No Taxation Without Sensation

The trend of corporate inversions has highlighted problems with our corporate tax code. Inversions happen when American corporations shift their corporate nationality to a foreign jurisdiction, often through a merger with a foreign corporation. These inversions avoid the 35 percent U.S. marginal corporate tax rate, one of the highest in the world.

A wide variety of commentators, including James Pethokoukis of AEI, have suggested that one response to inversions and other problems with the code is simply to eliminate the corporate tax. The result would simplify taxes, reduce corporate efforts at legal tax avoidance, and boost economic growth from greater corporate investment. Any revenue loss could be balanced by increases in other taxes. For example, individuals could pay ordinary rates of tax on dividends and yearly appreciation on the value of assets.  Additional ways of making up the revenue might include a carbon tax.

My point here is not to endorse any particular version of corporate tax revision (although I think moves in this direction would be sensible), but to note that such reform would be salutary for another reason that should be of substantial concern to classical liberals in formulating tax policy. The more individuals feel the pain of taxes, the more taxes will constrain the size and growth of government. It  is thus imperative to make taxes more transparent and more salient to individuals.

The corporate income tax may be the most egregious example of a tax that is not transparent. While corporations collect and pay the taxes, corporations do not ultimately bear the tax. People do –  the corporations’ shareholders, employees, and customers. But for any given company it is hardly clear how the corporation’s tax bill is shared by different stakeholders. Indeed, because of the fiction that the corporation is paying, most people may well think that the corporate tax is a free lunch.

Another example of government law that makes a tax less transparent is government withholding. Here at least people can access information about the money taken out of their pay check each week, but many, if not most, people become inured to the deduction. They would likely feel the tax more acutely if they paid it in lump sum at around tax time. Instead, many people have too much withheld and receive a refund when they pay their income taxes. To be sure, withholding protects against inability to pay when individuals fail to save an amount sufficient to pay their taxes.  But it also diminishes the pain of parting with money that is a natural restraint on government.

Reducing withholding by a significant percentage would make that pain more acutely felt. Perhaps this reform could be accompanied by moving the due date from taxes to April 15 to Oct. 30. That additional reform would make politicians feel the full pain of taxes as well!