Kevin Milligan and I had a little back and forth a couple weeks ago about the use of privately owned corporations by the wealthy to reduce their tax liabilities (in the comments here). This provoked a few thoughts, which I was going to write up. I was inspired to move them back to the front burner today, while reading Andrew Coyne’s provocatively titled column, “If we really want to soak the rich, we should abolish the corporate income tax.” He wrote this, it would appear, after having read the recent Mowat Centre working paper, Corporate Tax Reform, by Robin Boadway and Jean-François Tremblay.

First a bit of housecleaning. Not only is the headline misleading, but Coyne mucks things up when stating their central thesis:

If you want to soak the rich, in other words, abolish the corporate income tax — and with it the tax break on dividends and capital gains. That in a nutshell is what the economists Robin Boadway and Jean-Francois Tremblay have proposed in a recent paper for the Toronto-based Mowat Centre.

This is actually not what they propose — in or out of a nutshell. In the section titled “Abolish the Corporate Tax?” this is what Boadway and Tremblay write:

This efficiency benefit would come at a substantial cost in terms of tax revenue forgone. The same efficiency gains can be achieved without sacrificing all revenues by designing the corporate tax to be a tax on rents. We would therefore rule it out as a desirable tax reform (p. 47).

If you’re willing to use the term “abolish” quite loosely, e.g. the way that Jean Chretien “abolished” the GST, then you might say that they want to “abolish” corporate taxes. But what they really want to do is replace the tax on profits with a tax on rents, or supra-normal profits. Later on in the column Coyne explains it correctly. One can think of this as a different sort of tax, but I think it’s easier just to think of it as giving a deduction to corporations for payment of the normal rate of return on capital, to be applied to both debt and equity. So in the same way that the interest the firm pays on debt is deductible, the firm would also be able to deduct a portion of the dividends it pays to shareholders, and it would only have to declare as “profit,” for tax purposes, earnings that exceed this normal rate of return. The details are complicated, but I think that instead of thinking of this as “abolishing” corporate tax, it’s actually closer to the truth to describe it as giving corporations something like the “personal deduction” that individuals enjoy. Also, it is worth noting that Boadway and Tremblay recommend that a shift to a tax on rent be accompanied by an increase in the rate of corporate tax.

Finally, Coyne slips it in a bit sideways, but a crucial part of the Boadway and Tremblay proposal is to increase the personal income tax rate on dividends and capital gains. That’s where the “soak the rich” part comes in. The argument — and it is an interesting argument — is that dividends are currently taxed at a lower rate in the hands of individuals, in order to avoid “double taxation,” once in the hands of the firm, again in the hands of the beneficiary. However, if the corporation is able to shift the tax on profits to other constituencies, then the tax paid by corporations isn’t really being paid by shareholders. So by taxing corporations less, and taxing individual investment income more, the Boadway/Tremblay policy makes it more difficult for the rich to shift their tax liabilities onto others.

I can see the argument for this. However, there always the danger of equivocation when talking about “the rich” or “inequality.” There is broad-based economic inequality, of the sort captured by a GINI coefficient, and then there is the specific problem of the very rich (whom we can refer to, for simplicity, as the 1%). While it is true that most Canadians are already able to exempt the entirety of their investment income from taxation (through home ownership, RRSPs, TFSAs), this is manifestly not the case with the 1%, who continue to use corporate ownership as a vehicle for tax avoidance.

Shortly after writing about this, I came across the following working paper, by Michael Wolfson, Mike Veall and Neil Brooks, “Piercing the Veil – Private Corporations and the Income of the Affluent.” It seems to me that before we talk about “soaking the rich,” or about the distributive effect of corporate taxes generally, the issues raised by this paper need to be addressed.

Finally, it may be just me, since I don’t talk to a lot of quantitative analysis people, but it seems me the way that Wolfson, Veall & Brooks got their data (described on p. 9, and in appendix A) is incredibly cool. I look forward to reading the additional papers based on this data set that they promise at the end.