Corporate Income Tax May Be Bad Economics but It Gets the Job Done

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Taxing corporate profits may not make for good economic theory. But economists say it is a practical tool governments use to collect revenue that might otherwise evade the tax collector.

In theory, economists generally dislike the idea of corporate income taxes because the added costs are passed on as higher prices, depressed wages or reduced dividends for stockholders, said Daphne A. Kenyon, an associate professor of economics at Simmons College in Boston.

“We’re not entirely clear (whom) it is being passed on to,” said Kenyon, who has conducted an Urban Institute study of competition among states for business. “If it is a disguised tax on consumers, why not have a tax on consumption and not go through the back door?”


And if the tax is indeed passed on to stockholders, the result is double taxation, which economists consider a cardinal sin for any tax system that purports to be fair.

The stockholder not only receives a reduced dividend, but government gets a second bite when it extracts income tax on that dividend as well, said Dick Feenberg, a researcher with the National Bureau of Economic Research in Cambridge.

“That’s an injustice that is very hard to correct,” Feenberg said.

Don’t look for corporate income taxes to disappear soon, though. As other economists note, companies, like individuals, benefit from public roads, sewers, fire and police protection, as well as a work force educated in public schools.

And there is another compelling reason: Governments use the corporate tax as a “proxy” to keep investors in check.

“If you didn’t have corporate income taxes,” added Kenyon, “you would have a lot of incentive for people to start up mock corporations as places to hold money on an untaxed basis indefinitely. . . . It would set up loopholes for sneaky people to get around paying taxes.”

Taxing Business


Though manufacturing has been in steady decline in California, manufacturers continue to pay the biggest chunk of the corporate income tax. Some experts say this is evidence that the tax system has failed to keep up with changes in the state’s economy, which is shifting more to service firms.


Share of Total Taxes Paid in 1991 Services: 11.05% Manufacturing: 29.65% Trade: 16.46% Finance/Insurance: 20.97% Utilities: 16.49% Other*: 5.39% * Includes Agriculture, mining and construction.

Note: Data is for companies reporting positive net income.


The state’s 99 biggest public companies--a list led by Chevron, Arco, Hewlett-Packard and BankAmerica--together pay just over one quarter of all the corporate income tax collected by the state. Their share of tax payments is slightly larger than their share of all taxable corporate income.

Income Tax Paid, 1991 Taxable Income, 1991 Top 99 26.6% 24.6% All Other Companies 73.4% 75.4%

Source: Franchise Tax Board compiled by Richard O’Reilly, Times director of computer analysis.