Guest Post

Corporate Taxes - Who Really Pays? 

Howard W. Beatty

One of the key differences between Mitt Romney’s and Barack Obama’s approaches to improving our economy is their view on taxation and specifically corporate taxes.  Obama wants to maintain US corporate tax rates at 35% (the highest in the developed world) whereas Romney has proposed cutting corporate tax rates to 25%.  This is often described by Romney’s opponents as a giveaway to big corporate interests and therefore a poor idea.  But, who really pays corporate taxes and who would benefit if they were cut?

Any business, large or small, is simply a group of people using their knowledge and skills in combination with natural and capital resources to produce a product which they try to sell to customers at a price high enough to cover all of their costs.  The revenue received for selling their product is first used to pay income and other taxes and the remainder is split between four different groups of people – owners, employees, suppliers and communities.  Unless the company can tap the only other source of money, customers, by raising prices, higher corporate taxes means less after tax cash flow for the other uses.

For many corporations, the single greatest use of after tax cash flow is the payment of cash (dividends) to owners (shareholders).  For companies with profit sharing agreements with employees, higher taxes also means less profit to be shared with employees.  Reduced dividend or profit sharing payments means those people will have less money to spend or invest and will have to look elsewhere to make up the shortfall.  Lower net profits discourages investment in US companies and encourages investment in countries with lower corporate taxation and therefore greater growth prospects.  The opposite is also true, i.e. lower corporate taxes encourages investment and leads to greater corporate growth and better economic performance overall.

Higher corporate taxes can also mean less after tax cash flow available for investments to grow the company.  (In a natural resource company such as oil and gas, this means the company will shrink as assets in the ground are produced and sold without being replaced.)  Reduced investment in growth affects a wide range of people.  Customers will see lower supply or choices as factories are not expanded and also pay higher costs than otherwise as production facilities are not modernized.  Employees will have less hours of work or fewer people will be employed.  Suppliers will see less demand for their goods and services leading to lower overall economic activity.  Communities will therefore experience a lower level of economic activity and likely less charitable, “give-back” by companies with less funds available to support those activities.  The opposite is also true, i.e. reducing corporate taxes means more money is available for investment which would benefit customers, employees, suppliers and communities.

Since a large use for corporate cash flow is often labor costs, higher corporate taxes may mean employees may experience lower or no wage increases.  Conversely, lower taxes could result in higher wages.

Finally, companies may try to raise prices to generate the cash to pay higher taxes.  Their ability to do so will be limited by competition between companies or their customers’ ability to switch to another product or do without but, to the extent possible, raising prices will result in less money for customers to spend on other items, thereby reducing economic activity.  Lower corporate taxes could result in lower prices. 

Taken altogether, higher corporate taxes will result in some combination of lower earnings for company owners, reduced wages for employees, higher prices for customers and/or reduced economic activity affecting everyone.  Conversely, reducing corporate taxes will result in a combination of higher earnings for company owners, higher wages for employees, lower prices for customers and/or increased economic activity benefitting everyone.  In short, there is no free lunch; corporate taxes are paid by everyone.  Reducing corporate taxes allows everyone to keep and spend more of their own money which is consistent with a free and prosperous country.