Whenever tax policy comes to public attention, the issue of fairness arises. That is just as true in regard to the taxation of corporate enterprises – the subject of this article – as it is for personal taxes.
Is It ‘Fair’ to Grant or Deny Tax-Exempt Status to an Enterprise Classified as ‘Not for Profit’?
The Trump administration’s clash with Harvard and other universities about their tax-exempt status will seem fair to some and unfair to others.Section 501(c)3 of the U.S. Internal Revenue Code stipulates that tax exemption may be granted to corporations “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes ... no substantial part of the activities of which is carrying on propaganda ... and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.”
We have seen examples in the past of how the tax code can be weaponized for partisan purposes. During the Obama years, we had the notorious case of the IRS withholding or delaying the granting of tax-exempt status to not-for-profit organizations that were deemed too conservative. Today, Team Trump is threatening to withdraw the tax exemption from universities that are deemed too woke.
Is It Fair to Grant Privileged Tax Treatment to Nonprofits While Continuing to Tax For-Profits?
In practice, according to many analysts, such as the Tax Foundation, “The vast majority of tax-exempt organizations are business-like in form and function, such as credit unions, utilities, insurance companies, hospitals, universities, professional athletic associations, golf clubs, casinos, cemeteries, and consulting firms, to name a few. And many of these organizations use their tax-exempt status to compete with taxpaying for-profit firms.” We end up with absurdities such as the immensely wealthy NCAA (college sports business) being considered a “charitable” nonprofit organization.
The fundamental problem here is widespread ignorance of how important profits are for a society’s well-being. I groan every time I hear a college student answer the question, “What are you going to do after graduation?” with the piously delivered refrain, “I’m going to find a non-profit to work for.” Such young adults have had professors who have inoculated them with the poisonous Marxian dogma that profits are somehow unnecessary, illegitimate, and morally tainted. They truly believe that they are being virtuous by not participating in a for-profit enterprise. Nothing could be further from the truth.
A quick review of the ABCs of profit: 1) Profits are not a transfer of wealth from one party to another, but are mutual. The first rule of voluntary exchange is that both sides profit; otherwise, the exchange would not take place. 2) Thus, the larger the profit earned by the producer, the greater the value received by the consumer. 3) Profits are new wealth; entrepreneurial vision has found a way to combine inputs with a total market value of A and turned that value into more than A, thereby increasing the total wealth of society.
What Is a Fair Rate of Taxation of For-Profit Businesses?
As I have written before (see here and here), because in practice corporations pay different effective rates of taxation, the only truly fair rate is zero. Besides being notoriously inefficient from an economic point of view (even pro-taxation establishments like the OECD have stated that taxing corporate profits is the worst form of taxation) there are other ethical problems with taxing corporate profits: 1) It creates a system of double taxation by first taxing profits, then taxing shareholder dividends; 2) By making corporations unpaid tax collectors, it imposes a form of “unpaid servitude” (see Thirteenth Amendment); 3) Corporate profits don’t belong to the corporation, but to its shareholders, and they are not justly taxed until they become actual income, whether to the shareholders or to the employees. (This problem of potential wealth versus actual, spendable wealth is the same problem that arose when Joe Biden called for a “wealth tax” on individuals’ stock holdings.)The Only Truly Fair Solution
The anti-wealth left will hate this, but there is a single simple solution to all three of the contentious questions about tax fairness examined herein. It is the solution mentioned in the previous paragraph: to make the tax rate zero—not just on what are today classified as for-profit firms, but on the so-called not-for-profits, too. Then Harvard et al. wouldn’t have to worry about a president withdrawing their tax exemption, because they never would be subject to taxes on their income in the first place. There would be no need for squabbling about whether Enterprise A should be classified as not-for-profit, since there would be no advantage to it.[Note: There is one other wrinkle, and that is that, currently, donations to not-for-profits are tax deductible. But such contributions comprise only about 12 percent of not-for-profit income, and the government has no business tilting the table in favor of certain enterprises. It is the same unfairness as government subsidies. In both cases, government alters the cost structure so as to confer a benefit on favored constituents. It’s time for that corrupt practice to end.
As the old economic truism states, “Corporations don’t pay taxes; only people do.” Let’s set free thousands of accountants and lawyers to do other work instead of playing the complicated game of seeing who can extract the most favors from government. If you argue that the government needs more revenue, then have the courage and honesty to call for individual tax rates high enough to fund your grandiose government spending plans, and see if the American people agree that taxes should be that high.
