Barro: Eliminate Federal Corporate Income Tax

January 22, 2009

In this morning's Wall Street Journal, Harvard economist Robert Barro (most famous for his work on Ricardian equivalence) discusses the issue of fiscal stimulus. Near the end of his op-ed, Barro says this:

Much more focus should be on incentives for people and businesses to invest, produce and work. On the tax side, we should avoid programs that throw money at people and emphasize instead reductions in marginal income-tax rates -- especially where these rates are already high and fall on capital income. Eliminating the federal corporate income tax would be brilliant. On the spending side, the main point is that we should not be considering massive public-works programs that do not pass muster from the perspective of cost-benefit analysis. Just as in the 1980s, when extreme supply-side views on tax cuts were unjustified, it is wrong now to think that added government spending is free.

So should the federal corporate income tax really be eliminated? The answer is that it really depends on what tax base you want and whether or not you integrate the corporate and individual sides. The corporate income tax could be eliminated if you moved from an hybrid income tax base to a pure consumption tax base by replacing it with say a value added tax. But one could keep a corporate income tax and eliminate the double taxation of savings by also moving towards expensing and some other steps, while maintaining the corporate income tax as a tax on economic profits (i.e. those in addition to the time value of money return).

Or the corporate income tax could be eliminated while maintaining an income tax through an integration of the corporate and individual tax codes as Hubbard outlined back in the early 1990s. (Politicians don't like this because it basically admits that people pay all taxes, which is of course 100 percent true and indisputable.)

But what if we eliminated the corporate income tax today with nothing else done? This would essentially allow savings to accrue tax-free through a corporate holding (just like a consumption tax). This may or may not be an efficient way to get to a consumption tax given that people would need to set up corporations to allow their savings to accrue tax free (those exceeding the limitations currently placed on a traditional retirement account today), but it may be the simplest politically.

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