Correct Suggestions Made on Corporate Income Taxes
October 19, 2008
William F. Shughart II
“Don’t tax me, don’t tax thee, tax that fellow over by the tree.”
Tax reform is contentious and despite inevitable special pleading, Mississippi’s Tax Study Commission did in the end recommend some changes to the tax code worth serious consideration. However, the list of good ideas does not include raising the state excise tax on cigarettes, expanding the state sales tax base, allowing local governments to impose sales taxes of their own, or working with other states to tax mail-order and Internet purchases.
Nor does it include continuing in any way, shape or form so-called incentive programs designed to lure new businesses to the state by offering subsidies and special tax breaks to them. Insofar as such giveaways selectively benefit politically well-connected private companies, they represent improper uses of the public purse, which is supposed to finance programs that promote the general welfare. Taking money away from existing Mississippi companies and giving it to newcomers violates horizontal equity, a widely accepted principle of public finance; it also is grossly unfair. A far better recipe for economic growth would be to cut taxes on all businesses, including those already located here.
The commission does in fact recommend reducing the tax burden on corporations in a number of ways. One is to reduce or eliminate the franchise tax, which requires businesses to pay $2.50 on every $1,000 of capital employed in the state. Another is to tax all tax capital gains at 3 percent, the lowest income tax rate. A third recommendation is to exempt the first $10,000 of corporate income from taxation entirely, drop the 3 percent and 4 percent tax brackets, and to tax any income in excess of that amount at 5 percent.
Oddly, though, while the commission proposes modest increases in the standard deductions and exemptions allowed under Mississippi’s individual income tax, it says nothing about exempting the first $10,000 of personal income from taxation, meaning that the state will continue to tax the first dollar of taxable personal income at a rate of 3 percent.
Taxes on corporate income now generate only about 7 percent of the taxes collected by the state. And there are sound reasons for doing away with the corporate income tax altogether, as at least some members of the commission recommend as a long-term goal.
A corporate income tax exposes such income to double taxation—any income distributed to shareholders in the form of dividends also is taxed on their personal income tax returns. It is also true that some of the burden of the income tax paid by corporations is shifted forward to consumers in the form of higher prices; the remainder is shifted backward to employees in the form of lower wages, to suppliers in the form of lower prices received for raw materials and other factors of production, and to owners in the form of lower profits.
Although what economists call the incidence of the corporate income tax differs from industry to industry, the bottom line is that corporations do not pay taxes, only people do. Abolishing the corporate income tax not only would lighten the tax burden on company owners, their customers, employees and suppliers, but also would send a clear signal that Mississippi truly is open for business. Whatever revenue is “lost” by doing away with the corporate income tax would be more than made up for by the gains in personal income tax receipts produced by stronger economic growth.
Economic growth likewise would be promoted by exempting at least some interest and dividend income from the state personal income tax. One reason that the United States has a very low savings rate is that the first dollar of interest income earned is taxed at the saver’s combined state-federal marginal personal income tax rate. The first dollar of dividend income receives the same tax treatment. Mississippi could take the lead in encouraging savings and investment by doing away with these counterproductive tax provisions.
Indexing capital gains for inflation would be another progressive step.
Paying too much attention to other states’ tax codes prevented the commission from considering the bold measures needed to jumpstart the state’s economy. It should be sent back to the drawing board and asked to listen more closely to economic experts specializing in public finance than to the representatives of special-interest groups. That is, of course, assuming that the whole purpose of the commission’s work was not, as I suspect it may have been, to provide political cover for jacking up the excise tax on cigarettes.