A brief treatise on corporate tax levels, starring Joe

I'll start by agreeing with both Ginna and Lord Kitchener's Own that it's great to have a civilized policy debate happening in political blogosphere. In keeping with that, a few of Ginna's comments (both here and on Gin and Tonic) deserve further commentary on my part.

To start with, I disagree with Ginna's characterization of money taxed from corporate earnings as "our money". This assumption seems to be based on the view that wealth inherently belongs to the individual who nominally acquires it, with no regard for the societal context which allows for that wealth to be generated, as a consequence of which all taxation is illegitimate. I'll hope that we can find agreement on how that perception is wrong.

In order to get to that agreement, I rely on the presumption that some form of government is necessary. I presume this point isn't in any great dispute, given that Ginna backs the Conservative Party rather than an anarchist/libertarian group.

Given that starting point, some level of taxation has to follow in order to allow the necessary government to function. The optimal level of taxation must be the level at which government is able to provide all services properly kept on the government level, without taking in extra revenue which goes to improper/unnecessary/undesirable purposes. To the extent that taxation happens up to that level, I don't see how there can be any dispute that taxation is legitimate, and that the money taxed is properly the state's rather than the individual's (particularly to the extent that a lack of proper government could make it impossible for the wealth to be generated in the first place).

The questions of what services fall to the government to be provided, and accordingly what level of taxation is optimal, are ones where I highly doubt we'll find too much common ground. (Not to mention that they probably cover a strong majority of the total content of political debate.) I'll thus leave them aside for now, except to comment that I think it's perfectly fair to say that increasing or decreasing the role of government on policy grounds has to fit the definition of "tilting public policy".

Let's move on then to look at the nature of the corporation, and the role of the government in making corporations viable. Ginna's first post pointed out the following:

Due to the vagaries of Canadian tax law, it makes no sense for businesses which actually employ someone other than the owner to operate as anything other than a corporation. Think about that for a minute. There are no middle tiers in Canadian business. My mom has a corporation. Incorporation is not that hard - everybody's doing it!

Why then is everybody incorporating if it results in having to pay an extra 21% in taxes on net revenue? Ginna provides the answer: based on other provisions of tax law, for the vast majority of businesses, the investment in incorporation provides a pure financial gain (along with limited liability and other benefits).

Indeed, it's very simple for a single operator or small group of owners to acquire "the freedom to run (one's) own businesses, without government interference at all outside regulatory" by conducting a business as a sole proprietorship or partnership. The corporate tax is thus far easier to avoid than personal income taxes or consumption taxes. Nonetheless, most businesses choose to incorporate to get access to other benefits...despite the existence of the corporate tax at its current level.

Seen in this context, lower corporate tax rates aren't properly seen as a matter of keeping more of a business' own money in the pockets of its owners. Rather, they're a way of ensuring that corporations pay even less of the true value of their privileged legal status than they already do. Or through the lens of my take on the proper role of government, lowered corporate tax rates attempt to transfer even more of the value of an externality to profitable corporations of all sizes - without asking the question of who's ultimately paying the cost of the externality.

Out of an abundance of caution, I'll make clear that I fully support the presence and growth of corporations as a means of generating wealth. But it still has to be said that corporations (even more than most people or groups) benefit directly from government policy, and it's not the least bit unreasonable to expect them to contribute back a portion of those benefits.

Thus concludes (for now) my take as to why neither taxes in general, nor corporate taxes in particular, can be fairly seen as an affront to individual choice. But let's get back to the original question of what impact a corporate tax cut will have on small businesses generally.

Over at Gin and Tonic, Ginna is skeptical that larger organizations will necessarily use their money better:

I would probably also add that the author has a common and somewhat touching faith in the ability of large corporations to be ruthlessly efficient, and marshall their resources accordingly. Most stock investors know that the promised efficiences almost rarely happen, which is why when it does (WalMart!) the effects are brutal. Luckily for our plucky small business owners, that's rarely the case.

On this point, I'll offer one caveat to my previous post: not all large businesses are foreseeably profitable in the near term, and the ones who aren't won't acquire any advantage from a reduction in taxes. Of course, those are often huge industries with historical political support such as airlines, major manufacturers, etc. who likely don't have to compete with too many Joes anyway. But for those who are able to plan to benefit from the tax cut, I'll stand by the argument that they're likely to do much more as a result than smaller businesses.

In essence, the management of the cut by either of the sign corporations will follow a two-step process: first, the company will assess how best to spend the money; second, the company will actually go out and spend it.

On the first step, Ginna makes a fair point that diminishing returns will come into play: Joe probably has a pretty good idea what options are available generally, and the choice to pay additional people to come up with new ideas won't necessarily add value. The question of whether SignCo does better than Joe's at this step will depend on the amount of resources that each puts into the step, and how efficient each is at using the resources.

But there's no way for Joe to actually gain on his larger competitor at this step unless SignCo is actively wasting resources: if there's no efficiency to be found by putting multiple heads to the task, then nothing stops SignCo from putting its own decision in the hands of an individual who'll take no more time and effort than Joe. And I don't think it takes any great faith in the magic of large corporations to assume that they generally try to act in their own economic self-interest.

In most cases, there will be some benefit to be had by putting more than one person's knowledge to use, and the resources that SignCo puts into analyzing the use of the money will pay off at least somewhat. In addition, if SignCo has a greater geographical reach, then it is able to examine more possible beneficial investments than Joe does. Call this a small win for SignCo in spotting different ways to spend the money, with a possibility of a neutral result.

Before analyzing the second step, let's add another fairly simple premise which I don't think can be in dispute. The premise is that economies of scale exist: if X amount of money will buy Y amount of goods, then in virtually all cases 2X amount of money will buy somewhat more than 2Y of the same type of goods. The reasons for such an effect aren't too important, but probably include a lack of duplication in the process and resources necessary produce the additional units of Y, and the general willingness of businesses to minimize risk by giving lower prices in exchange for a more secure source of revenue.

At the second step, the issue is then solely one of economies of scale. Even if Joe's and SignCo put the tax cut money into precisely the same type of capital investment, SignCo's greater size allows it to get proportionally more return on the investment.

And then there's the effect of the investments of all the other corporations going through the same process. This too favours SignCo strongly: larger businesses will have a strong incentive to make any capital purchases from another large supplier rather than trying to cut separate local deals with each Joe, while there isn't a particularly strong incentive for Joe to direct his investment one way or the other as between larger or smaller businesses.

As Ginna points out, there's probably also some pie-enlarging effect going on. From the standpoint of each Joe, the question is whether the gains from the larger pie outweigh the losses in competitiveness. And I allow for the fact (as I did in my earlier post) that for some Joes, perhaps including Ginna's own business, the benefits will outweigh the costs.

But then, remember Ginna's original argument that small businesses are our main economic drivers, and that we should accept corporate tax cuts predominantly for their potential positive effect on small business. Now, that argument has been completely turned on its head:

The WalMart myth tells us that small businesses can't compete with large. When the big box killers come to town, they destroy the home-grown. And truly, this is often the case. But I would argue that the larger problem is that the failed businesses failed to adapt and compete.

Suddenly small business isn't seen as something to embrace at all; rather, it's something which we should try to put through an accelerated evolution process of adapt or die, with the knowledge that the latter fate will often occur. Needless to say, this strikes me as a rather counterproductive way of treating the businesses which now offer more than half of our private employment.

I'll grant that Ginna's original post included an attempt to side-step this issue, in the statement that how small businesses would spend the tax cut isn't the point. But I don't accept that position. How the tax cut will be used is entirely the point, as the core question is what to do with the money currently collected by the federal government. Even if taxation were generally illegitimate, in order to justify making only the corporate tax cut we'd still have to examine the comparative legitimacy of different types of taxes rather than relying on a blanket statement that the effect of one person's chosen policy is irrelevant.

In sum, the effect of a corporate tax cut isn't only to divert resources from other sectors to a corporate sector which is already doing rather well; the cut also makes it more difficult for small businesses who collectively employ more people to survive as compared to larger ones who employ less. And it doesn't seem to me a tough call to say that some other policy, be it another form of tax cut, a social investment or even a payment on the national debt, must be a better use of those resources.