. A large percentage of business in America are operating as C or S type corporations and farms that are treated as individual obligations for tax purposes. Partnerships also have some favorable positions but the reported profits are still treated as taxation based on the individual on the IRS form 1040. We may be remiss in that we continually favor the large, or share based corporation over individual proprietorship and continue to place them in a favorable manner.

  • Report this Comment On February 06, 2012, at 12:19 PM, vaderblue wrote:

    It's not taxes that concerns me. It is congress and their lack of discipline and leadership in paying debt. They think congress is not a business and they do not model themselves creating budgets and balance sheets,

    The US Senate is where our problems lie and until the people who follow politics in this country wake up, well, can a stone float.

    We should have corporate taxes but not sure how and how much they should pay.

    Corporations pay taxes, fines, penalties, p/r

    incorporation, unemployment taxes, it;s riduculous when our Senate can't cut out earmarks and pork instead of creating a money channel for reserves to make Long Term Debt

    Payments.

  • Report this Comment On February 06, 2012, at 12:43 PM, medicalquack wrote:

    I think they have the wrong business model here with taxes and should base it more like a sales tax in what I call the Alternative Millionaire's tax, license and tax those data sellers as it's making billions for corporate USA as they feed the addition via gamificaion for little or no cost. You can't stop folks from writing code, nor do we want to but we can get smarter about how it is used and certify some algorithms for accurate results instead of the default of "desired" results and the 2 should be the same,but sadly they are not.

    http://ducknetweb.blogspot.com/2011/12/alternative-millionai...

    All the free taxpayer data is out there to mine and take corporate USA gives nothing or very little back for this while state government servers slow down to a crawl and put governor software out there to keep some of the bots out. Attack of the Killer Algorithms chapter 11:)

    http://ducknetweb.blogspot.com/2012/02/gamificationyou-have-...

  • Report this Comment On February 06, 2012, at 1:05 PM, Foosballking wrote:

    How about we focus on the government spending >$110 billion more than they take in on a monthly basis? Shut down the EPA, the Department of Education, and all other non-consitutional government functions. And to those who would say the same for the DoD - it's the one function the government does that they're supposed to. The problem is it is managed like any govt function.

  • Report this Comment On February 06, 2012, at 1:29 PM, mzambrzuski wrote:

    Corporations push the corporate taxes they "pay" onto the consumer anyway by way of price increases. Implementation of a NRST (i.e. FairTax) would allow the federal gov't to collect the same amount they are now and allow consumers to enjoy a ~20% decrease in product cost, making the 23% NRST negligible, and actually a savings after you factor in the fact that everyone would be taking home 100% of their paycheck every 2 weeks.

  • Report this Comment On February 06, 2012, at 3:40 PM, DJDynamicNC wrote:

    A cogent case.

    I'm not one to advocate for the elimination of corporate taxes entirely, but the proposals on offer here appear solid.

    Some concerns:

    By shifting the tax burden to the shareholder level, are we not then incentivizing corporations to structure executive pay scales back towards out and out salaries and bonuses rather than through stock holdings, further attenuating the link between corporate performance and executive pay?

    Would this move not also push companies away from going public and incentivize their remaining private, further insulating the general public from sharing in the wealth generated by corporate activity?

  • Report this Comment On February 06, 2012, at 3:42 PM, DJDynamicNC wrote:

    @Foosballking:

    Since the Constitutionally-appointed Supreme Court has used its Constitutionally-derived powers of judicial review to find the laws enacting the EPA and Department of Education to be Constitutional, then those functions of government are explicitly Constitutional, as found using Constitutional methods by our Constitutional government.

    You are free to disagree, but you may wish to look up the function of the Supreme Court in the Constitution before you decide to try to overrule them. I disagree with some Supreme Court decisions but that doesn't mean I don't acknowledge their Constitutionally ascribed authority.

  • Report this Comment On February 06, 2012, at 3:44 PM, DJDynamicNC wrote:

    PS - I can't honestly believe you actually think the DoD is the only Constitutionally mandated role for government, so please clarify your position on all of the other topics covered by the Constitution when you get a chance.

  • Report this Comment On February 06, 2012, at 4:05 PM, mdk0611 wrote:

    I don't think I would classify the REIT's, MLPs and, for that matter S Corporations as "tax breaks". They are pass-through entities, just as partnerships have been for generations. Their profits are indeed taxed, but at the investor level. So while corporate tax revenues decrease individual tax collections increase.

    And for the person who wanted a sales tax type system for corporate taxation please be aware that every grocery store in

    America (along with every other low margin business) would be in Chapter 11 within a year if that system were adopted.

  • Report this Comment On February 06, 2012, at 5:28 PM, glassbd86 wrote:

    "Corporate Tax" does not equal "tax paid by companies."

    It's a distinction others have made, but still seems to be ignored: "Corporate" Tax usually means tax on a C-Corporation, i.e. a company filling out Form 1120. There are many other types of tax forms out there available to companies that we would normally think of as "Corporations" -- pass-through structures, partnerships, etc., that would not be included in this net.

    There is a strong aversion to corporate form because of the inherent double-taxation in the Corporation / Shareholder arrangement, and that, combined with alternative tax structures, consistently skews the US amount of "corporate tax" paid in the US relative to countries with different taxable entities. If you eliminate the corporate tax, you will see a strong shift to C-Corp structure.

  • Report this Comment On February 06, 2012, at 6:15 PM, Mega wrote:

    Incorporating a business in the US is worth something (maybe less than 18.5% but more than 0%). We shouldn't just be giving it away.

  • Report this Comment On February 06, 2012, at 6:28 PM, dennyinusa wrote:

    The government is not a business.

    Government’s role is to do things most companies will not do because there is no chance for profit. If providing health insurance to the old, disabled and children in poverty was profitable I’m sure some smart CEO would be doing. If providing help after a disaster was profitable I’m sure we would not need FEMA. No CEO looking for profit would want to vote or defend something that 50 to 60 percent of the people may disagree with. Such as Ending Slavery, The Right to Vote regardless of Race, Women’s Right to Vote, Social Security, Civil Rights, Healthcare or the right to build a Mosque. Government should lead the people to do what is needed, even though it may be difficult. Be willing to do things that will help the next generation. Tell people the truth. During the 1970’s President Carter suggested people turn down the thermostat and wear a sweater. He promoted conservation and clean energy initiatives. He led by example turning down the White House thermostat and wearing a sweater, he also put solar panels on the White House. This shows leadership, courage and vision. When President Reagan took office some of his first official acts of office included removing the solar panels from the roof of the White House and reversing most of Carter's conservation and alternative energy policies. If only we had followed through with President Carter’s policies.

  • Report this Comment On February 06, 2012, at 8:07 PM, BMFPitt wrote:

    I would happily trade away the corporate tax in exchange for an end to all subsidies and tariffs. Uncle Sam would be coming out way ahead on that deal, as would the American people.

  • Report this Comment On February 07, 2012, at 10:26 AM, up6903 wrote:

    Either a natioal sales tax or a flat tax. Both will have no leverage for individauls and corporations to lobby for special deal on not paying a portionof their responsibilities to the country. No write offs and no deductions for all. We are all in the game.

  • Report this Comment On February 07, 2012, at 11:32 AM, wolfman225 wrote:

    I agree that eliminating the corporate tax in it's entirety is worth looking into. As has been said, no corporation pays taxes. They simply incorporate those expenses into their overhead and adjust their prices accordingly. For those who believe corporations and "the rich" should pay more in taxes, perhaps the tax can be replaced with some kind of "minimum distribution of profits" to shareholders in the form of dividends or profit-sharing, which would then be taxable at the individual level? This would also have the advantage of putting the money directly into the economy through the hands of individuals, as opposed to having it filter through the government first.

    One other thought, for the seemingly "anti-corporate" types here: Perhaps the elimination of the corporate tax could be the first step to building an argument for ending corporate "personhood"? Just a thought.

  • Report this Comment On February 07, 2012, at 12:34 PM, DJDynamicNC wrote:

    @Wolfman re: minimum profit distribution - That's an intriguing idea! The devil, as always, is in the details, but it certainly sounds like exactly the sort of idea I could get behind.

    As for corporate personhood, my favourite commentary on the topic is Colbert's "Mitt Romney is a serial killer" ad. :lol:

  • Report this Comment On February 08, 2012, at 11:44 AM, TMFEldrehad wrote:

    One thing that I think many overlook when discussing this subject, no matter what their perceptions of how our tax system could be structured:

    What are taxes on corporations?

    They are taxes on customers, shareholders, suppliers, and employees.

    They are taxes, in the end, paid by people.

    Somehow, that seems to all to often get lost in the shuffle.

  • Report this Comment On February 08, 2012, at 12:08 PM, wolfman225 wrote:

    ^I thought that was my point. That customers (ie, people) are the ones that pay taxes, not corporations. I simply proposed a potential solution that would be somewhat "revenue neutral" based on how some utilities investments are set up. Some funds (for electric utilities, I believe) are required to distribute gains to shareholders, typically done in the form of higher dividends. It should be possible to adapt the corporate tax system to something similar.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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