Scapegoating corporations is bad economics

Sen. Barack Obama has consistently exhibited a pronounced hostility to corporations. Such rhetoric, while politically useful, raises questions about his understanding of economics and his ability to lead on serious economic issues.

Obama railed against Senator McCain’s plan to reduce corporate income tax rates. The Illinois senator deployed all the standard rhetoric of corporate giveaways, lack of fairness, and bad economics. He relied on an Ebenezer Scrooge caricature in which corporations add little value and exploit their workers, investors, and customers to gain advantage and wealth. The truth about corporations is fundamentally different.

A corporation is simply a legal arrangement that brings interested individuals together to achieve some common end. It is actually impossible for a corporation to incur the burden of a tax. All business taxes must ultimately be paid for by people, whether by customers in the form of higher prices, employees in the form of lower wages. or owners of the business in the form of lower returns.

Research indicates that. by and large, the costs of business taxes are borne by employees in the form of lower wages. Corporate income taxes, necessarily and by design, reduce the retained earnings of a firm. This results in less money being available for investment in machinery, equipment, new technologies, and training.

It is these investments that ultimately make workers more productive and fuel sustainable increases in wages and benefits. By increasing corporate taxes, government prevents or at least reduces these vital investments.

Taxes also impose indirect costs by changing the incentives to work, save, invest, and act entrepreneurially, which affects the larger economy. Studies of how different taxes affect these incentives have consistently shown that corporate income taxes impose far greater costs on society than more efficient types of taxes such as sales taxes.

For example, a regularly cited study by Harvard professor Dale Jorgenson concluded that it cost the U.S. economy $0.84 to raise one additional dollar of tax revenue using corporate income taxes compared to $0.26 if sales taxes were used. There are clearly more and less costly ways to raise revenues. Unfortunately, it appears as if Senator Obama prefers the more expensive options for non-economic reasons.

Consider also the issue of competitiveness. The statutory corporate income tax rate in the United States is 35 percent, one of the highest in the industrial world. The common retort is that the government offers a series of credits and deductions that reduces the actual or effective rate. Even the effective corporate tax rate, however, is still highly uncompetitive.

For example, a recent analysis by highly regarded tax economist Jack Minta placed the effective tax rate on services at 27.8 percent, more than 40 percent higher than the average of 19.6 percent. At that tax rate, the United States ranked 18th highest among the 80 countries included in the study. The results for manufacturing were not much better: 25.4 percent compared to an average rate of 19.1 percent, which ranked the U.S. with the 24th highest tax rate of 80 countries.

It seems clear that most of the fundamental assumptions that underpin Senator Obama’s view of business taxes are incorrect. They are relatively expensive compared to other taxes, and average workers like Joe Six-Pack and hockey moms pay the tab rather than some corporate Ebenezer Scrooge. Indeed, the country’s corporate taxes are already uncompetitive.

Neither presidential candidate disputes that the American economy is in rough shape. One of the keys to recovery must be a more productive and pro-growth corporate tax system. To provide that, Obama would have to abandon his own anti-corporate vision and take on powerful factions within his own party. The nation may soon rely on Senator Obama’s ability to recognize the error in his ways if he becomes President Obama. Otherwise the country’s economy will continue to under-perform.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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