Wednesday, September 18, 2013

Recent Scholarship of Note on Normative and Practical Challenges in Corporate Taxation

Yariv Brauner recently posted "Whither Choice of Entity," in which he examines choice of entity and policy implications in support of the repeal of corporate taxation, or failing that, a redefining of corporate residence to move toward source-based taxation, preferably with formulary apportionment. He provides a comprehensive picture of the ongoing chaos created by entity classification and residence assignment rules. Brauner correctly mourns the lack of normative principles underlying the differential taxation of entities, which he attributes to the "unorganized thinking" that characterizes much of the discussion about how choice of entity rules impact people's business choices, and the general messiness of policy-making as it evolves haphazardly through lobbying and political posturing.  He concludes:
In light of the incredible variety of options beyond mere incorporation or non-incorporations, one must wonder why tax law uses corporate or private law as the baseline for the application of its rules. Most importantly, why do we attribute importance to the act of incorporation? ...[T]here is nothing particularly special about businesses that carry a piece of paper stating that they are incorporated. A legal response to that may not be very feasible. We do not have a satisfactory legal answer to the central question: why do we tax corporations separately when only humans bear the burden of such taxation.
...The most obvious lesson is that the potentially negative impact of the corporate income tax on our tax system goes beyond the complexity it imposes on our tax system, and even beyond its negative political implications. In that, it reinforces the conclusion that the first-best step in a reform must include the elimination of the corporate income tax as a firm-level tax, perhaps replacing it with a withholding mechanism to preserve the efficacy of corporations as revenue collecting devices, or with other proxy solutions, such as mark-to-market taxation of public corporations only. 
Another solution... may be to replace the current residence based taxation of entities that relies exclusively on corporate personhood with an alternative, more substantive tax regime. This could be an increasingly source-based rather than residence-based tax regime, yet such a reform faces several difficulties, including the need to retain residence as a primary determinant of taxation, the difficulty of identifying the source of income, the difficulty of asserting a fairness-based tax base division between source and residence once established, etc. A better solution would be to adopt formulary taxation that relies on agreement between competing jurisdictions rather than false pseudo-economic notions. 
Henry Ordower verifies Yariv's concerns and takes a related approach in Preserving the Corporate Tax Base Through TaxTransparency, in which he states:
When, where, and at what rate to tax the income of business entities are the fundamental questions for the corporate income tax. Answers to those questions should remain independent of the taxpayer’s choice of business form, because one may achieve identical revenue outcomes with entity opacity or transparency. When the answers to those questions vary with business form and tax system structure, opportunities to arbitrage those differences across national borders and diminish or avoid tax on the corporate in- come inevitably emerge.
Tax professionals, administrators, academics, economists, and business participants may and often do disagree on whether a corporation’s (or other business entity’s) income from the operation of its business should be taxable to the corporation itself or taxable to its owners. Opinions also may diverge on whether to tax investment income differently from income from the operation of a business. Despite those disagreements, as long as there is to be an income tax, all will agree that the choice of one business form over another should not result in income from business operations escaping income tax completely.
Similarly, income should be subject to tax primarily where the taxpayer produces income from the operation of a business. Taxing income where the taxpayer’s principal office or seat of management happens to be makes sense only under a system that taxes residents and citizens on their worldwide incomes (a global model of taxation like the United States has) and then only secondarily to the place of income production in order to prevent taxpayers from gaining an advantage by placing their income in low-tax jurisdictions. 
...[A] wholly transparent income tax system would improve existing corporate tax systems and establish tax neutrality between entities currently subject to the corporate income tax and those that are not. Full transparency is consistent with international treaty obligations and simultaneously eliminates many international tax arbitrage opportunities. Business needs rather than tax benefits would drive choice of business form. If accompanied by a robust system of international apportionment of business income, a fully transparent corporate income tax would eliminate most income allocation arbitrage as well as tax system structure arbitrage opportunities.
Read them both to get a good sense of the history, evolution, and ongoing challenges facing corporate income taxation.

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