The traditional American corporation has been a fixture in the U.S. economy for generations. Corporations allow entrepreneurs to shield themselves from liability, spread ownership out to an unlimited number of shareholders, and more easily raise funds for large-scale business investments.
While many modern politicians and pundits have spent copious time denouncing the evils of corporate America, the reality is that without the legal protections and financial opportunities provided by corporations, the United States would never have developed into the economic superpower it is today.
Despite its many advantages, the American corporate business model is slowly and painfully dying, and with it, a tremendous potential for future economic growth. According to a recent study by William McBride at the Tax Foundation, the United States loses roughly 60,000 corporations every year, and about 1 million corporations have been lost since the mid-1980s. According to the study, the number of corporations in the United States is at its lowest point in 40 years.
As a result of the declining number of corporations, only 60 percent of U.S. business profits now come from this type of business structure, a relatively low figure compared to many of the other successful economic nations of the world.
The reasons behind the decline of the American corporation are not difficult to discover. The United States continues to have the industrialized world’s highest corporate income tax rate, beating out numerous notorious high-tax nations like Belgium and France. Additionally, the U.S. tax code provides many incentives for those starting businesses or restructuring businesses to stay away from traditional corporations, also known as “C corporations.” For instance, C corporations are subject to multiple layers of taxation, which means the profits of the corporation are taxed, the shareholders’ profits are taxed, and all of the employees working for the corporation pay personal income taxes, as well.
The various disadvantages created by the federal government have led numerous entrepreneurs to choose alternative business structures to avoid paying high tax rates. Since the early 1990s, the number of partnerships has more than doubled, and sole proprietorships continue to be an option many small business owners utilize to avoid the complicated tax maze formulated by the IRS.
The number of S corporations has also risen dramatically as a result of the detrimental taxes placed on traditional corporations. Unlike C corporations, S corporations pass all taxes on to the owners of the business; the corporation does not pay any taxes on its profits. Owners pay personal income rates on the profits of the corporation, which significantly limits the total amount of taxes paid. Perhaps the largest disadvantage of an S corporation compared to a traditional corporation is that the number of shareholders in the company is limited to 100, which can significantly stifle the ability of the corporation to raise funds quickly for important projects.
The continuous decline of corporations in the United States significantly harms economic growth. Not only do traditional C corporations allow businesses the possibility to quickly obtain an infusion of cash to spur expansion through stock offerings, they also protect owners from debt and financial liabilities in a way partnerships and sole proprietorships simply cannot. When corporations fail, the repercussions for the owners are virtually non-existent. When sole proprietorships and partnerships fail, owners are often stuck with devastating amounts of debt that often prevent future business ideas from ever taking shape.
In the Tax Foundation’s report, McBride correctly asserts:
Unfortunately, [the decline of corporations in America is] troubling for the long-term health of the economy. C corporations usually provide the most efficient business structure for large-scale projects and investments. However, high corporate tax rates drive activity away from the corporate sector, artificially limiting this important aspect of the economy and harming productivity and workers’ wages, [as well as leaving] potential growth and economic activity on the table.
None of these fears seem to have bothered President Barack Obama when he formulated his $4 trillion budget proposal released in early February. Obama’s plan calls for raising taxes on corporations to pay for increased government spending and a massive $478 billion public works project.
Unless the federal government implements tax reforms that will encourage the growth of all businesses, including corporations, the U.S. economy will continue to improve at a sluggish pace, and future breakthrough business ideas will be developed in countries that provide a more favorable economic climate.
Justin Haskins (Jhaskins@heartland.org) is an author, blogger, and the editor of The Heartland Institute, a leading free-market think tank headquartered in Chicago, IL. Follow him @TheNewRevere.