Cut the Corporate Tax Rate? Representative Ryan’s 8.5% Business Consumption Tax
By Randall Holcombe • Thursday January 27, 2011 11:25 AM PDT • 4 Comments
President Obama did not offer much in the way of specifics in his State of the Union address this week, so one thing that did stand out was his specific recommendation that we lower the tax rate on corporate income. A Republican response to the president’s speech was given by Wisconsin Representative Paul Ryan, and while Ryan didn’t mention it in his response, he has recommended replacing the corporate income tax with a “Business Consumption Tax” at an 8.5% rate.
Ryan’s Business Consumption Tax is a Value Added Tax (VAT). I have argued against creating a VAT in the United States, but Ryan’s Business Consumption Tax avoids many of the negative factors that would make a VAT undesirable here.
The compliance costs on taxpayers would be less the way Ryan’s Business Consumption Tax computes value added for tax purposes than the system used for tax computation in the European Union, and while there is always a threat that this tax could open the door for a wider application of a VAT, the tax is limited in both a political and economic sense, and is designed as a replacement for the corporate income tax.
The Business Consumption Tax would have a broader tax base than the current corporate income tax (fewer loopholes), and that produces the tax’s biggest advantage: it allows the marginal tax rate to drop from the current 35% to 8.5%.
Perhaps the biggest change from the current tax system is that a firm’s labor costs are part of its value added, so firms that are labor intensive (for example, software companies) would find their tax bills rising relative to manufacturing firms that are capital intensive. This could create a political hurdle too high to clear, should Ryan’s plan ever be seriously considered.
Having listened to the State of the Union address, the intriguing thing is that President Obama says he wants to lower the corporate tax rate, and Representative Ryan has a plan to do it — big time. A drop from 35% to 8.5% would make tax considerations a minor issue in new investment compared to the penalty of over a third of corporate income that now is levied on corporate profits that firms are unable to drop through the loopholes. Obviously, businesses will be more productive when they make their resource allocation decisions on how profitable they will be rather than on whether they can avoid taxes.
I’ve heard Obama critics say that he has no intention of following through on his rhetoric on limiting government. But the president did say he wants to cut the corporate tax rate, and the Ryan plan is an interesting starting point for answering the president’s rhetoric, if for no other reason than that it would reduce the corporate tax rate to a quarter of its present level.
Tags: Budget and Tax Policy, Business, Economics, Free Market, Politics, Taxation 
The corporate tax rate should be 0%. Anyone with more than four connected neurons knows that corporate taxes are consumer taxes. Eliminate corporate taxes and prices for goods and services will fall enabling more people to pay for them. The lowered costs and improved standards of living will boost consumer morale. Reduced taxes will pressure governments to cut back on services and “entitlements” that should return to the private sector (and that will be affordable because consumers are spending less on goods and services).
Dr. T | Jan 27, 2011 | Reply
I quite agree, Dr. T. That’s why 8.5% looks better than 35%, even if not as good a 0%.
Along these lines, Florida Governor Rick Scott has pledged to eliminate Florida’s corporate income tax, phasing it out over 7 years. That’s at the “promise” stage now. We’ll see if it comes to pass.
Randall Holcombe | Jan 27, 2011 | Reply
It’s meaningless to say that “8.5% looks better than 35%” when the 35% is applied to profits which in some circumstances are less than zero and the 8.5% applies against “value added” which in many cases will result in a larger tax.
barry milliken | Feb 1, 2011 | Reply
Dr. T, your argument spells out exactlly why the corporate tax will never be lowered. As you mnetion, the corporate tax is a tax on consumers – BUT – it is a “hidden” tax, much like the employer’s share of the SSI tax is a “hidden” tax on what would have been income to the worker.
As you further point out, in so doing, ending the corporate tax will lower the cost of bring goods and services to market, and as such with lower prices there are then lower sales tax receipts. Thus, a lower corporate tax, while good for the economy, will NEVER be agreed upon by those currently “fed” by both corporate taxes, and sales taxes.
joe4liberty | Feb 7, 2011 | Reply