Suppose the corporate income tax were eliminated and corporate income allocated to shareholders on a pro rata basis according to their proportion of outstanding stock. How would such a change in tax policy affect the excess burden and incidence of the tax, assuming that all forms of investment income are included in a comprehensive income tax base?
To analyze the impact of eliminating the corporate income tax and allocating corporate income to shareholders on a pro rata basis, we need to consider the excess burden and incidence of the tax.
The excess burden of a tax refers to the loss of welfare or economic efficiency caused by the tax. It includes the deadweight loss, which arises when the tax reduces economic activity.
The incidence of a tax refers to who bears the economic burden of the tax. In the case of a corporate income tax, it is assumed that the burden is shared between shareholders (in the form of lower dividends) and other factors of production (such as employees through lower wages or consumers through higher prices).
By eliminating the corporate income tax, there would be several potential effects:
1. Excess burden: The elimination of the corporate income tax would likely reduce the excess burden as it removes the distortions and disincentives created by the tax. With no tax on corporate profits, firms would have more incentive to invest and expand their operations, leading to increased economic activity.
2. Incidence of the tax: Under the proposed change, corporate income would be allocated to shareholders on a pro rata basis. This means that shareholders would receive their share of the corporate income directly based on their ownership proportion. As a result, they would bear the entire burden of the tax. Shareholders would be responsible for reporting and paying taxes on their allocated corporate income on their individual income tax returns. Therefore, the incidence of the tax would shift entirely onto shareholders.
It's important to note that while the corporate income tax would be eliminated, shareholders would still be subject to individual income taxes on their allocated corporate income. The effect of this change on the overall tax burden depends on the individual income tax rates and the progressivity of the tax system.
To assess the specific impact on the excess burden and incidence of the tax, further analysis considering the specific tax rates, economic conditions, and distributional effects would be required.