February 7, 1992
"Big Flaw: Corporate Debt is a Tax Advantage"
San Jose Mercury News
By Timothy Taylor
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WHY ARE the relatively popular taxes in decline? When most people are asked
about the taxes they would least hate to see increased, taxes on corporations
and on items like alcohol and cigarettes usually head the list.
But the corporate income tax has slipped, falling from 4 to 5 percent of gross
national product in the 1950s to less than 2 percent today. The Tax Reform Act
of 1986 did force corporations to pay a bit more, as is shown by an upward tick
on the accompanying chart. Excise taxes -- that is, the taxes on products like
cigarettes, alcohol and gasoline -- have slipped dramatically as well, from nearly
3 percent of GNP in the 1950s to less than 1 percent of GNP now.
In 1950, corporate and excise taxes combined raised 46 percent of total federal
revenue. In 1992, they will raise only 13 percent. With the federal government
in desperate need of ways to reduce the budget deficit, numbers like these should
While any tax increase hurts, at least excise taxes have the virtue of imposing
costs on individuals whose behavior is imposing costs on society. For example,
alcohol leads to about 19,000 fatal auto accidents involving drunken driving each
year; 370,000 people undergo treatment for alcoholism per year; there are many
other alcohol-related injuries and illnesses.
Yet the federal taxes on alcohol will collect only $8 billion next year, surely
far less than the social costs created by alcohol use and abuse. Raising the price
of alcoholic beverages by 10 percent would lead to a drop in demand of about 7
percent, according to evidence collected by the Congressional Budget Office.
A similar argument can be made for higher taxes on tobacco or on gasoline.
A million new cases of lung cancer were diagnosed in 1990, and hundreds of thousands
of deaths every year are attributed to tobacco use. Burning gasoline pollutes
the air, creating smog and perhaps even a greenhouse effect.
Yet the federal tax on tobacco will raise only $5 billion in 1992, and the
gasoline tax will raise only $12 billion, again far less than the costs society
is bearing from consumption of these products.
Using a tax to raise the price of cigarettes by 10 percent would lead to about
a 5 percent decline in consumption, and more among younger smokers who aren't
yet hooked. Raising the price of gasoline by 10 percent would reduce the amount
consumed by about 2 percent in the short run, and perhaps 8 percent in the long
Excise taxes aren't always politically popular, in part because they do pressure
people to change their behavior. On the other hand, the corporate income (or profits)
tax is primarily popular largely because many refuse to believe that people, individual
consumers, actually pay it.
But corporations are just collections of people, and their tax bill either
comes out of what is paid to workers, executives or shareholders, or forces the
company to charge more to consumers. Somehow, somewhere, some person pays every
dollar of corporate tax. Economic studies have generally found that relatively
wealthy shareholders do end up paying the corporate income tax, rather than executives,
or the average worker or consumer.
But the fact that shareholders pay much of the corporate tax points out a gaping
flaw in the way the tax is designed, a flaw that bears heavy responsibility for
the explosion of corporate borrowing and takeovers during the 1980s.
The problem is that interest payments are treated as an expense by the tax
code, while profits that are paid to shareholders or reinvested are taxed. As
a result, a company can reduce its profit -- and thus its tax bill -- by taking
on a lot of debt and paying a lot of interest. Many of the corporate takeovers
and buyouts of the 1980s used borrowed money to buy stock, thus benefiting from
the tax advantages of debt.
Now that the recession has arrived, though, many heavily indebted corporations
are discovering that debts have a problem of inflexibility. When a heavily indebted
company can't make its interest payments, it goes belly-up. In fact, the entire
economy suffers when indebted companies seek to avoid default on their loans by
cutting back on investment and laying off workers. If many of those companies
had avoided so much debt, and instead stayed responsible to shareholders, they
could have cut back on dividends in these hard times and stayed in business.
The Department of the Treasury has just released a report that analyzes the
corporate tax code's bias toward debt, and proposes solutions. One prototype,
called the Comprehensive Business Income Tax, would remove the tax-motivated incentives
to take on heavy debt, without costing the government any revenue. Even if the
government wasn't running a $400 billion budget deficit in 1992, raising excise
taxes on alcohol, tobacco and gasoline makes some sense. But under the current
tax code, raising taxes on corporations just provides a greater incentive for
them to take on more debt. The priority for corporate taxation should not be raising
revenue, but reforming the system.
Sunday: The Deficit
THE CORPORATE AND EXCISE SHARE
Chart shows corporate income taxes and excise taxes as percentages of the gross
national product. (Fever chart)
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