Corporations Deserve a Flat Tax

By Harvey Golub

The Wall Street Journal   April 17, 2002

 

With April 15 behind us, let’s talk about another tax that every American pays on a daily basis: corporate income taxes. I know whatyou’re thinking: You’re not a corporation, so you don’t pay corporate taxes. Not so. While the IRS and the corporate tax code maintain this fiction, the truth is corporate income taxes are passed on to consumers. Worse still, the money corporations spend trying to lower their tax burdens creates a considerable drag on the economy.

What’s to be done? The most sensible strategy would be to slash all corporate income taxes to zero. That’s right, abolish the tax completely. Doing so would free up much-needed investment capital, promote growth and reveal to individuals the real cost of a tax “someone else pays.” Unfortunately, that’s about as likely to happen as the Cubs winning the 2002 World Series.

There is an alternative. Here’s my suggestion: Congress should eliminate almost the entirety of the corporate tax code and, in its place, create a single tax rate of, say 35%, to be paid on operating  income, i.e., earnings before interest and taxes, as calculated under Generally Accepted Accounting Principles. This would generate the same total revenue to the Treasury as today, but without the hassle. (In point of fact there would be residual issues to deal with, like foreign-source income and tax-exempt bond income, but these items overall are small in number and relatively straightforward.)

As it stands today, corporate income taxes are one of the largest cost items for most companies, averaging fully half of reported after-tax income. To make matters worse, the capital expended is completely unproductive. As corporations view it, spending money on taxes does not increase revenues, does not allow the company to be more productive, does not attract new customers or help retain old ones, does not add to intellectual capital or product development. Thus, unlike other costs, it has no redeeming virtue or benefit to the company or to society.

Is it any wonder then that corporations will go to extraordinary lengths to reduce the taxes they pay? They will move their headquarters outside the country; they will set up special purpose subsidiaries; they will structure ordinary transactions in ways to minimize taxes; they will structure extraordinary transactions to create some tax benefit; they will lobby Congress to provide them with special breaks; they will hire legions of accountants, lawyers and investment bankers – at enormous cost — to reduce their tax burden. Many have been very successful at accomplishing just that. The corporate tax burden in the U.S. averages about 35% of operating income, but many corporations pay little or no taxes while others pay up to half their income.

The cost to the economy of all this game playing is huge — in direct costs, in time, and in the effort needed to battle with the IRS and think up complex and convoluted schemes whose major benefit is simply to reduce taxes. Sometimes these schemes evolve into full-blown scandals reported on the pages of this newspaper. Occasionally the scandal is so large it calls into question the integrity of our capitalist system. Does anyone believe that many of Enron’s actions would have taken place if the company didn’t have to pay taxes on its unrealistically high earnings?

It’s obvious why corporations work so hard to cut their tax burden – the rewards of doing so can be huge. To illustrate: If two corporations have operating income of $10 per share and one pays 35% in taxes and the other 25%, the difference in corporate market value is large. At a price/earnings ratio of 20, one company is worth $130 per share and the other $150. That is a big difference, and one worth spending time and treasure to achieve.

However, with an across-the-board 35% tax on operating income, corporations would find it difficult to reduce taxes without reducing net income, thereby reducing share price and therefore the value of their stock and stock options. Thus, the objectives of both the IRS and corporations would be aligned, with the Financial Accounting Standards Board and the Securities and Exchange Commission setting the rules. The economy overall would benefit hugely by eliminating a huge overhead burden. Imagine no more tax shelters, no more hyped earnings, no more reducing reserves to make earnings targets.

If this is such a good idea, why haven’t we already done it? The simple answer is that there would be lots of losers in a simplified and transparent tax system: corporations that have effectively structured their operations or gotten benefits in the current tax code and therefore pay a below-average tax bill would be upset; investment bankers, accountants, lawyers, and IRS officials would lose their jobs or major sources of revenue; Congress’s tax writing committees would lose their ability to grant or withhold favors, and therefore would lose their ability to extract political contributions.

Obviously, there is a formidable list of special interests operating against reform. But in this time of business scandal and income overreaching — along with Congress’s desire to reduce the impact of money on the political process – it’s worth a shot. Indeed, now seems the ideal time to implement such a policy.

 

Mr. Golub, former chairman and CEO of American Express, is currently chairman of Lee Putnam Ventures, Client Logic and AirClic. He serves on the board of directors of Dow Jones, publisher of this newspaper.

 

 

(See related letter: “Letters to the Editor: A Disastrous Use of GAAP”

— WSJ April 23, 2002)