A corporation is merely a shell containing assets: without its shareholders, bondholders, managers and employees, it would have no future earning potential. In principle, the legal entity “corporation” is simply the desire of investors to escape risk. In sole proprietorships and partnerships, the people that own the company are financially and legally responsible for the actions of their company. If the company goes bankrupt in one of these instances, the person or persons that own the company can watch their own personal assets (cars, houses, golden retrievers) be called in to repay obligations. This is not the case for corporations: barring serious foul play, the people that run and own the company can only lose their initial investment and have personal protection from people suing the company (except in cases of criminal mismanagement: thanks, Sarbanes-Oxley).
This is absolutely essential in a large multinational corporation with investors spread around the globe. If a Taiwanese investor can be financially held responsible beyond their initial investment for the mistakes made in a company halfway around the world, this risk is going to have to be compensated for. Corporations create an effective way of mitigating this problem and allowing firms to have a broader set of potential investors.
Their stand-alone nature is one of the major arguments for taxing the profits of corporations at very high marginal rates, which resemble those levied on personal income. Proponents of the tax argue that corporations are seen as individuals in the eyes of the law, so they should be seen as individuals in the eyes of the IRS.
The issue with this reasoning is the fundamental but ignored truth that corporations are owned by investors. Unless dispersed in the form of dividends, share buybacks or capital appreciation (stock price increases due to the increase in the value of the company), it is impossible for individuals to directly benefit from the corporation’s profits, aside from salaries and stock options in the company. The money that is not given out in dividends or share buybacks is plowed back into effective investments.
With the highest marginal federal tax rate currently at thirty-five percent of pre-tax profits, the United States has one of the highest corporate tax rates in the world. This represents a significant amount of money that is not available to be invested back into the company.
The benefits of eliminating the corporate tax are significant. First, American companies would have an immense strategic advantage over foreign companies which are also generally subject to a corporate tax. Such an advantage would stimulate permanent and productive job creation here in the United States. Second, this would encourage more people to invest because it would remove inequities in the tax code that disadvantage the poor. As it stands right now, regardless of how rich or poor you are, if you are invested in a company, your “income” from that firm will be first taxed at the corporate tax rate.
Is this fair? If you are making $30,000 but are still committed to building wealth and investing for retirement, should your return from investing in a corporation be initially taxed at the same rate as someone who makes $200,000 a year? As things stand right now, apparently.
The final, but most important positive side effect of eliminating the corporate tax is it abolishes the tax shield that companies receive by issuing debt. Interest paid to bondholders is tax deductible; this creates a large amount of money that can be kept from the government out of the same initial profit. Arguably, this aspect of the tax code encourages companies to take on more debt than they normally would.
After a financial meltdown that was largely caused by the overleveraging of individuals and companies, does it make sense that our current tax system encourages leveraging up?