Hello, I thought about the idea how corporation tax should be abolished, as having the income tax - which anyway is paid by the corporation - as well seemed rather redundant(as Friedman proposed)....

Hello, I thought about the idea how corporation tax should be abolished, as having the income tax - which anyway is paid by the corporation - as well seemed rather redundant(as Friedman proposed).

Now, I am rather confused about this hypothetical situation:

We, XXX, have a chance of selling product Y for the price of $300 to a danish businessman, we have the economic capacity to hire employees for $1000 and now have the following options:

A. Hire the workers in Sweden, where the income tax is 50% and corporation tax is unheard of.

B. Hire the workers in Norway, where the income tax is unheard of, though there exists a corporation tax of 50%.

  • In both cases, a real/after-tax wage of $100 per employee is required.

In Sweden, our $1000 would allow us to hire 5 employees, as an income of $200 will lead to a real wage of $100. Those five employees would each produce one sample of Y, thus generating a revenue of $1500. A profit of $500 is to be expected

In Norway, our $1000 would allow us to hire 10 employees - each generating $300. Revenue: $3000. Corporation profit before tax: $3000-$1000=$2000. After tax profit: $1000.

In this case, an investment of $1000 would generate a net profit of $1000 in Norway, though only $500 in Sweden, thus illustrating, that corporation tax is more effective for government earnings as well as private.

I hope you see why this causes me trouble understanding Friedman's idea, and I hope that you will point out the missing link that falsifies this hypothetical example.

Yours sincerely Deracless

Asked on by deracless

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

I think that the issue here is that you have set up your hypothetical in a way that does not capture Friedman’s criticism of corporate taxes.  As you have set up your hypothetical, we are faced with the choice of having either a corporate tax or an income tax.  Friedman is not talking about a choice like this.  Instead, he is saying that a system that has both types of tax is unfair.  This is because the money that the corporation makes in profits (and which it must therefore pay in taxes) is also taxed as income.  The problem, then, is that this money is taxed twice.

When a company makes a profit, it distributes its profits to its shareholders in the form of dividends.  These dividends are taxed.  If the company has to pay taxes on the profits and the shareholders have to pay taxes on the dividends (which are also part of the profits), the profits are being taxed twice.  This is what Friedman and other conservative economists do not like.  They are not necessarily saying that an income tax is superior to a corporate tax.  What they are saying is that it is wrong to have both of these taxes together.

Sources:

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