Paul Krugman is right about the problem — But wrong about the solution

This blog is motivated by a recent blog by Paul Krugman, who argued for raising the corporate tax rate in a recent Substack column. While I happen to disagree with him on this proposition, his bringing up this topic opens the door for a discussion of taxes more broadly.

With respect to corporate taxes, let me start with my agreement with Krugman. In his article, he documented a sharp drop in corporate tax receipts as a share of national income, as reflected in the following chart:

Back in the 1950s this fraction peaked at around 47 percent. These days, it’s less than 15 percent. Krugman postulates that this substantial decline has contributed to our tax system becoming less progressive over time, which, in turn, has contributed to more extreme income disparities in our nation. Krugman’s remedy is to raise corporate tax rates. Doing so would align our corporate tax rates more closely with those of other developed countries. Additionally, raising the corporate tax rate would be consistent with popular opinion that supports the view that corporations aren’t paying enough.

Like Krugman, I also see extreme wealth disparities in our country as a problem in need of correction, and I agree that the reduction of progressivity is something that should be reversed. The remedy, however, is not to raise corporate taxes but rather to implement a wholesale restructuring of our tax system. In an earlier post I argued for the elimination of the employee-paid portion of payroll taxes. Here, I want to go further.

As I see it, our tax system appears to have evolved from the Willie Sutton school of thought. Willie Sutton, of course, was the bank robber who, when asked why he stole from banks, answered that he did so because that was where the money was. In a similar vein, Congress instituted corporate income taxes, because they needed a way to generate additional tax dollars, and taking it from corporations was politically expedient, even though doing so tramples on the concept of fairness.

Consider two different enterprises alike in every way except that one is registered as a corporation and the other a sole proprietorship or partnership. The first would be subject to the corporate income tax while the second would not. A fairer system would set the corporate income tax rate at zero and simply tax the recipient for any distributions made by the company. This design is called a distributed-profits tax, and it’s currently in use in Estonia and Latvia in its pure form. (Other countries have slight variants.)

Beyond that structural inequity, under the current tax regime in the U.S., income that corporations distribute to shareholders in the form of dividends faces double taxation — the first instance being the corporate tax on the company’s profits, and then as income to the shareholders who receive dividends. Although the degree of double taxation is mitigated by the fact that qualified dividends (which are the predominant dividend type) are taxed preferentially relative to wage income, my point still holds.

Also worth noting is that if corporate profits are retained, as opposed to being distributed, corporate taxes are still paid, thereby reducing the value of the company. Thus, the shareholders effectively are paying taxes on income that they haven’t received. In contrast, general investors who see their assets appreciate aren’t taxed on those appreciated values until those assets are sold and profits are realized (i.e., until the investor has the money in hand derived from the liquidation of the assets). Is the disparate treatment fair? I think not.

So what should happen? In my view, the corporate tax ought to be scrapped entirely and replaced with progressive income taxes being assessed on distributed‑profits — a system in which rising marginal rates apply as distributions rise. More importantly, this logic should be applied more broadly. In particular it should govern all wealth transfers. In practice, that means an overhaul of federal estate taxes. I’d eliminate basis adjustments, step‑ups, and every capital‑gain convention tied to inherited or gifted assets. Under the tax regime I’m suggesting, anyone receiving assets — from any source and in any form — would treat that receipt as income and be taxed accordingly, applying a progressive rate structure. Again, this concept of income is not original. It’s a derivative of the Haig-Simon definition of income, which appeared in finance literature in the early 1900s.

Under the current system, any heir to a fortune effectively stands to get a windfall gain for which they, personally, bear no tax liability. This tax feature, perhaps more than anything else, may be responsible for the extreme wealth concentration that we’ve been experiencing. To me — and I expect to Krugman as well — this concentration of wealth in the upper echelon of the economic ladder derives from the fact that the super-rich in this country are able to pass along megafortunes to their heirs, and the system seems to endorse the idea that those heirs have a right to that property without it being a taxable event to them.

To be fair, heirs do face a tax consequence when they eventually sell inherited assets, but that liability applies only to the appreciation after the transfer — not to the full value of what they received. In so doing, the system institutionalizes an unlevel playing field that inhibits the economic mobility of our citizenry and ultimately threatens the health of our democracy. Over time, substituting progressive distributed‑profits taxation for both corporate and estate taxes would make a meaningful dent in the extreme wealth disparities we’ve been living with. Conceptually, the fix is straightforward. Politically, it’s another matter. I know I’m tilting at windmills, but to my mind the extreme concentration of wealth in our country is a problem that demands a bold solution. Nothing short will suffice.