The corporate income tax--a feature of the U.S. tax system for several decades--is a natural part of a tax system that seeks out income and taxes it wherever it is found. Such a system is flawed, however, and the corporate income tax is one of its most serious flaws.
Through a corporation, large groups of investors can pool their resources, share their risks, and adjust their investments through stock market trading. Although partnerships are a less flexible way to organize a business in that they rely on a relatively small number of investors who can adjust their share only through costly negotiations, their small size creates more accountability. The choice between organization types depends on various trade-offs that the market can work out.
A firm becomes a corporation when it needs capital to grow, even though this decision brings with it the corporate income tax, which effectively takes one-third of all profits ever generated by a new corporation but puts up no cash.
The corporate income tax distorts the allocation of capital between partnerships and corporations by forcing corporations to offer a higher return on investment since they must both pay their investors a competitive return and give the government its third. Thus enterprises that can be efficiently organized as partnerships, such as commercial real estate companies, have easier access to capital since they do not pay corporate income tax, causing too much capital to be directed to such activities. …