The problem of the corporate tax

Cite this Article
Larry Ribstein, The problem of the corporate tax, Truth on the Market (September 27, 2011),

John Steele Gordon, writing in the WSJ, peels the corporate veil away from Warren Buffett’s tax situation:

Warren Buffett recently claimed that he had paid only $6.9 million in taxes last year. But Berkshire Hathaway, of which Mr. Buffett owns 30%, paid $5.6 billion in corporate income taxes. Were Berkshire Hathaway a Subchapter S corporation and exempt from corporate income taxes, Mr. Buffett’s personal tax bill would have been 231 times higher, at $1.6 billion.

Gordon describes our two tax systems — corporate and personal tax — as an “original sin.” According to Gordon, the system lets the rich play tax games by arbitraging differences between corporate and personal rates. It also creates a “field day for demagogues and the misguided to claim that the rich are not paying their ‘fair share'” by ignoring the effect of the so-called “corporate” tax on the real people who own corporations.

Actually, the mischief goes deeper than Gordon suggests.  First, the corporate tax has helped entrench in the popular mind the idea that the merely legal creation of the corporation is actually flesh and blood.  This fuels the post-Citizens-United rhetoric on the evils of “corporate” speech as being somehow magically different from all other political activity by associations.

Second, the corporate tax has been a great engine of agency costs.  As discussed in my Rise of the Uncorporation, business associations such as LLCs and partnerships can mitigate corporate managers’ misuse of the owners’ money by replacing cumbersome corporate-type monitoring with obligations to distribute excess cash.  If more firms were uncorporations, we would not see the enormous cash hordes of today’s firms.  Lacking investment opportunities, they (e.g. Berkshire Hathaway?) would return the cash to their owners. But the “second” tax on distributions gives managers (Warren Buffett?) a powerful argument against distributing cash.  In fact, Steven Bank has adduced strong evidence that the corporate tax originated in 1936 as part of a deal promoted not by populists but by corporate managers (Bank, Corporate Managers, Agency Costs, and the Rise of Double Taxation, 44 Wm. & Mary L. Rev. 167 (2002)).

Third, the tax manipulations run deeper than Gordon suggests.  The difference between corporate and personal taxation helps maintain the sharp separation in the U.S. between the corporation and the uncorporation.  Only certain types of firms — those engaging in “passive” types of business such as resource management — can be both publicly held and free of corporate taxation.  Yet many other types of firms could benefit from uncorporate governance.  As a result, as discussed in my book, “uncorporate” governance must operate indirectly, through entities such as hedge and private equity funds.  Abolition of the “corporate” tax would encourage the use of more direct mechanisms for loosening managers’ reins over firms’ cash in a wide variety of firms.

In short, the corporate tax obfuscates analysis of business forms and helps inflate agency costs.  It’s not just unfair, as Gordon suggests.  It’s stupid.