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Corporate Taxation

Corporate Taxation



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Published by: legalmatters on Aug 11, 2007
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Charlotte Crane
 Northwestern University School of Law
© Copyright 1999 Charlotte Crane
Much of the traditional economic literature has until relatively recentlyignored almost all of the details of the coverage of the tax and the legalinstitutions within which the tax has developed. As a result, most of therules used in establishing corporate tax liabilities are the outgrowth of legalformalisms. Although many discussions of reforms of tax rules use as theirstarting point some rudimentary assumptions about incentives and effects,few of these discussions consider less obvious incentives and interactions orattempt to verify their analysis empirically.This chapter will therefore focus primarily on those treatments that gobeyond these typical rudimentary assumptions. The bibliography deals onlywith those works that go well beyond descriptive treatments and practicalexpositions of the legal rules in question.
 JEL classification:
K22, K34
Corporate Income Tax, Tax Burden and Incidence, CorporateFinancial Structure
1. Introduction and Note on Scope
Corporations, measures of corporate profits, and taxes imposed thereon areuniquely legal institutions. They have no physical reality; they are entirelythe product of legal and accounting rules. But because of the importance of corporate activity in modern economies, scholars in economics and financewho have no other interest in law or legal institutions have long had aninterest in analyzing the effects of corporate taxes. To the extent that thiswork uses economic analysis to understand and predict the behavior of firmsas well as the development of legal rules, this body of literature must beconsidered in any review of the treatment of the corporate tax as ‘law andeconomics’. References to works in a wide variety of methodologies aretherefore included in this bibliographic review.Much of this traditional economic literature has until relatively recentlyignored almost all of the details of the coverage of the tax and the legalinstitutions within which the tax has developed. At least in the United
Corporate Taxation
6060States, these details have evolved through a continuing dialog between thelegislature (which until relatively recently formally prescribed only the mostskeletal of rules) and the courts (which have felt free to allow the approachesof the common law to contribute to the development of the legal rules), asprompted by the Internal Revenue Service. As a result, most of the rulesused in establishing corporate tax liabilities (for instance, those according towhich entities are classified as subject to the tax, those according to whichdebt is distinguished from equity, those according to which shareredemptions are distinguished from dividends, and those according to whichcorporate reorganizations are classified as taxable or nontaxability) are theoutgrowth of legal formalisms, particularly the idea that a corporation can bean entity entirely separate from its participants. These formalisms developedwithout any conscious attention to their economic effect. There are thereforeonly a few justifications and analyses of the substantive rules of corporatetaxation of the sort those well-read in other areas of law and economicsmight find familiar. Indeed, a leading monograph analyzing the corporatelaw through the lens of law and economics makes only scant reference to thepossibility that taxes have an influence on the legal relationships betweencorporations and their shareholders (Easterbrook and Fischel, 1991).Furthermore, the evolution of most of these details has historically been, andcontinues to be, dominated by manipulation of these formal constructs byinstitutions for which there is only rudimentary understanding of theirnature as ‘economic’ actors. Although many discussions of reforms of taxrules use as their starting point some rudimentary assumptions aboutincentives and effects (most commonly, that taxpayers will attempt tominimize tax burdens at least to the extent that the avoided burden exceedsthe cost of avoidance and that differential treatment of economically similartransactions will produce inefficient distortions), few of these discussionsconsider less obvious incentives and interactions or attempt to verify theiranalysis empirically. (Roin, 1988; Kanda and Levmore, 1991, and Arlen andWeiss, 1995, are notable exceptions). This review will therefore focusprimarily on those treatments that go beyond these typical rudimentaryassumptions. Thus only a small portion of the literature considered here canbe solidly classified as ‘law and economics’, rather than traditionaleconomic analysis of the effect of tax laws on legal institutions.This chapter focuses on the effects of taxes that are encountered only byincorporated entities, and does not consider the effects of taxes that areimposed regardless of the legal form in which capital is held. Thus it doesnot generally consider the effect of taxes on overall capital formation beyondbasic questions of corporate financial structure. However, many of the workscited herein, particularly earlier works, may have (in many cases knowingly,but in other cases unwittingly) assumed a substantial congruence between
Corporate Taxation
167the ‘business’ and ‘corporate’ sectors, and there is, therefore, a substantialoverlap with that literature. For survey treatments of capital and businesstaxes generally, see Gravelle (1994) and Halpern and Mintz (1992, withemphasis on Canada).This bibliography deals only with those works that go well beyonddescriptive treatments and practical expositions of the legal rules inquestion. The reader is cautioned, however, that, perhaps more than otherareas of the law, the rules outlining the base of the corporate income tax arecomplex, and that assumptions about the impact of potential tax liabilitiescan rarely be made without a relatively sophisticated understanding of them.Comprehensive introductions to the overall income tax systems of various jurisdictions and an introductory bibliography can be found in Ault (1997);additional descriptions of the corporate tax systems in specific jurisdictionscan be found in Brooks (1997) (Canada); Pender (1997) (Australia); Muten(1997) (Scandinavia); Teixeira (1997) (Portugal, Great Britain, Holland).More detailed surveys of tax-base defining rules and rates can be foundin the looseleaf services of the International Bureau of FiscalDocumentation, as well as in various pamphlet series of the largeraccounting firms, including Coopers and Lybrand, Klynveld Peat MarwickGoerdeler, Price Waterhouse, and Deloitte Touche Tohmatsu International.Useful short summaries of various topics include Auerbach (1990) (thepredominant features of the classical double tax), Shoven and Waldfogel(1990) (the treatment of debt and equity), Scholes and Wolfson (1991) (thegeneral pattern of rules for mergers and acquisitions) and the internationalscheme generally.Wiseman (1974), Harberger (1983) and Goode (1951) should give thereader good perspective on the early contributions of traditional economists.A useful survey of the issues raised by the presence of taxes in the traditionalcorporate finance literature is provided by Gordon and Malkiel (1981).Other more recent surveys of slightly different scope include that by Head(1997), Mintz (1995) (including tables showing the prominent features of the tax schemes used in various jurisdictions and providing more generalbackground on taxes, costs of capital and risky investments), and Cnossen(1997), focusing on the OECD jurisdictions.
2. Overview of the Tax
Under the ‘classical’ scheme for taxation of corporate income, corporationsare recognized as separate taxable entities, legitimately subject to tax upontheir income. Distributions of earnings to shareholders are also taxed asincome to shareholders, as if they represented entirely new values availableto be taxed. Such schemes essentially tax the earnings on corporate equity

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