Monday Morning: Companies don’t pay taxes, people do

Congress made a great deal of fuss last week about Enron Corp.’s use (or abuse) of the tax laws to avoid paying its “fair share” of corporate income taxes. Last year, a similar fuss was made about companies’ moving their corporate headquarters offshore to reduce their income tax burdens.

But as my first economics professor was fond of saying, “Companies don’t pay taxes, individuals do.”

Those in Congress who lambaste corporations for not paying their income taxes, or who suggest increasing corporate income taxes, are either fools or knaves.

They are fools if they think that corporations can be made to pay income or other taxes.

Corporations don’t pay taxes, because they are artificial entities structured to facilitate the activities of people. They simply collect taxes.

This is because they pass them on to individuals: employees (in the form of lower wages and benefits), customers (in terms of higher prices) or shareholders (as lower dividends). Individuals ultimately must pay all corporate taxes.

Many members of Congress probably understand this, which means they are being dishonest with voters when they complain about companies not paying their fair share of income taxes. They are therefore knaves.

What politicians complain about is that companies are attempting to avoid acting as tax collectors for the government. Those in Congress who aren’t fools are afraid their effort to hide the true level of taxation of individuals by disguising it as a corporate tax will fail and that they will have to tax overtly rather than covertly.

These members of Congress may also be afraid they will lose their ability to win votes by handing out various forms of tax relief to favored industries and companies.

But if companies don’t pay taxes, why do they go to such lengths to avoid collecting them?

There are several reasons. First, if they pass the taxes on to employees, the employees may complain or, worse, go to work for companies that collect the taxes from customers and shareholders.

If they pass the taxes on to customers, their products may become less competitive with those of companies that successfully pass the taxes on to employees or shareholders, or foreign companies that may collect taxes at lower rates.

If they pass the taxes on to shareholders in the form of lower dividends, they may be less competitive in the capital markets against companies that successfully avoid collecting them or pass them on to employees and customers.

Further, collecting and paying these taxes costs companies a significant amount of money, reducing earnings.

Corporate income taxes also contribute significantly to the confusion over the true earnings of companies and may cause inefficiencies and mispricing in the capital markets.

What would happen if the corporate income tax were abolished?

Either wages would rise, or dividends would, or prices would fall. The government’s income would drop unless the dishonestly named corporate income tax were replaced with another source of revenue, perhaps a consumption tax that might stimulate more saving and hence facilitate more investment.

Although it might be desirable, abolition of the corporate income tax is unlikely.

The tax is too valuable to politicians, and not because of the revenue it brings in. It gives them power over those who run companies.

Mike Clowes is editorial director of InvestmentNews and sister publication Pensions & Investments.