Tuesday, January 22, 2002

Should we pass the McArdle Act? Megan McArdle has proposed abolishing the corporate income tax. Let’s dissect her arguments. 1: Corporations aren’t people Yes, but allowing income to pile up tax free may not be what we want to do, to allow corporate status to be a no-string-attached IRA, deferring taxes until a dividend is paid. Fair point, but not hugely persuasive. 2: The Corporate Income Tax Costs the Economy More than it Earns I’m not on board with her prof’s stats of $300B in costs to bring in $205B. Some accounting would still be done, if for investors if not for Uncle Sam. If the point were true, even a liberal would be on board. A fairer statement would be that the cost of compliance is an additional drag on the economy. 3: The Corporate Income Tax is extremely Distortionary This one doesn’t hunt too well. In the article, McArdle posits an 8% return and borrowing at 9%. If you can get a 2.5% tax break from the borrowing, you’d get a (8+2.5-9) 1.5% net return. This would only be true if the 8% were tax free. The real result from her scenario would be a 1% before-tax loss. She does have a point that there are many games that can be played with tax policy, like having a non-profit’s building owned by a corporation (who can deduct depreciation to increase cash flow) and rented back at a lower net cost to the non-profit. Comparable games could be played in with a no-corporate-tax universe as well. Bond and money market mutual funds will, instead of paying dividends, reinvest profits tax-deferred and set up loan departments to borrow money against the balance for people needing cash flow. Such tax-deferred schemes would take $20-30 billion out of tax revenues. 4: It is Impossible to Close the Loopholes 5: Eliminating the Corporate Income Tax Makes Corporate Welfare Harder These two go together-loopholes are corporate welfare. Without tax breaks, businesses would have to get direct subsidies to do things, which will be harder to justify. Getting rid of the corporate income tax will cause a mass evacuation of lobbyists from Washington and dry up the corrupting influence of campaign donors trying to buy tax breaks. It will trash the real-estate market on K Street, and that’s good. This is actually one of the better selling points of the plan. What are the upsides of the McArdle Act? Trashing K-street, putting a lot of the tax industry into more productive endeavors and giving investors a better return, thus encourage equity investments and giving a long-term boost to the economy What are the downsides? Somewhat less tax revenue in the short term and some new tax-avoidance schemes. Over the long haul, the economic boost from the tax abolition will be made up by additional taxes from personal income. In the short term, however, we’ll have to account for a possible tax revenue shortfall in the early years. That will make it a real tough sell.

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