The Corporate Income Tax System: Overview and Options for Reform
Congressional research reportDec 1, 2014
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The Corporate Income Tax System: Overview
and Options for Reform
-name redactedSpecialist in Economics
-name redactedSpecialist in Public Finance
December 1, 2014
Congressional Research Service
7-....
www.crs.gov
R42726
The Corporate Income Tax System: Overview and Options for Reform
Summary
Many economists and policy makers believe that the U.S. corporate tax system is in need of
reform. There is, however, disagreement over why the corporate tax system needs to be reformed,
and what specific policy measures should be included in a reform. To assist policy makers in
designing and evaluating corporate tax proposals, this report (1) briefly reviews the current U.S.
corporate tax system; (2) discusses economic factors that may be considered in the corporate tax
reform debate; and (3) presents corporate tax reform policy options, including a brief discussion
of current corporate tax reform proposals.
The current U.S. corporate income tax system generally taxes corporate income at a rate of 35%.
This tax is applied to income earned domestically and abroad, although taxes on certain income
earned abroad can be deferred indefinitely if that income remains overseas. The U.S. corporate
tax system also contains a number of deductions, exemptions, deferrals, and tax credits, often
referred to as “tax expenditures.” Collectively, these provisions reduce the effective tax rate paid
by many U.S. corporations below the 35% statutory rate. In 2014, the sum of all corporate tax
expenditures was $154.4 billion.
The significance of the corporate tax as a federal revenue source has declined over time. At its
post-WWII peak in 1952, the corporate tax generated 32.1% of all federal tax revenue. In 2013,
the corporate tax accounted for 9.9% of federal tax revenue. The decline in corporate revenues is
a combination of decreasing effective tax rates, an increasing fraction of business activity that is
being carried out by pass-through entities (particularly partnerships and S corporations, which are
not subject to the corporate tax), and a decline in corporate sector profitability.
A particular aspect of the corporate tax system that receives substantial attention is the 35%
statutory corporate tax rate. Although the United States has the world’s highest statutory corporate
tax rate, the U.S. effective corporate tax rate is similar to the Organization for Economic Cooperation and Development (OECD) average. Further, the United States collects less in corporate
tax revenue relative to Gross Domestic Production (GDP) (2.3% in 2011) than the average of
other OECD countries (3.0% in 2011).
This report discusses a number of economic considerations that may be made while evaluating
various corporate tax reform proposals. These might include analyses of the likely effect on
households of certain reforms (also known as incidence analysis). Policy makers might also want
to consider how certain corporate tax provisions contribute to the allocation of economic
resources, choosing policies that promote an efficient use of resources. Other goals of corporate
tax reform may include designing a system that is simple to comply with and administer, while
also promoting competitiveness of U.S. corporations.
Commonly discussed corporate tax reforms include policies that would broaden the tax base (i.e.,
eliminate tax expenditures) to finance reduced corporate tax rates. Concerns that the U.S.
corporate tax system inefficiently imposes a “double tax” on corporate income have led some to
consider an integration of the corporate and individual tax systems. The treatment of pass-through
income—business income not earned by C corporations—has also received considerable attention
in tax reform debates. How the United States taxes income earned abroad, and the possibility of
moving to a territorial tax system, have emerged as important issues.
Congressional Research Service
The Corporate Income Tax System: Overview and Options for Reform
Contents
Structure of the Corporate Income Tax ............................................................................................ 1
Corporate Tax Rates .................................................................................................................. 2
Corporate Tax Expenditures ...................................................................................................... 3
Treatment of Losses................................................................................................................... 5
Corporate Income Earned Abroad ............................................................................................. 6
Taxation of Shareholders ........................................................................................................... 6
Which Companies Pay? ................................................................................................................... 7
Corporate Income Tax Revenues ................................................................................................... 11
International Comparisons ............................................................................................................. 12
Tax Rates ................................................................................................................................. 12
Tax Revenues........................................................................................................................... 13
Economic Considerations .............................................................................................................. 15
Why Have a Corporate Income Tax?....................................................................................... 15
Corporate Tax Incidence .......................................................................................................... 16
Evaluating the Corporate Income Tax ..................................................................................... 17
Equity ................................................................................................................................ 18
Efficiency .......................................................................................................................... 19
Simplicity and Administrability ........................................................................................ 22
Options for Reform ........................................................................................................................ 23
Broader Base, Lower Rates ..................................................................................................... 23
Integration of the Corporate and Individual Tax Systems ....................................................... 25
Other Options for Reducing “Double Taxation” of Corporate Income ............................. 25
Taxation of Pass-Through Income ........................................................................................... 26
International Tax: Territorial vs. Worldwide Taxation ............................................................. 27
Comparing Current Corporate and Business Tax Reform Proposals ............................................. 28
Figures
Figure 1. Individual and Corporate Tax Expenditures in FY2014 ................................................... 4
Figure 2. Distribution of Business Types, 1980 and 2008 ............................................................... 8
Figure 3. Distribution of Corporations and Corporate Taxes Paid in 2008 by Industry .................. 9
Figure 4. Corporate Tax Revenue as a Percentage of GDP, 1946-2019 ........................................ 12
Figure 5. Corporate Tax Revenue as a Percentage of GDP in 2011............................................... 14
Tables
Table 1. Five Largest Corporate Tax Expenditures in FY2014........................................................ 5
Table 2. Corporate Tax Rates: Comparing the United States to the Rest of the OECD................ 13
Table 3. CBO’s Distribution of Corporate Income Tax ................................................................. 18
Table 4. Treasury’s Distribution of Corporate Income Tax............................................................ 19
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The Corporate Income Tax System: Overview and Options for Reform
Table 5. Comparing Business and Corporate Tax Reform Proposals ............................................ 32
Contacts
Author Contact Information........................................................................................................... 35
Congressional Research Service
The Corporate Income Tax System: Overview and Options for Reform
T
he corporate income tax system has been a focus of many recent debates about tax reform
and the economy. Many economists and policy makers argue that reform of the corporate
income tax system is needed, although a variety of rationales on why and how have been
offered. Some argue that a simpler system with lower tax rates is necessary to encourage
domestic investment, employment, and economic growth. Others argue that reform is needed to
close loopholes and restrict access to tax havens, both of which are seen by some to allow
corporations to avoid taxes too easily. A number of others have advocated for corporate tax
reform on the basis that the current system puts American corporations at a disadvantage when
compared with foreign competitors. Many believe it is a combination of these arguments that
justify reforming the corporate tax system.
This report presents information and research on the corporate tax to help policy makers
understand and evaluate arguments presented in the tax reform debate. Many of the topics and
ideas discussed here are analyzed in greater detail in the other CRS reports and academic research
referenced throughout. This report first reviews the structure of the corporate income tax. Data on
which companies pay the corporate tax, corporate tax revenue, and how the U.S. system
compares to the rest of the world are then presented and analyzed. Next, the economic effects of
the corporate tax are reviewed—including a discussion of the purpose of the corporate tax, who
bears the burden of the tax, and how to evaluate alternative corporate tax systems. The report then
reviews broad reform options and concludes with a comparison of specific proposals that have
been offered.
Structure of the Corporate Income Tax
The corporate income tax generally only applies to C corporations (also known as regular
corporations). These corporations—named for Subchapter C of the Internal Revenue Code (IRC),
which details their tax treatment—are generally treated as taxable entities separate from their
shareholders.1 That is, corporate income is taxed once at the corporate level according to the
corporate income tax system. When corporate dividend payments are made or capital gains are
realized income is taxed again at the individual-shareholder level according to the individual tax
system. This treatment leads to the so-called “double taxation” of corporate profits. In contrast,
non-corporate businesses, including S corporations2 and partnerships,3 pass their income through
to owners who pay taxes. Collectively, these non-corporate business entities are referred to as
1
For more information, see CRS Report R43104, A Brief Overview of Business Types and Their Tax Treatment, by
(name redacted).
2
An S corporation is a closely held corporation that elects to be treated as a pass-through entity for tax purposes. S
corporations are named for Subchapter S of the IRC, which details their tax treatment. By electing S corporation status,
a business is able to combine many of the legal and business advantages of a C corporation with the tax advantages of a
partnership. For more information, see CRS Report R43104, A Brief Overview of Business Types and Their Tax
Treatment, by (name redacted).
3
A partnership is a joint venture consisting of at least two partners organized to operate a trade or business with each
partner sharing profits, losses, deductions, credits, and the like. A partner is an investor in such an entity and may be an
individual, a trust, a partnership, a corporation, another entity (such as a limited liability company), or a broker that is
holding the ownership interest of an unnamed partner. Partnerships are established under the individual laws of each
state, although their tax treatment at the federal level is determined by the Internal Revenue Code (IRC). The most
common partnerships include general partnerships, limited liability partnerships, limited partnerships, publicly traded
partnerships, and electing large partnerships. For more information, see CRS Report R43104, A Brief Overview of
Business Types and Their Tax Treatment, by (name redacted).
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The Corporate Income Tax System: Overview and Options for Reform
pass-throughs. For these types of entities, business income is taxed only once, at individual
income tax rates.
The corporate income tax is designed as a tax on corporate profits (also known as net income).
Broadly defined, corporate profit is total income minus the cost associated with generating that
income.4 Business expenses that may be deducted from income include employee compensation;
the decline in value of machines, equipment, and structures (i.e., deprecation); general supplies
and materials; advertising; and interest payments. The corporate income tax also allows for a
number of other special deductions, credits, and tax preferences. Oftentimes, these provisions are
intended to promote particular policy goals, as deductions reduce taxes paid by corporations.
A corporation’s tax liability can be calculated as:
Taxes = [(Total Income – Expenses)(1 – p) × t] – Tax Credits,
where t is the statutory tax rate and p is the Section 199 production activities deduction. The
Section 199 deduction, which is discussed in “Corporate Tax Expenditures” section, effectively
lowers the corporate tax rate for those corporations engaged in domestic manufacturing
activities.5
The corporate tax system becomes increasingly complex as the details of specific provisions are
examined. The following sections discuss some of the more fundamental features of the tax
system.
Corporate Tax Rates
Most corporate income is subject to a 35% statutory tax rate. To generate this flat rate, which
applies to the largest businesses, income is taxed at rates that vary from 15% on the first $50,000
of income to 35% on income over $18,333,333.6 This rate structure benefits smaller corporations,
encouraging some small firms to incorporate to take advantage of scenarios where paying
corporate taxes is less costly than paying according to the individual tax system.7
The corporate tax rate increases above 35% for two income brackets. Corporations with taxable
income between $100,000 and $335,000 are subject to a 39% tax rate, and corporations with
income between $15,000,000 and $18,333,333 are subject to a 38% tax rate. These “bubble”
brackets increase the effective tax rate for higher-income corporations by offsetting any tax
savings they would realize from having the first $75,000 in income taxed at lower rates.
4
The primary components of business income are revenues generated from the sale of goods and services. Other
income sources include investment income, royalties, rents, and capital gains.
5
For more information on the production activities deduction, see CRS Report R41988, The Section 199 Production
Activities Deduction: Background and Analysis, by (name redacted).
6
Corporations providing services in the fields of health care, law, engineering, architecture, accounting, actuarial
science, the performing arts, and consulting are taxed at a fixed rate of 35%, regardless of their amount of taxable
income. Internal Revenue Code (IRC) §11(b)(2) denies personal service corporations the benefits of corporate
graduated rates.
7
For more information on benefits for small businesses in the corporate tax system, see CRS Report RL32254, Small
Business Tax Benefits: Current Law and Main Arguments For and Against Them, by (name redacted).
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One of the main points of contention in the debate over the corporate tax is that the 35% tax rate
is too high. This rate is the statutory federal tax rate, defined as the legally imposed rate on
taxable income. But this rate alone does not determine how much corporations pay in taxes.
Because of a number of business tax benefits (deductions, credits, exemptions, etc.) in the
corporate tax system, the effective (or actual) tax rate paid by corporations is typically less than
the statutory rate. These tax benefits, known as tax expenditures, are discussed in the next section.
It is also important to understand that effective tax rates can vary substantially among U.S.
corporations and across corporations in the same industry. For example, some corporations rely
more on debt financing, which is treated more favorably than equity financing in the tax code.
Those corporations that rely on tax-preferred financing reduce their effective tax rate relative to
those who do not. Some corporations and industries rely more on certain physical assets that can
be depreciated (“written-off”) more quickly than investments made by companies in others
industries, which again leads to differing effective tax rates. Other corporations and industries
have more extensive overseas operations, which may affect their effective U.S. tax rate.
Corporate Tax Expenditures
The corporate tax system contains a variety of incentives designed to encourage certain types of
behaviors and assist certain businesses. These incentives are formally known as corporate tax
expenditures and include special credits, deductions, exemptions, exclusions, and tax rates that
result in revenue loss for the federal government.8 Some of the largest corporate tax expenditures
include the domestic production activities deduction (Section 199 deduction) and the deferral of
income earned abroad. Tax expenditures are not exclusive to the corporate tax system. In fact,
individual tax expenditures result in nearly eight times the revenue loss to the federal government
(see Figure 1) relative to corporate tax expenditures.
8
The Budget Control Act of 1974 (P.L. 93-344) officially defines a tax expenditure as “revenue losses attributable to
provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or
which provide a special credit, a preferential rate of tax, or a deferral of tax liability.” The Joint Committee on Taxation
(JCT) produces an estimate of the all individual and corporate tax expenditures each year. The latest tax expenditure
estimates are available at http://www.jct.gov/.
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Figure 1. Individual and Corporate Tax Expenditures in FY2014
Source: CRS calculations using estimates in U.S. Congress, Joint Committee on Taxation, Estimates of Federal
Tax Expenditures for Fiscal Years 2014 - 2018, committee print, prepared by Joint Committee on Taxation, 113th
Cong., August 5, 2014, JCX-97-14.
In 2014, the sum of all corporate tax expenditures was $154.4 billion.9 Table 1 provides a list of
the five largest corporate tax expenditure provisions in 2014. The largest corporate tax
expenditure in 2014 was the deferral of active income of controlled foreign corporations,10 with
an estimated revenue loss of $83.4 billion. Other top-five corporate tax expenditure provisions
include those related to domestic production activities (Section 199),11 the deferral of tax on gains
from like-kind exchanges, interest on state and local government debt, and the deferral of tax on
installment sales.
Not shown in Table 1 are the combined capital cost recovery provisions known as “bonus” and
“accelerated” depreciation for equipment.12 In previous years, the combined estimate for these
provisions was one of the largest tax expenditures, resulting in an estimated $13.9 billion revenue
loss for 2013, for example.13 For 2014, however, the expenditure estimate yielded a revenue gain
of $23.7 billion. The discrepancy can be understood by considering the timing effect depreciation
investment incentives have on tax revenue collections. Bonus depreciation, which had been
available from 2007 through the end of 2013, allowed firms to take a larger (or “bonus”) upfront
9
The sum of all corporate tax expenditures is calculated using the estimates provided in U.S. Congress, Joint
Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2012 - 2017, committee print,
prepared by Joint Committee on Taxation, 113th Cong., February 1, 2013, JCS-1-13.
10
For additional background, see CRS Report R42624, Moving to a Territorial Income Tax: Options and Challenges,
by (name redacted).
11
For additional background, see CRS Report R41988, The Section 199 Production Activities Deduction: Background
and Analysis, by (name redacted).
12
The tax expenditure estimate includes accelerated depreciation as well as bonus depreciation. For more on bonus
depreciation, see CRS Report RL31852, Section 179 and Bonus Depreciation Expensing Allowances: Current Law,
Legislative Proposals in the 113th Congress, and Economic Effects, by (name redacted).
13
U.S. Congress, Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2012 - 2017,
committee print, prepared by Joint Committee on Taxation, 113th Cong., February 1, 2013, JCS-1-13.
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The Corporate Income Tax System: Overview and Options for Reform
deduction for certain investment property, but also lead them to take smaller depreciation
deductions in later years. This resulted in revenue losses in the early years of the depreciation
period, and revenue gains in the later years. The 2014 revenue estimate reflects the fact that bonus
depreciation has expired, and that a significant amount of previously eligible equipment is in the
later years of the depreciable schedule.
Table 1. Five Largest Corporate Tax Expenditures in FY2014
billions of dollars
Corporate Tax Expenditure
Estimated Revenue Loss in in 2014
Deferral of Active Income of Controlled Foreign
Corporations
83.4
Deduction for Income Attributable to Domestic
Production Activities
12.2
Deferral of Gain on Like-Kind Exchanges
11.7
Exclusion of Interest on Public Purpose State
and Local Government Bonds
9.3
Deferral of Gain on Non-Dealer Installment
Sales
6.9
Corporate Tax Expenditures Total
154.4
Source: CRS analysis using data from U.S. Congress, Joint Committee on Taxation, Estimates of Federal Tax
Expenditures for Fiscal Years 2014 - 2018, committee print, prepared by Joint Committee on Taxation, 113th
Cong., August 8, 2014, JCX-97-14.
Notes: The sum of individual tax expenditure estimates may not equal the total value of tax expenditures
because of interaction effects. Tax expenditure estimates are projections of foregone revenue (or revenue cost)
associated with various tax provisions and thus do not reflect actual revenue loss. Columns may not sum due to
rounding.
Treatment of Losses
Another important component of the corporate tax system is the treatment of losses. A
corporation that loses money in a particular year experiences what is known as a net operating
loss (NOL).14 No corporate tax is due when a company has a NOL because they do not have
profits (e.g., total income less expenses is negative). In addition, a NOL can be “carried back” and
deducted from up to two prior years’ taxable income. The corporation is then eligible for a refund
equal to the difference between previously paid taxes and taxes owed after deducting the current
year’s loss. If the loss is too large to be fully carried back, it may be “carried forward” for up to
20 years and used to reduce future tax liabilities.
Allowing for the carryback of losses reduces the distorting effects of taxation on investment and,
in turn, increases economic efficiency.15 The government, by allowing NOL carrybacks,
effectively enters into a partnership with taxpayers, sharing both the return to investment (tax
14
For more information on the tax treatment of corporate losses, see CRS Report RL34535, Tax Treatment of Net
Operating Losses, by (name redacted).
15
Evsey D. Domar and Richard A. Musgrave, “Proportional Income Taxation and Risk-Taking,” The Quarterly
Journal of Economics, vol. 58, May 1944, p. 388.
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revenue) and the risk of investment (revenue loss). When corporations earn income, they pay
taxes. However, when corporations have losses, past and future tax liabilities are reduced through
loss carrybacks, reducing risk. The further back losses can be carried, the closer is the taxpayergovernment partnership, and the less distorting taxation becomes on investment.16 Further gains
in economic efficiency are possible if the government can spread risk better than can be done in
private markets. Additionally, the ability to carry back losses helps to prevent two firms that earn
the same amount over a given time period, but differ in the timing of when the income is earned,
from paying different amounts in taxes.17
Corporate Income Earned Abroad
The taxation of American corporations with overseas operations is another important part of the
corporate tax. The United States taxes American corporations on their worldwide income.18 This
approach to taxation is referred to as a worldwide (or resident-based) tax system. In contrast, a
territorial (or source-based) system would tax American corporations only on income earned
within the physical borders of the United States. In reality, no country has a pure worldwide or a
pure territorial tax system.
Under current law, corporations are allowed a credit, known as the foreign tax credit, for taxes
paid to other countries.19 The foreign tax credit may not reduce a corporation’s tax liability below
zero. Additionally, corporations are not required to pay U.S. tax on overseas income until income
is repatriated to the United States. This ability to defer taxes is often known simply as “deferral.”
Deferral is not an option, however, with “Subpart F” income, which generally includes passive
types of income such as interest, dividends, annuities, rents, and royalties.20
Taxation of Shareholders
The after-tax profits of a corporation are typically subject to tax again when shareholders receive
dividend distributions. Under current law, the tax rate on dividends is 0%, 15%, or 20%
depending on a taxpayer’s ordinary income tax bracket.21 Taxpayers with an ordinary income tax
rate of 15% or less pay the 0% rate on dividends. Taxpayers in the 25%, 28%, 33%, and 35% tax
brackets are subject to a 15% tax rate on dividends. The 20% top rate applies to taxpayers in the
39.6% income tax bracket (single filers with taxable income above $406,750; married filers with
taxable income above $457,600). Shareholders must also pay taxes on any capital gains they
16
For further discussion, see CRS Report RL34535, Tax Treatment of Net Operating Losses, by (name redacted).
See Appendix A in CRS Report RL34535, Tax Treatment of Net Operating Losses, by (name redacted) for a
numerical example.
18
The concepts discussed here are described in greater detail in CRS Report R41852, U.S. International Corporate
Taxation: Basic Concepts and Policy Issues, by (name redacted), and CRS Report RL34115, Reform of U.S.
International Taxation: Alternatives, by (name redacted).
19
See IRC §901.
20
Subpart F income is named after the section of the Internal Revenue Code where its tax treatment is defined. An
exception to Subpart F income is for “active financing” income. Active financing income is income earned by
American corporations that operate banking, financing, and insurance lines of business overseas. The active financing
exception expired at the end of 2013. In the past, this provision has been extended as part of “tax extenders.”
21
For information on current and historical individual income tax rates, including dividend tax rates, see CRS Report
RL34498, Individual Income Tax Rates and Other Key Elements of the Individual Income Tax: 1988 to 2013, by (name
redacted).
17
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realize from selling shares that have appreciated in value.22 The tax rate on the gain from
investments held less than a year (short-term capital gains) is equal to the taxpayer’s ordinary
income tax rate. Gain from investments held longer than a year (long-term capital gains) is the
same as for dividends—0%, 15%, or 20%—depending on the shareholder’s ordinary income tax
bracket.
Dividend and capital gains income may also be subject to a net investment income tax.23 Since
2013, a 3.8% tax is imposed on the lesser of (1) net investment income; or (2) the excess of
modified adjusted gross income (MAGI) above a threshold amount.24 This threshold amount is
$250,000 for taxpayers filing a joint return, $200,000 for single filers, and $125,000 for married
filers filing separately.
Which Companies Pay?
Currently, about 6% of businesses are organized as C corporations, and thus subject to the
corporate income tax. As Figure 2 shows, this change is a significant decrease from the 17% of
businesses that choose the corporate form in 1980. Some of this shift can be explained by various
legislative and regulatory changes over this time period that reduced the top individual tax rate
below the top corporate tax rate (making it more attractive to be a pass-through), increases in the
shareholder limit for S corporations, and the ability of LLCs to elect partnership tax status.25
The share of business income generated by C corporations has also changed over time. In 1980,
for example, corporations were responsible for nearly 80% of total business income. Today,
corporations generate less than half of total business income, with the remainder coming from
pass-throughs.26 C corporations, however, still generate a disproportionate share of all business
income.
Although C corporations only account for 6% of all businesses, they generate a disproportionate
share of business income. But just as the fraction of businesses choosing the corporate form has
decreased over time, so too has the fraction of income they generate.
22
Capital gains are earned through the sale of capital assets. Capital assets include real estate, household furnishings,
and stocks or bonds. A capital gain (or loss) is the difference between the sales price of an assets and the asset’s basis,
which is generally the asset’s cost. For more information, see Internal Revenue Service Topic 409 – Capital Gains and
Losses, available at http://www.irs.gov/taxtopics/tc409.html.
23
Net investment income includes interest, dividends, capital gains, annuities, royalties, certain rents, and certain other
passive business income. Net investment income also includes net gain from the sale of property not used in a trade or
business.
24
For more information, see CRS Report R41413, The 3.8% Medicare Contribution Tax on Unearned Income,
Including Real Estate Transactions, by (name redacted).
25
For a more detailed analysis of this shift see, CRS Report R43104, A Brief Overview of Business Types and Their
Tax Treatment, by (name redacted).
26
The exact figure has fluctuated over time and is sensitive to swings in the business cycle. For example, C
corporations generated 27% of business income in 2009 (a recession year), and 54% in 2005. CRS calculations using
the Internal Revenue Service Integrated Business Data, Table 1, http://www.irs.gov/pub/irs-soi/80ot1all.xls. Net
income is measured as net income less deficit. Regulated investment companies (RICs) and real estate investment trust
(REIT) were excluded.
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Figure 2. Distribution of Business Types, 1980 and 2008
Source: CRS calculations from Internal Revenue Service’s Integrated Business Data
When looking at an industry level breakdown of what types of firms pay the corporate tax,
manufacturing ranks number one (see Figure 3). In 2008, manufacturing was responsible for
about 32% of corporate taxes paid. The wholesale and retail trade industry was next, accounting
for 17% of corporate taxes paid, followed by the finance and insurance industry, which paid 16%
of corporate taxes. The share paid by all other industries then drops sharply—8% paid by holding
companies and the information industry, 4% by mining firms, and then no industry type
accounted for more than 3% of taxes paid.
This distribution of taxes paid is partly explained by the fact that most corporate business activity
is conducted by a rather small number of large firms. This distribution is evident from a
comparison of the distribution of taxes paid to the distribution of corporations across industry (see
Figure 3). For example, while manufacturing paid 32.3% of taxes, it only accounted for 6.1% of
corporations. Similarly, the finance and insurance industry paid 16.0% of taxes, but contained
4.3% of all corporations. In total, the five industries that paid the most in taxes (80.9% combined)
only accounted for 33% of corporations. Only the wholesale and retail trade industry paid taxes in
proportion to their share of corporate firms.
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Figure 3. Distribution of Corporations and Corporate Taxes Paid in 2008 by Industry
Source: CRS calculations from Internal Revenue Service’s Statistics of Income, http://www.irs.gov/pub/irs-soi/
08co21ccr.xls. Taxes paid are measured as “Total income tax after credits.”
Notes: Data from 2005 display a similar distribution.
There is also substantial variation in taxes paid by corporations in different industries. One way to
compare the tax burden across industries is to look at various measures of an effective tax rate.
The ratio of taxes paid divided by profits is known simply as the “effective rate.” The effective
rate incorporates various tax benefits and subsidies that reduce the taxable income base relative to
financial profits, and hence reduce the tax rate firms actually incur relative to the statutory rate.
The “effective marginal tax rate” is the rate of taxation on a projected investment project: it is an
estimate of how much the return on an investment will be paid in taxes. The effective marginal
rate is arguably the most well suited measure for determining the effect of tax rates on investment
decisions.
Data compiled by Aswath Damodaran, professor of finance at New York University, have been
used to look at effective tax rates for U.S. companies across industrial sectors.27 Damodaran’s
data set includes financial information from roughly 6,000 U.S. public companies. Effective tax
rates are calculated as taxes paid divided by taxable income (in the basic calculations, companies
27
This data is available online at http://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html.
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reporting losses that pay no taxes are considered to have an effective tax rate of zero).28 Industries
with low effective tax rates tend to be those that are more likely to make large investments or
expenditures on research and development (activities that are rewarded in the tax code).
Examples include the biotechnology and semiconductor industries. Industries that tend to have
higher than average effective tax rates include retail, food services, and utilities.29
Research has also shown that, in recent years, effective tax rates reported to shareholders on
earnings statements by the most profitable U.S. companies have declined.30 This decline has
occurred despite the fact that the statutory corporate tax rate has remained constant at 35%. The
decline in effective tax rates for large U.S. corporations over time can largely be explained by
increased international activity, combined with lower foreign tax rates. Tax expenditures have
played a limited role in this change.
Economists oftentimes use an effective tax rate to evaluate how the tax system affects incentives
for capital investment. The effective marginal tax rate, which measures the impact of the tax
system on investment decisions, can be defined as ( ρ − r ) / ρ , where ρ is the real before-tax
return on the marginal (or incremental) investment and r is the real return paid to investors.31
Higher effective marginal tax rates indicate greater potential investment distortions. Negative
effective tax rates indicate that the tax code is actually subsidizing investment to the point where
taxpayers are willing to accept a before-tax rate of return that is less than the after-tax rate of
return for an investment.32
There are a number of factors that contribute to differences in effective marginal tax rates. These
factors include the form of business organization, financing method (e.g., debt versus equity),
whether a particular industry is more capital intensive than others, inflation, etc.33 Tax
expenditure provisions also contribute to variation in effective marginal tax rates. A 2005
Congressional Budget Office (CBO) study calculating effective marginal tax rates for different
asset types in the corporate sector found an overall effective marginal tax rate of 26.3%.34
28
For more on Damodaran’s effective tax rate calculations, see http://aswathdamodaran.blogspot.com/2011/01/taxpolicy.html.
29
Base-broadening, rate-reducing corporate tax reforms will likely change effective tax rates faced by different
industries. If all tax expenditures were eliminated to reduce corporate tax rates, industries that currently have low
effective tax rates due to tax expenditures could experience increased tax burdens. For further discussion, see the
section “Broader Base, Lower Rates” below.
30
Martin Sullivan, Corporate Tax Reform: Taxing Profits in the 21st Century (New York, NY: Apress, 2011).
31
Assume, for example, that investors require an after-tax rate of return of 6% on a given investment. Assume next that
a project must have a real before-tax rate of return of 9% to cover taxes, depreciation, and payments to investors. Under
these conditions, the effective tax rate would be 33%.
32
For more on this method of computing effective tax rates, see Congressional Budget Office, Computing Effective Tax
Rates on Capital Income, Background Paper, Washington, DC, December 2006, https://www.cbo.gov/publication/
18259.
33
Changes in the tax code have contributed to fluctuations in effective marginal tax rates on capital income over time.
For more information, see CRS Report RS21706, Historical Effective Marginal Tax Rates on Capital Income, by (name
redacted).
34
Congressional Budget Office, Taxing Capital Income: Effective Rates and Approaches to Reform, Washington, DC,
October 2005, http://www.cbo.gov/publication/17393. More detail on CBO’s effective tax rate calculations is available
at https://www.cbo.gov/publication/18259.
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Gravelle (2011) also calculates effective tax rates by asset type, finding an average effective tax
rate of 30%.35
Both the 2005 CBO study and Gravelle (2011) identified the computers and peripheral
equipment, automobile equipment, and industrial and commercial building sectors as being
highly taxed—facing effective marginal tax rates of 30% or above. Assets with the lowest
effective marginal tax rates—less than 20% in both studies—were communications equipment,
ships and boats, railroad equipment, mining structures, and petroleum and natural gas structures.
Corporate Income Tax Revenues
Corporate tax revenues have been declining over the last six decades. The corporate tax reached
its post-World War II era peak in 1952 at 5.9% of gross domestic product (GDP) (see Figure 4).
In 2013, the corporate tax generated revenue equal to approximately 1.6% of GDP. The corporate
tax has also decreased in significance relative to other revenue sources. At its post-WWII peak in
1952, the corporate tax generated 32.1% of all federal tax revenue. In that same year the
individual tax accounted for 42.2% of federal revenue, and the payroll tax accounted for 9.7% of
revenue.36 In 2013, the corporate tax accounted for 9.9% of federal tax revenue, whereas the
individual and payroll taxes generated 47.4% and 34.2%, respectively, of federal revenue.37
There are several factors that help explain the declining significance of the corporate tax.38 First,
the average effective corporate tax rate has decreased over time, mostly as a result of reductions
in the statutory rate and changes affecting the tax treatment of investment and capital recovery
(depreciation). Second, the increasing fraction of business activity that is being carried out by
pass-throughs (particularly partnerships and S corporations) has led to an erosion of the corporate
tax base. Third, corporate-sector profitability has fallen over time, leading to a further erosion of
the corporate tax base. Declining corporate sector profitability may be a result of several factors,
including a shift within the corporate sector from less volatile to more volatile industries, a shift
in the age of corporations from older to younger, and shifting of profits out of the United States
and into lower-tax countries.39
35
(name redacted), “Reducing Depreciation Allowances to Finance a Lower Corporate Tax Rate,” National Tax
Journal, vol. 64, no. 4 (2011), pp. 1039-1054.
36
For more information on the various components of the U.S. tax system, see CRS Report RL32808, Overview of the
Federal Tax System, by (name redacted) and (name redacted).
37
Data on the percent of revenue by source comes from the Office of Management and Budget, Table 2.2,
http://www.whitehouse.gov/omb/budget/Historicals.
38
For a more detailed analysis of declining corporate tax revenues, see CRS Report R42113, Reasons for the Decline in
Corporate Tax Revenues, by (name redacted).
39
For more on the effects on international profit shifting see, CRS Report R40623, Tax Havens: International Tax
Avoidance and Evasion, by (name redacted); Kimberly A. Clausing, “The Revenue Effects of Multinational Firm
Income Shifting,” Tax Notes, March 28, 2011, pp. 1580-1586; Kimberly A. Clausing, “Multinational Firm Tax
Avoidance and Tax Policy,” National Tax Journal, vol. 62 (December 2009), pp. 703-725; Martin A. Sullivan, “U.S.
Multinationals Shifting Profits Out of the United States,” Tax Notes, March 10, 2008, p. 1078-1082; and Martin A.
Sullivan, “Shifting of Profits Offshore Costs U.S. Treasury $10 Billion or More,” Tax Notes, September 27, 2004, p.
1477-1481.
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Figure 4. Corporate Tax Revenue as a Percentage of GDP, 1946-2019
Source: CRS graphic based on data from Office of Management and Budget, FY 2015 Budget, Historical Tables,
Table 2.3, http://www.whitehouse.gov/omb/budget/Historicals.
Notes: Data for years 2014 to 2019 are estimates.
International Comparisons
Tax Rates
Comparisons between corporate tax rates in the United States and those found elsewhere in the
world are made frequently. The focus among non-economists tends to be on comparing statutory
rates. Economists, however, generally prefer to compare effective tax rates when making
international comparisons. The reason for this is that every country has a different tax system, and
the statutory tax rate is just one component of each system. For example, some countries may
have higher or lower rates, allow for faster capital recovery (i.e., deprecation), or offer corporate
tax credits not offered by other countries. Effective tax rates attempt to account for all the system
differences and are more indicative of the tax burden in each country.
When making comparisons between U.S. and worldwide tax rates it is also important to indicate
whether tax rates are simple (unweighted) averages or whether they are adjusted (weighted) to
account for the size of the economies being compared. If the U.S. tax rate is compared to world
tax rates that do not account for the size of other economies, then a small economy, such as
Iceland, can have the same effect on the average international rate as a large economy, such as
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Germany or Japan. It is therefore more appropriate to compare the U.S. tax rate to a weighted
average of international tax rates. Typically, each country’s tax rate is weighted by its gross
domestic product (GDP) when computing the average.
Table 2 compares the statutory tax rate, the weighted effective rate, and the weighted effective
marginal rate in the United States to the rest of the Organization for Economic Co-operation and
Development (OECD) countries. While the U.S. statutory tax rate is about 10 percentage points
higher than the other OECD countries, the U.S. effective tax rate is about the same as effective
rates found elsewhere. The OECD, however, excludes several large economies, in particular
China and Brazil.40 Table 2 also shows that the tax rate most relevant for investment decisions—
the weighted effective marginal rate—is also similar between the United States and the rest of the
world.
Table 2. Corporate Tax Rates: Comparing the United States
to the Rest of the OECD
Tax Rate Measure
United States
OECD
Statutory
39.2%
29.6%
Weighted Effective Tax Rate
27.1%
27.7%
Weighted Effective Marginal Tax Rate
20.2%
18.3%
Source: CRS Report R41743, International Corporate Tax Rate Comparisons and Policy Implications, by (name re
dacted).
Notes: The statutory and weighted effective tax rate come from Table 1 in the cited CRS report. The weighted
effective marginal rate comes from Table 6. See the discussion in the cited report for more information about
the methodology used for the tax rate estimates.
Tax Revenues
Corporate tax revenues in the United States are below the average of all OECD member
countries. Figure 5 displays corporate tax revenues for OECD member countries as a percentage
of GDP for 2011. The average OECD member collected corporate taxes equal to 3.0% of GDP
compared to the United States, which collected revenues equal to about 2.3% of GDP. Corporate
tax receipts in the United States have been below the OECD average since 1997, and before that
they fluctuated closely around the OECD average. Aside from a few outliers, most OECD
countries collect revenue within a couple percentage points of each other.
There are a couple of reasons why the United States collects less in federal corporate tax revenue
than other countries. For example, as Figure 4 shows, corporate tax revenues in the United States
have generally declined since WWII. At the same time, corporate tax revenues in other OECD
countries (particularly European countries) have remained relatively stable even in the face of
declining tax rates.41 Some countries have adopted base-broadening policies to offset tax rate
40
OECD members are generally countries with advanced economies. The OECD works closely with other large
economies that are less economically advanced. For more information on current OECD members, see
http://www.oecd.org/about/membersandpartners/.
41
Ruud A. DeMooij and Gaetan Nicodeme, Corporate Tax Policy, Entrepreneurship and Incorporation in the EU,
European Commission, Directorate-General for Economic and Financial Affairs, No. 263, January 2007, p.6.
http://ec.europa.eu/economy_finance/publications/publication808_en.pdf.
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decreases, typically in the form of reduced investment credits, less generous loss offset rules, and
limitations on interest deductibility and depreciation.42 Recent research also suggests that there
has been a shift from the non-corporate to corporate sector in some countries, and that in other
countries limited liability outside the corporate form is not available, making it more attractive to
shift to a corporate form.43 Combined, these factors appear to explain why corporate tax rates
have fallen elsewhere while revenues have held steady.
Figure 5. Corporate Tax Revenue as a Percentage of GDP in 2011
OECD Member Countries
Source: CRS graphic based on data from OECD, Revenue Statistics, Comparative Tables, http://stats.oecd.org/
Index.aspx?DataSetCode=REV.
Notes: Chile and Mexico had missing data and were therefore excluded from this analysis.
42
Ibid., p. 13.
U.S. Department of the Treasury, Treasury Conference on Business Taxation and Global Competitiveness:
Background Paper, July 23, 2007, p. 18, http://www.treasury.gov/press-center/press-releases/Documents/
07230%20r.pdf.
43
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Economic Considerations
Why Have a Corporate Income Tax?
A variety of reasons have been offered to justify the corporate tax since the enactment of the
Corporate Tax Act of 1909 (P.L. 61-4). To avoid constitutionality issues, Congress structured the
tax as an excise tax on the privilege of doing business in the corporate form (i.e., limited liability
and access to capital markets).44 While the new corporate income tax was challenged by several
corporations that claimed it to be unconstitutional, the Supreme Court accepted its rationale and
ruled that the privilege of doing business in the corporate form could be measured by profits.45
The privileged-based rationale for the corporate tax is generally not accepted by economists
today. Economists tend to view the risk-sharing from limited liability and pooling of resources as
beneficial to the economy.
The corporate tax system serves to ensure a comprehensive income tax system. Absent a
corporate income tax, corporate earnings would not be taxed until they were paid out to
individuals. Thus, corporations would have an incentive to avoid taxes by retaining earnings.46
Shareholders would avoid taxes so long as corporations did not pay out earnings. Further,
shareholders would benefit when corporations retained earnings over long periods of time, as
delaying payouts would reduce the present value of the tax burden (assuming no change in tax
rates over time).47
Some economists also favor the corporate tax as a tax on profits, or economic rents.48 Economic
rents are profit levels above the required rate of return for factors of production (e.g., labor,
capital). If the corporate tax could be designed to tax only pure profits or economic rents,49 the
corporate tax would not induce efficiency losses. Firms maximize profits by optimizing on output
and price. Taxes on pure profits or economic rents do not distort a firm’s choice of output, and
thus do induce distortions or efficiency losses. In practice, since pure profits and economic rents
are difficult to measure, taxes are levied on accounting profits as described above (see “Structure
of the Corporate Income Tax”). Thus, the corporate tax as currently applied is not a tax on pure
profits or economic rents. Consequently, the corporate tax in its current form does distort
economic decision making, which can reduce overall economic output.
44
In 1895, the Supreme Court found that an income tax enacted a year earlier was unconstitutional because it was a
direct tax not apportioned among the states according to population. See Pollock v. Farmers’ Loan and Trust Co, 157
U.S. 429 (1895). The individual income tax was enacted in 1913, following ratification of the sixteenth amendment
(Amendment XVI) to the United States Constitution, which allowed Congress to levy an income tax without
apportioning in among the states.
45
Joseph A. Pechman, Federal Tax Policy, 4 ed. (Washington, DC: The Brookings Institute, 1983), p. 129.
46
Organisation for Economic Co-Operation and Development (OECD), Reforming Corporate Income Tax, Policy
Brief, July 2008, http://www.oecd.org/tax/taxpolicyanalysis/41069272.pdf.
47
Additionally, a significant share of gain is never taxed given the current structure of the estate tax system. Heirs, as
recipients of corporate stock, are not taxed on the decedent’s gain.
48
Organisation for Economic Co-Operation and Development (OECD), Reforming Corporate Income Tax, Policy
Brief, July 2008, http://www.oecd.org/tax/taxpolicyanalysis/41069272.pdf.
49
A pure tax on profits would tax only economic profits, where economic profits are revenues less both accounting
costs and economic costs, such as the opportunity costs associated with a firm’s factors of production. The opportunity
cost of labor, for example, is the wage that would be earned by labor if that labor were employed by or engaged in the
most attractive alternative activity.
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An alternative to having a corporate tax would be to directly tax the factors of production that
make up the corporation (i.e., labor and capital). This option would eliminate the corporate tax
entirely, effectively taxing all corporations as pass-through entities. While this approach
represents one way to address concerns of double taxation on corporate profits, it would leave
open the possibility that corporations could be used to shelter income if unrealized capital gains
remained untaxed.50
Corporate Tax Incidence
Since corporations are legal, not physical entities, corporations cannot actually bear the burden of
taxes. Instead, the tax is passed along to individuals connected with corporations, including
corporate owners (shareholders), workers, and customers. For example, the tax could be passed
along to these individuals in the form of lower dividends or capital gains (corporate owners),
reduced salaries and fringe benefits (employees), or higher prices (customers).
Traditional analysis of the corporate tax, in a closed economy, indicates that it is corporate owners
who bear the tax burden, and the owners of capital more generally in the long run.51 In contrast, a
number of more recent theoretical studies find that labor can bear the majority of the tax burden,
in an open economy.52 The theoretical findings, however, appear to rely critically on particular
assumptions that drive the results. When these assumptions are relaxed the burden of the
corporate tax is found to fall mostly on capital—in line with the traditional analysis.
In recent years, a number of economists have taken a statistical (empirical) approach to determine
the incidence of the corporate tax. While these studies tend to conclude that a substantial portion
of the corporate tax burden falls on labor, methodological limitations lead these results to be
questioned.53 Given the unreliability of recent empirical research, and the consistency of
traditional theoretical models, some economists have been reluctant to move away from
traditional incidence assumptions, where owners of capital are assumed to bear most of the
burden of the corporate tax.54
Government agencies that analyze how the incidence of the corporate tax is distributed have
recently changed incidence assumptions used in producing distribution tables.55 The
Congressional Budget Office (CBO) now assumes that 75% of the burden of the corporate
income tax falls to owners of capital, with the remaining 25% assigned to households in
50
For further discussion, see “Integration of the Corporate and Individual Tax Systems” in the “Options for Reform”
section below.
51
The traditional view on the incidence of the corporate tax originated with the development of the “Harberger model”
in 1962 and subsequent refinements. See Arnold Harberger, “The Incidence of the Corporate Tax,” The Journal of
Political Economy, vol. 70 (June 1962), pp. 215-240.
52
A review and critique of recent theoretical research, as well as a discussion of the extensions of the Harberger model
can be found in Jennifer C. Gravelle, Corporate Tax Incidence: Review of General Equilibrium Estimates and Analysis,
Congressional Budget Office, Working Paper 2010-03, May 2010.
53
These studies are reviewed in Jennifer C. Gravelle, Corporate Tax Incidence: A Review of Empirical Estimates and
Analysis, Congressional Budget Office, Working Paper 2011-1, Washington, DC, June 2011 and CRS Report
RL34229, Corporate Tax Reform: Issues for Congress, by (name redacted).
54
For further discussion, see Kimberly A. Clausing, “In Search of Corporate Tax Incidence,” Tax Law Review, vol. 65,
no. 3, pp. 433-472.
55
The Joint Committee on Taxation (JCT) does not assign corporate tax incidence to individuals.
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proportion to their labor income.56 Prior to this change, the entire burden of the corporate tax was
assumed to be borne by owners of capital. Until 2008, the Department of the Treasury made a
similar assumption. Recently, however, the Treasury changed their incidence assumption, such
that 82% of the corporate income tax burden is allocated to owners of capital, and 18% to labor
income.57
The recent change in corporate tax incidence assumptions has important implications for policy
analysis. When it is assumed that the entire burden of the corporate tax is borne by capital,
revenue-neutral changes in the tax burden do not change the distribution of the tax burden. This
means that base-broadening, rate-reducing tax reforms would not change how the tax burden is
allocated across households. For example, a corporate tax rate cut financed by decreased
depreciation deductions would not change the distribution of the corporate tax. However, under
the new methodology, where a portion of the corporate tax burden falls on labor, changes in tax
rates and changes in deductions that are revenue-neutral may change how the tax burden is
distributed. Rate cuts financed by reduced depreciation deduction allowances, for example, would
tend to reduce the progressivity of the corporate tax system when part of the burden falls on labor,
as assumed by the Treasury.58
Evaluating the Corporate Income Tax
Several metrics can be used to evaluate the corporate tax system. These metrics can also help
policy makers evaluate proposed reforms to the current system. One metric, equity, evaluates how
the corporate tax burden is distributed across individuals. Generally, it is believed that the
corporate income tax contributes to the overall progressivity of the U.S. tax system.59 A second
metric, efficiency, looks at potential distortions in economic activity that result from the corporate
tax system or specific provisions within that system. The third metric discussed here is
“competitiveness.” Policy makers frequently note that the U.S. tax system should be competitive.
This precise definition of this concept, however, is often unclear. Finally, an ideal tax system
would be simple, such that both the costs imposed on taxpayers of complying with the tax system
and administrative costs are minimized.
56
CBO provides background information on the changes in corporate tax rate distribution assumptions in
Congressional Budget Office, The Distribution of Household Income and Federal Taxes, 2008 and 2009, Washington,
DC, July 2012, pp. 13-15, http://www.cbo.gov/sites/default/files/cbofiles/attachments/43373AverageTaxRates_screen.pdf.
57
Julie-Anne Cronin, Emily Y. Lin, and Laura Power, et al., Distributing the Corporate Income Tax: Revised U.S.
Treasury Methodology, Office of Tax Analysis, Department of the Treasury, Technical Paper 5, Washington, DC, May
2012. Part of the tax on capital is allocated to owners of capital in general, with another portion allocated to capital
earning economic rents.
58
This result arises in part since rate changes are predicted to affect normal returns to capital, labor, and supernormal
returns to capital. Changes in depreciation deductions are predicted to affect normal returns to capital and labor.
Because higher income persons receive a disproportionate share of the supernormal returns to capital, rate cuts provide
a greater benefit to higher income groups.
59
Tax system progressivity is measured by the proportion of taxes paid by various income groups, relative to their
share of income received.
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Equity
Some economists believe that the corporate income tax contributes to the overall progressivity of
the tax system. CBO periodically publishes statistics on the distribution of federal taxes and
household income.60 Corporate income taxes are estimated to be highly progressive. The average
corporate income tax rate paid by those in the top 1% of the income distribution is 6.9% (see
Table 3). Those in the bottom quintile of the income distribution have an average tax rate of
0.7%. Further, in 2010, households in the top earnings quintile paid 78.8% of all corporate taxes
(while earning 51.9% of pretax income). CBO estimates that households in the bottom quintile
paid 1.7% of all corporate tax liabilities, while earning 5.1% of all pretax income.
In allocating the burden of the corporate income tax across households, CBO assumed that 75%
of the burden was borne by owners of capital, while the remaining 25% was allocated to labor
income. Previous CBO studies evaluating the distribution of federal taxes allocated the entire
economic burden of the corporate income tax to owners of capital.61
Table 3. CBO’s Distribution of Corporate Income Tax
2010
Average Corporate
Income Tax Rate
(%)
Share of Corporate
Income Tax
Liabilities (%)
Share of Pretax
Income (%)
Lowest Quintile
0.7
1.7
5.1
Second Quintile
0.7
3.1
9.6
Middle Quintile
0.8
5.5
14.2
Fourth Quintile
1.0
9.5
20.4
Highest Quintile
3.1
78.8
51.9
All Households
2.1
100.0
100.0
91st to 95th Percentiles
1.5
7.1
9.9
96th to 99th Percentiles
2.3
13.7
12.5
Top 1%
6.9
49.5
14.9
Before-tax Income
Group
Source: Congressional Budget Office.
Notes: The average corporate income tax rate is calculated as corporate taxes divided by before-tax household
income. The CBO assumes that 25% of the corporate income tax is allocated to workers in proportion to their
labor income. Changing the portion of the corporate tax burden allocated to labor would change the estimated
distribution of the corporate tax burden (see the section “Corporate Tax Incidence” above).
The Treasury recently has started distributing a portion of the corporate tax burden (18%) to labor
income.62 The implications of this assumption are illustrated in Table 4. Treasury estimates
60
Congressional Budget Office, Average Federal Tax Rates in 2010, Washington, DC, December 2013,
http://www.cbo.gov/publication/44604.
61
For further discussion of the distribution of corporate tax burdens, see “Corporate Tax Incidence” above.
62
See the section “Corporate Tax Incidence” above.
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suggest that, in 2012, if the entire burden of the corporate income tax were allocated to capital,
taxpayers in the highest quintile would bear 80.9%. If it is assumed that 18% of the corporate tax
burden falls on labor income (as is assumed by the Treasury), that share falls to 76.0%.
Alternatively, if half of the corporate tax income were assumed to be borne by labor income
earners, the share of the corporate tax burden falling on the top income quintile would be 68.9%.
Generally, the larger the share of the corporate tax burden that is assumed to fall on labor, the less
progressive the corporate tax appears.
Table 4. Treasury’s Distribution of Corporate Income Tax
2012
82% Capital / 18%
Labor
100% Capital
50% Capital / 50%
Labor
Lowest Quintile
1.1
0.8
1.4
Second Quintile
3.2
2.3
4.6
Middle Quintile
6.6
5.2
8.8
Fourth Quintile
12.0
9.7
15.8
Highest Quintile
76.0
80.9
68.9
All Households
100.0
100.0
100.0
Top 10%
66.1
72.8
56.0
Top 1%
43.0
49.8
30.6
Cash Income Group
Source: Julie-Anne Cronin, Emily Y. Lin, and Laura Power, et al., Distributing the Corporate Income Tax: Revised
U.S. Treasury Methodology, Office of Tax Analysis, Department of the Treasury, Technical Paper 5, Washington,
DC, May 2012.
Efficiency
Economic inefficiencies arise when taxes distort market choices. When businesses and
individuals make choices that are motivated by taxes, economic resources may not be put to their
most productive use. Corporate tax reforms and corporate tax systems designed to minimize
economic distortions can help promote an efficient economy. Generally, tax systems that impose
large tax rates on broad tax bases limit tax-induced distortions in economic activity.
Broadly, the corporate tax system distorts the allocation of capital across economic sectors. The
corporate tax may reduce economic efficiency to the extent that it causes a misallocation of
capital between corporate and noncorporate business forms.63 Certain provisions in the tax code,
which lead to different effective tax rates on different types of investments, can also distort the
allocation of resources (see the effective tax rate discussion in the section “Which Companies
Pay?” above).
63
Further discussion can be found in CRS Report RL34229, Corporate Tax Reform: Issues for Congress, by (name re
dacted).
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Some of the exemptions, credits, deductions, and other tax preferences in the U.S. tax system
represent attempts to address instances where markets fail to maximize economic efficiency.
Take, for example, tax incentives for research and development (R&D) related activities.64 R&D
that leads to technological innovation is associated with positive externalities. That is, there are
benefits to R&D that accrue to those not directly involved in or paying for the research itself.
Economic theory suggests that activities that generate positive externalities tend to be
underprovided by markets. Thus, providing a tax subsidy for R&D, thereby directing additional
economic resources to R&D related activities, could lead to additional R&D and improve overall
economic efficiency.65
Tax preferences that narrow the tax base may necessitate higher tax rates to raise sufficient
federal revenues over time. The potential for economic distortions caused by higher marginal
rates should be weighed against the potential efficiency gains associated with various tax
preferences. Tax preferences or tax expenditures that narrow the tax base, that do not otherwise
enhance economic efficiency, can ultimately reduce economic efficiency by requiring higher
marginal rates over time.66 Features of the U.S. corporate tax system that contribute to varying tax
burdens across different asset types include the design of accelerated depreciation rules and the
Section 199 production activities deduction.67
Removing certain provisions, such as accelerated depreciation, in exchange for reduced tax rates,
will not necessarily improve economic efficiency. Slowing depreciation, and making depreciation
more neutral across different types of assets, could increase the cost of capital. Additionally,
modifying depreciation to be more neutral across assets while reducing the corporate tax rate
provides a windfall benefit to existing capital. The burden on new investments increases, but all
capital benefits from reduced tax rates.68
The U.S. corporate tax system also contains a tax-induced bias towards debt financing, which
raises economic efficiency concerns. The primary factor contributing to this bias is the fact that
interest payments can be deducted from income, while dividend payments cannot.69 Rising levels
of corporate debt, and the possible contribution of high debt levels to the recent global economic
crisis, have increased policy makers’ interest in evaluating the current tax treatment of debt.70
64
For background on tax incentives for R&D, see CRS Report RL31181, Research Tax Credit: Current Law and
Policy Issues for the 113th Congress, by (name redacted).
65
The effectiveness of the research tax credit depends on whether the credit motivates additional research activity,
rather than simply reward companies for engaging in research activity that would have taken place without a tax credit.
For more on this issue, see U.S. Government Accountability Office, The Research Tax Credit’s Design and
Administration Can Be Improved, GAO-10-136, November 2009, http://www.gao.gov/new.items/d10136.pdf.
66
The government also has alternative revenue generating options, including taxes on individuals. If less revenue is
raised through the corporate tax system, the federal government may look to alternative revenue sources.
67
Table 8 in CRS Report RL34229, Corporate Tax Reform: Issues for Congress, by (name redacted) illustrates the
effect of depreciation rates and the Section 199 deduction on the tax burden of different assets. See also Testimony of
(name redacted), Senate Committee on Finance, Tax Reform Options: Incentives for Capital Investment and
Manufacturing, March 6, 2012, http://www.finance.senate.gov/imo/media/doc/
Testimony%20of%20Jane%20Gravelle.pdf.
68
For further explanation and numerical examples, see also Testimony of (name redacted), Senate Committee on
Finance, Tax Reform Options: Incentives for Capital Investment and Manufacturing, March 6, 2012,
http://www.finance.senate.gov/imo/media/doc/Testimony%20of%20Jane%20Gravelle.pdf.
69
Reduced tax rates on dividends and capital gains help reduce the debt-equity bias by reducing double-taxation for
equity investments.
70
In July 2011, the Committee on Ways and Means and Senate Finance Committee held a joint hearing titled Tax
(continued...)
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Empirical evidence does suggest that tax policy affects firms’ debt choices. For example, a recent
study summarizing the results of the literature found that a one percentage point increase in tax
rates increased the debt-asset ratio between 0.17 and 0.28.71 Overall, the size of the distortion has
been estimated to be less than 5% of corporate tax revenues.72
The differential treatment of domestic and foreign-source income by U.S. multinationals also
raises concerns that business decisions of U.S. multinational corporations may be motivated by
tax policy. If multinational corporations allocate resources differently than they would under a
neutral tax policy, current tax policy creates economic inefficiencies.73 If, however, resource
reallocation in response to tax rate differentials is limited (i.e., there is limited capital mobility),
then efficiency losses may be small.74
Finally, the economic efficiency of the corporate tax depends on what is actually being taxed. If a
corporate tax can be designed such that the tax is levied on only economic profits,75 the tax
should not change firms’ output decisions in the short run, and thus should have limited efficiency
consequences.76 In practice, however, the corporate tax is not levied on pure economic profits.
The opportunity cost of capital is included in the tax base. In this sense, the corporate tax acts as a
tax on capital, and could discourage capital formation in the corporate sector.
Competitiveness
Policy makers often use “competitiveness” as a rationale for corporate tax reform.77 Economists,
however, question whether “competitiveness” makes sense as a tax policy objective for a country.
(...continued)
Reform and the Tax Treatment of Debt and Equity. Witness testimony is available at http://waysandmeans.house.gov/
Calendar/EventSingle.aspx?EventID=250212.
71
See Ruud de Mooij, The Tax Elasticity of Corporate Debt: A Synthesis of Size and Variations, International
Monetary Fund, Working Paper, WP-11-95, April, 2011, http://www.imf.org/external/pubs/ft/wp/2011/wp1195.pdf.
72
The distortion appears small due to limited substitution between debt and equity. For more, see CRS Report
RL34229, Corporate Tax Reform: Issues for Congress, by (name redacted).
73
For a discussion of efficiency considerations related to U.S. international tax policy, see U.S. Congress, Joint
Committee on Taxation, Economic Efficiency and Structural Analysis of Alternative U.S. Tax Policies for Foreign
Direct Investment, prepared by Joint Committee on Taxation, 110th Cong., June 25, 2008, JCX-55-08.
74
See CRS Report RL34229, Corporate Tax Reform: Issues for Congress, by (name redacted).
75
Economic profits are profits that remain after all costs, including the opportunity costs of inputs, have been
subtracted. While the U.S. tax system does allow for deductions for the cost of inputs, there are no deductions for the
opportunity costs associated with the use of resources.
76
Economic profits are those above the normal rate of return required for businesses to operate. Economic theory
suggests that firms maximize profits by producing at the point where marginal revenue is equal to marginal cost. Profits
are determined by the difference between the price and the average cost, times the number of units sold. A tax that is
levied on profits does not affect either the marginal cost of production or the marginal revenue. Thus, firms should not
change their production decisions as a result of tax policy changes, in the short run.
77
For example, the Obama Administration has claimed a commitment to tax reform that will support competitiveness
of American businesses by “increasing incentives to invest and hire in the United States by lowering rates, cutting tax
expenditures, and reducing complexity, while being fiscally responsible.” See The White House and the Department of
the Treasury, The President’s Framework for Business Tax Reform, February 2012, p. 1, http://www.treasury.gov/
resource-center/tax-policy/Documents/The-Presidents-Framework-for-Business-Tax-Reform-02-22-2012.pdf.
Representative Dave Camp, Chairman of the Committee on Ways and Means, supports moving to a territorial-based
tax system, claiming that such a policy “makes American companies more competitive on the global stage.” Committee
on Ways and Means, “Camp Releases International Tax Reform Discussion Draft,” press release, October 26, 2011,
http://waysandmeans.house.gov/News/DocumentSingle.aspx?DocumentID=266168.
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For economists, the typical objective is economic efficiency, or the optimal use of limited
resources.
From an economic perspective, growth is not a zero-sum game, or something for which countries
compete. Enhanced economic well-being in one country generally does not reduce economic
opportunities in other countries. In fact, if one country experiences economic growth, those
benefits tend to spill over to that country’s trading partners, as higher domestic incomes increase
the demand for imported goods and services. Trade between nations can benefit all countries
involved. Thus, while individual firms may compete, countries trade.78
Much of the confusion surrounding the concept of “competitiveness” as a tax policy objective
stems from the fact that what it means for a country to be “competitive” is not clearly defined.
Some economists, in an attempt to define “competitiveness,” have noted that “competitive”
policies are those that promote domestic business globally, while increasing the U.S. standards of
living.79 Krugman (1994) argues that this and similar definitions are flawed, noting that “the
growth rate of living standards essentially equals the rate of domestic productivity growth—not
productivity relative to competitors.”80 The direct policy objective of promoting domestic
business globally is also not clear. Is the goal to have tax policies that encourage U.S. firms to
invest abroad, to better compete in international markets? Or is the goal to prevent the movement
of U.S. business operations overseas? These two are different policy objectives often promoted in
the name of “competitiveness.”81 Given the confusion surrounding “competitiveness” as a policy
objective, keeping the focus on the economic objectives of neutrality and economic efficiency
could prove useful in designing tax policy that maximizes output and well-being.
Simplicity and Administrability
Complexity in the tax code contributes to increased compliance costs, as complex tax systems
require taxpayers to devote more time and economic resources to tax preparation.82 Tax code
compliance creates inefficiencies to the extent that resources devoted to tax preparation are not
available for other productive activities. Further, complex tax systems may put certain taxpayers
at a disadvantage, as those with limited resources may not be able to claim all tax benefits to
which they are legally entitled.83 Thus, complex tax systems may be viewed as unfair or
78
Numerous economists have made this point, including Paul Krugman, “Competitiveness: A Dangerous Obsession,”
Foreign Affairs, vol. 73, no. 2 (March/April 1994), pp. 28-44 and (name redacted), “Does the Concept of
Competitiveness Have Meaning in Formulating Corporate Tax Policy?,” Tax Law Review, vol. 65 (2012), pp. 323-348.
79
See, for example, Richard H.K. Vietor and Matthew Weinzierl, “Macroeconomic Policy and U.S. Competitiveness,”
Harvard Business Review, March 2012, pp. http://hbr.org/2012/03/macroeconomic-policy-and-us-competitiveness/ar/1.
80
Paul Krugman, “Competitiveness: A Dangerous Obsession,” Foreign Affairs, vol. 73, no. 2 (March/April 1994), p.
34.
81
For further discussion, see (name redacted), “Does th e Concept of Competitiveness Have Meaning in Formulating
Corporate Tax Policy?,” Tax Law Review, vol. 65 (2012), pp. 323-348.
82
Estimates suggest that costs associated with tax compliance are roughly 1% of GDP. This estimate includes costs of
complying with individual as well as corporate income taxes. See U.S. Government Accountability Office, Summary of
Estimates of the Costs of the Federal Tax System, GAO-05-878, August 2005, http://www.gao.gov/new.items/
d05878.pdf.
83
It has been reported that small- and mid-sized companies forgo certain tax benefits because the costs associated with
claiming tax benefits exceeds the value of certain incentives. See John D. McKinnon, “Firms Pass Up Tax Breaks,
Citing Hassles, Complexity,” Wall Street Journal, July 23, 2012, p. A1, U.S. Edition.
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inequitable. Tax code complexity also increases administrative and enforcement costs.
Simplifying the current tax system could help reduce the tax gap.84
Options for Reform
Broader Base, Lower Rates
Corporate tax reform discussions have generally focused on reducing the top corporate tax rate
and offsetting the revenue loss by increasing the amount of income subject to tax (i.e., broadening
the tax base). If revenue neutrality is a goal then a reduction in the corporate tax rate is limited by
how much the tax base can be expanded. The rate can be reduced further (to zero) or the base
made less broad if revenue loss is not a concern. Revenue loss may not be an option given the
government’s current and future revenue needs. Some have suggested that cutting the corporate
tax rate below its current top rate of 35% could increase revenue. A recent CRS report reviewed
and critiqued the literature that purportedly supports this argument and found that the claims that
behavioral responses could cause revenues to rise if rates were cut do not hold up on either a
theoretical or an empirical basis.85
How much could the corporate tax rate be reduced while achieving revenue neutrality? The Joint
Committee on Taxation (JCT) has estimated that relying solely on elimination of corporate tax
expenditures, the rate could be reduced to 28%, although this proposal did not include the repeal
of deferral.86 The JCT estimates are only revenue neutral through a 10-year budget window. Some
provisions, such as treatment of depreciation, change the timing of revenue, but not the total
amount. Thus, estimates that are revenue-neutral through the 10-year budget window may not be
revenue neutral over other time frames. It is estimated that a long-run revenue neutral corporate
tax rate of 29.4% is attainable when the JCT estimates are adjusted to account for this timing
effect and deferral is included.87
The top corporate rate could be reduced further if other changes were made in addition to
eliminating all corporate tax expenditures. For example, the deductibility of interest, which is not
a tax expenditure, could be restricted or eliminated. Additional revenues could be raised through
the individual income tax system to pay for a corporate rate reduction. Examples of such options
include higher capital gains tax rates, accrual taxation of gains on corporate stock, and limits or
modest taxes on retirement savings (which would benefit from corporate rate reductions),
changes to tax preferences available to noncorporate businesses, and other reforms to business
taxation.88 At the same time, if the corporate tax rate is reduced, and tax reforms to the
noncorporate sector are enacted, some business activity may return to the corporate sector,
84
The Internal Revenue Service (IRS) defines the gross tax gap as the difference between the aggregate tax liability
imposed by law for a given tax year and the amount of tax that taxpayers pay voluntarily and timely for that year.
Relative to the size of corporate tax revenues, the tax gap is generally believed to be small. For additional background,
see CRS Report R41582, Tax Gap, Tax Enforcement, and Tax Compliance Proposals in the 112th Congress, by (name
redacted).
85
CRS Report RL34229, Corporate Tax Reform: Issues for Congress, by (name redacted).
86
Memo from Thomas A. Barthold, Joint Committee on Taxation, October 27, 2011.
87
See CRS Report RL34229, Corporate Tax Reform: Issues for Congress, by (name redacted).
88
See CRS Report R41743, International Corporate Tax Rate Comparisons and Policy Implications, by (name re
dacted).
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naturally broadening the base. Other business tax reforms may include changes to the taxation of
American multinationals operating overseas. If these reforms reduced profit shifting to low-tax
countries, the domestic corporate tax base may expand.89
It is important to think about how to broaden the corporate tax base.90 Most of the largest
corporate tax expenditures have an effect on marginal investment decisions. For example,
expensing of research and experimental expenditures, accelerated depreciation, and the lowincome housing tax credit, all increase the after-tax returns to investment. The Section 199
production activities deduction reduces marginal tax rates. Removing these types of expenditures
could increase the effective tax rate on capital investment, which would likely reduce investment,
and therefore output and short-run employment. There are a limited number of corporate tax
expenditures that could be repealed without increasing marginal tax rates on investment. Thus,
designing a revenue-neutral base-broadening corporate tax reform that does not increase marginal
tax rates on investment leaves limited room for rate reduction.91
Revenue-neutral tax reform that eliminated corporate tax expenditures in exchange for a reduced
corporate tax rate will likely increase the tax burden on some industries, while decreasing the
burden on others. Sectors that rely heavily on the research credit, such as the computers and
electronics industry, could see their tax burden increase if the research credit were repealed to pay
for a corporate rate reduction. Sullivan (2011) analyzes a hypothetical revenue-neutral corporate
tax reform that slows depreciation, repeals the Section 199 deduction, and repeals the research
credit, in exchange for a corporate rate reduction to 30%.92 Industries that would see the largest
decline in their effective tax rates in Sullivan’s analysis include securities, insurance, credit
intermediation, and retail trade. Industries that would see the largest increase in effective tax rates
include the computers and electronics, transport equipment, and electrical products sectors.
Generally, Sullivan’s hypothetical revenue-neutral corporate tax reform would increase effective
tax rates on the manufacturing sector.
Corporate tax base broadening, depending on its design, could have unintended consequences for
pass-through businesses. Pass-throughs would generally not benefit from a reduction in corporate
tax rates, since their income is not subject to the corporate tax. Additionally, since not all
“corporate” tax benefits are exclusively available to corporations, depending on how corporate
tax benefits are scaled back to offset a rate reduction, pass-throughs could see their tax burden
increase. Generally, business-related tax incentives are available to businesses that pay taxes
through the individual and corporate income tax system.93
89
Conversely, if corporate tax reforms increase the incentive to shift profits overseas, the domestic corporate tax base
could shrink.
90
For an analysis of how the way the base is broadened could affect the economy, see Nicholas Bull, Tim Dowd, and
Pamela Moomau, “Corporate Tax Reform: A Macroeconomic Perspective,” National Tax Journal, vol. 64, no. 4
(2011), pp. 923-942.
91
Similarly, some base-broadening measures could harm, rather than promote, economic efficiency. For more on this
issue see Alan D. Viard, “Two Cheers for Corporate Tax Base Broadening,” National Tax Journal, vol. 62, no. 3
(September 2009), pp. 399-412.
92
For an analysis of how a revenue-neutral tax reform that slows depreciation and repeals the Section 199 deduction
and research credits to pay for a corporate rate reduction would affect different industries, see Martin A. Sullivan,
“Winners and Losers in Corporate Tax Reform,” Tax Notes, February 14, 2011, pp. 731-734.
93
For example, roughly 25% of the revenue cost of the Section 199 domestic production activities deduction is due to
claims by the non-corporate sector. See CRS Report R41988, The Section 199 Production Activities Deduction:
Background and Analysis, by (name redacted).
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Integration of the Corporate and Individual Tax Systems
Subjecting corporate income to two levels of taxation introduces a number of economic
distortions. The current tax treatment of corporate income leads to otherwise similar corporate
and non-corporate business being taxed differently; it creates incentives for corporations to retain
earnings rather than distribute them; and the ability of corporations to deduct interest but not
dividends leads to a preference for debt over equity financing.
The distortions created by the corporate tax could be reduced by combining, or integrating, the
corporate and individual tax systems. There are a number of ways and degrees to which
integration could be pursued, and the list of options presented here is not exhaustive. Any reform
that involved even partial integration of the corporate and individual tax systems would require
careful consideration of numerous administrative details. Because of this, the discussion that
follows focuses on general integration options. A much more detailed and technical analysis of
various integration options may be found in a 1992 Treasury report on the subject.94 Another
consideration is the potential revenue implications of an integration-based reform. Generally,
integration of the corporate and individual tax systems would be expected to reduce federal
revenues. If a goal of tax reform is revenue neutrality, additional revenue-raising options would
need to be considered.
One integration approach would be to eliminate the corporate tax and allocate earnings directly to
shareholders in a manner similar to which partnerships and S corporations allocate income to
their partners and shareholders. In effect, C corporations, partnerships, and S corporations would
be treated identically for tax purposes, with all being treated as pass-throughs. The types of
administrative issues that this approach raises include what corporate tax items are to be passedthrough to shareholders; how will record keeping be handled (millions of shares are traded daily);
what anti-abuse measures are needed to prevent the use of corporations as tax shelters? Inability
to address these administrative challenges would likely make integration infeasible.
An approach related to shareholder allocation is one that would keep the corporate tax in place,
but give shareholders a credit for corporate taxes paid. The corporate tax in this case would act as
a withholding tax, which would likely address some of the tax sheltering concerns that arise with
direct allocations to shareholders. Additionally, keeping the corporate tax in place may ease
certain administrative burdens should policy makers decide some tax items should not passthrough to shareholders. Concerns surrounding the administrative complexity associated with a
full integration approach of this type have led the Treasury’s not recommending this approach in
their 1992 report.95
Other Options for Reducing “Double Taxation” of Corporate Income
Allowing corporations to claim a deduction for dividends paid could reduce the “double taxation”
of corporate income. This approach, however, would not fully eliminate the double taxation of
94
The Department of the Treasury, Integration of the Individual and Corporate Tax Systems: Taxing Business Income
Once, Washington, DC, January 1992, http://www.treasury.gov/resource-center/tax-policy/Documents/integration.pdf.
For a summary of the Treasury report, see R. Glenn Hubbard, “Corporate Tax Integration: A View from the Treasury
Department,” Journal of Economic Perspectives, vol. 7, no. 1 (Winter 1993), pp. 115-132.
95
R. Glenn Hubbard, “Corporate Tax Integration: A View From the Treasury Department,” The Journal of Economic
Perspectives, vol. 7, no. 1 (Winter 1993), pp. 115-132.
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corporate profits. A dividend deduction does not affect the taxation of capital gains. A dividend
deduction would also make it more attractive for firms to distribute rather than retain earnings,
thus reversing the current incentives for distributing or retaining earnings.
Rather than providing a deduction at the corporate level, double taxation could be reduced by
eliminating taxes for shareholders on dividends and capital gains, or just dividends. If dividends
and capital gains were both excluded from income, the double taxation of corporate income
would effectively be eliminated. Excluding just dividends would achieve partial relief.
Eliminating taxation of corporate income at the individual level would reduce progressivity in the
tax system, since dividend and capital gains income is disproportionately earned by higherincome households. Additionally, allowing firms a deduction for dividends paid or reducing
individual-level taxes on capital gains and dividends would reduce federal tax revenues.
Taxation of Pass-Through Income
One goal of some corporate tax reform proposals, and integration specifically, is to reduce the
discrepancy in the taxation of corporate and non-corporate businesses. An option that would be
consistent with this goal would be to subject certain pass-throughs to the corporate tax. Several
policy makers and the Obama Administration have expressed interest in taxing the largest passthroughs as corporations.96 This interest appears to be rooted in concern over the reduction in
corporate tax revenues over time, partly attributable to the shift in business activity away from the
corporate sector, and the perceived inequity and inefficiencies that exist because two otherwise
identical businesses are taxed differently simply because of their legal structure. Taxing large
pass-throughs as corporations would also allow for lower tax rates as it would broaden the
corporate tax base. Lower tax rates combined with a reduction in business tax disparity could
improve business tax equity and the allocation of resources relative to current policy.
Depending on how “large” pass-throughs were identified, a relatively small percentage of
businesses currently structured as pass-throughs could be affected by the corporate tax under
certain reforms.97 An estimated 0.3% of S corporations could be taxed as corporations if a “large”
pass-through is defined as one with receipts exceeding $50 million (0.2% for partnerships).98
96
In early 2011, Senate Finance Committee Chairman Max Baucus suggested the possibility of taxing pass-throughs
earning above a certain income as corporations. See, Nicola M. White and Drew Pierson, “Baucus Says Congress
Should Look at Taxing Passthroughs as Corporations,” Tax Notes Today, May 5, 2011. In addition, nearly all major tax
reform proposals released recently have called for some kind of base broadening which can be used to reduce tax rates
with the aim of improving the business tax environment. The President’s Economic Recovery and Advisory Board, for
example, specifically calls for examining the distinction between corporate and non-corporate forms, along with
general base broadening, lower tax rates, and reduced complexity. See, President’s Economic Recovery and Advisory
Board, The Report on Tax Reform Options: Simplicity, Compliance, and Corporate Taxation, Washington, DC, August
2010, http://www.whitehouse.gov/sites/default/files/microsites/PERAB_Tax_Reform_Report.pdf. For a summary of
other recent tax reform proposals see, CRS Report R43060, Tax Reform in the 113th Congress: An Overview of
Proposals, by (name redacted). On March 7, 2012, the House Committee on Ways and Means held a hearing on the
issue of pass-throughs taxation in the context of tax reform. Testimony given at that hearing may be found at
http://waysandmeans.house.gov/Calendar/EventSingle.aspx?EventID=282644.
97
CRS Report R42451, Taxing Large Pass-Throughs As Corporations: How Many Firms Would Be Affected?, by
(name redacted)
98
Ibid.
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Reducing this threshold to $10 million, an estimated 1.6% of S corporations could be taxed as
corporations (0.8% for partnerships).99
Although estimates suggest that only a small percentage of pass-throughs could be considered
large for corporate tax purposes, those firms are responsible for a significant amount of economic
activity—indicating that the proposed policy change could raise substantial revenue. For
example, 30% of S corporation receipts are generated by the largest 0.3% of S corporations, and
41% of partnership receipts are generated by the largest 0.2% of partnerships.100
International Tax: Territorial vs. Worldwide Taxation
Tax reform has raised an important question for policy makers with regards to American multinationals: is the current U.S. tax system for taxing American businesses with overseas operations
appropriate in a globalized business environment, or is reform needed?101 While the current U.S.
system is occasionally referred to as a worldwide tax system, in reality it is actually a hybrid,
containing features of both worldwide and territorial tax systems. In fact, no country has a pure
form of either tax system, although most developed countries have moved more in the direction
of a territorial tax regime.
The traditional metric used to evaluate an international tax system is how it affects investment
location decisions. Economic theory states that worldwide output would be maximized if
investments were taxed the same regardless of where they were made. In such an environment,
taxes have no impact on where firms choose to invest. Instead, investments would be made in
whichever location offered the highest rate of return, which, in turn, would result in resources
being allocated most efficiently and output being maximized. Equalization of tax treatment across
locations is most closely associated with a worldwide tax system. The current system U.S. tax
system could be moved more in that direction if deferral of foreign earned income were not
allowed and if the foreign tax credit limit were increased. While there have been proposals to
limit the ability to defer income, worldwide-related proposals tend to move in the opposite
direction with respect to the foreign tax credit, generally to prevent income shifting and to
preserve the tax base (see the section “Comparing Current Corporate and Business Tax Reform
Proposals”).
Alternatively, a reform could be adopted that includes a transition to a territorial type system.
Under a pure territorial system, the United States would forgo all income earned outside its
borders. A territorial system is argued to help domestic corporations compete in foreign markets
since they would face the same (foreign) tax rates as their competitors. But as was discussed
previously (see the section titled “Competitiveness”) countries do not “compete” in any economic
99
Using an asset-based measure of size produces similar estimates. It is estimated that between 0.3% and 1.0% of passthroughs could pay the corporate tax depending on whether a $100 million or $25 million asset threshold is used to
define a “large” firm.
100
The largest 0.2% of S corporations hold 43% of S corporation assets, while the largest 1.1% of partnerships hold
78% of partnership assets.
101
For more information on reform of the international tax system, see CRS Report RL34115, Reform of U.S.
International Taxation: Alternatives, by (name redacted); CRS Report R42624, Moving to a Territorial Income Tax:
Options and Challenges, by (name redacted); CRS Report R40623, Tax Havens: International Tax Avoidance and
Evasion, by (name redacted); and CRS Report R41743, International Corporate Tax Rate Comparisons and Policy
Implications, by (name redacted).
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sense, they trade, and it is trade that helps determine the economic well-being of a country.
Additionally, a territorial tax system does not necessarily enhance economic efficiency.
At the same time, a territorial system may lead to more investment in low-tax countries.
Proponents have argued that a territorial system would lead to an increase in corporate
repatriations (transfers in foreign subsidiary profits to U.S. parent companies), which would
promote domestic investment and employment. A popular technique that has been proposed to
transition to a territorial system is by providing a dividend exemption. With a dividend
exemption, corporations would be allowed to repatriate income from their foreign-located
subsidiaries via a divided payment and exempt, for example, 95% of that payment from taxation.
Research has questioned the effect of dividend repatriation exemptions on domestic investment
and employment.102
Another option would take a hybrid approach, with the goal of minimizing incentives to shelter
money in tax havens. The opportunity to keep money abroad for real business operations would
remain. One proposal would impose a minimum tax on foreign-earned income earned in countries
with low tax rates. The tax would be applied to deferred income earned in countries with a tax
below a particular rate, for example, 20%. Income earned in countries with rates below 20%,
thereafter, would be subject to a current U.S. tax of 20%. The income earned in countries with
rates above this level would be exempt from U.S. taxation. Some have expressed concern that
designing such a minimum tax may be too complex.103 An alternative to this approach that creates
a “cliff” effect by encouraging firms to move investment to countries with tax rates just above the
minimum is to impose an overall minimum tax with a credit for taxes paid.
Comparing Current Corporate and Business Tax
Reform Proposals
In recent years, economists, lawmakers, and others have offered a number of business and
corporate tax reform proposals. Table 5 summarizes key comprehensive reforms proposed by
Members of Congress and the Obama Administration. Also included in Table 5 are the business
and corporate tax reforms from the 2010 Fiscal Commission report.104
In 2013, Senate Committee Finance Chairman Max Baucus released several tax reform
discussion drafts.105 The draft on international tax reform proposes taxing passive and highly
mobile forms of foreign-earned income, as well as income earned from goods ultimately
consumed in the United States, at the full U.S. rate. Two alternatives were put forth for taxing
income earned from products and services sold abroad. “Option Y” would subject all foreignearned income to a minimum tax, which the draft sets at 80% of the U.S. statutory rate. “Option
102
CRS Report R40178, Tax Cuts on Repatriation Earnings as Economic Stimulus: An Economic Analysis, by (name r
edacted) and (name redacted).
103
This concern has been expressed by Ed Kleinbard, Professor of Law, University of Southern California Gould
School of Law. Reported in Julie Martin, “Minimum Tax on Multinationals Could Slow Profit Shifting,” Tax Notes,
March 19, 2012.
104
For additional details on tax reform as outlined by the Fiscal Commission, see CRS Report R41641, Reducing the
Budget Deficit: Tax Policy Options, by (name redacted).
105
These discussion drafts and related materials can be found at: http://www.finance.senate.gov/issue/?id=7D222262D589-4D5E-A2AB-1504273E2E61.
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Z” would tax 60% of foreign active business income at the U.S. rate. Similar to the Camp
proposal (discussed below), undistributed foreign earnings would be subject to a one-time tax.
The Baucus discussion draft sets this rate at 20%.
In other discussion drafts, Senator Baucus proposed reforms to cost recovery and accounting
rules. Specifically, proposed reforms would eliminate the modified accelerated cost recovery
system (MACRS), enacting instead a system that uses asset pools and longer lives that more
closely approximate economic depreciation. Certain intangibles, including research and
experimentation as well as advertising expenditures, would be capitalized and amortized. Last-in,
first-out (LIFO) inventory accounting rules would be repealed. Small-business expensing
allowances would be increased such that more businesses would be allowed to use cash
accounting.
Chairman Baucus has also released discussion drafts related to tax administration and energy tax
policy. The former includes a number of proposals designed to reduce the tax gap, enacting
additional data reporting requirements and anti-fraud provisions. The energy tax reform proposes
to eliminate most existing energy-related tax incentives, creating new “technology neutral”
production and investment tax credits.
House Ways and Means Committee Chairman Dave Camp has also released several tax reform
discussion drafts.106 The first, released in October 2011, addressed international tax issues.107
While the discussion draft did include text that would reduce the corporate tax rate to 25%
(supporting documentation indicated that this rate reduction would be paid for with unspecified
base-broadening provisions),108 the focus of the discussion draft was on provisions that would
shift the United States to a territorial tax system.
To shift towards a territorial tax, Chairman Camp’s proposal would exempt 95% of certain
foreign-source income from U.S. tax—including U.S. dividends paid to corporate shareholders
owning at least 10% of shares.109 Thus, generally, income earned abroad would not be subject to
U.S. tax. The proposal also suggests options for certain provisions designed to prevent erosion of
the corporate tax base, including use of Subpart F rules for certain passive and highly mobile
income and thin capitalization rules to prevent interest deductions for borrowing in the United
States that would finance overseas operations.
Chairman Camp has also released discussion drafts related to the tax treatment of financial
products and small businesses. The primary change proposed in the financial products discussion
drafts relates to the tax treatment of financial derivatives. Derivatives would be marked-to-market
at year-end, such that taxpayers would recognize income or losses. Transactions treated as hedges
for accounting purposes would also be treated as hedges for tax purposes so that businesses using
derivatives to hedge business risk would not be required to mark-to-market. The draft also
106
For the full text of these drafts, and related information, see http://waysandmeans.house.gov/taxreform/.
In supporting documentation, it was noted that the shift to a territorial tax system would be one component of
broader tax reform. For more information, see http://waysandmeans.house.gov/UploadedFiles/
Summary_of_Ways_and_Means_Draft_Option.pdf. All documents related to this proposal, including the draft
legislative text, can be found at http://waysandmeans.house.gov/taxreform/.
108
See the “Summary of Ways and Means Discussion Draft: Participation Exemption (Territorial) System,” available at
http://waysandmeans.house.gov/taxreform/.
109
For more information on territorial tax systems and Chairman Camp’s proposal, see CRS Report R42624, Moving to
a Territorial Income Tax: Options and Challenges, by (name redacted).
107
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proposes to repeal rules that allow securities dealers to pay capital gains taxes on 60% of their
derivatives income.
The small business discussion draft provides two different reform options. Option one would
revise existing rules related to pass-through entities, encouraging more C corporations to be taxed
as S corporations, and address partnership tax avoidance. Option two represents a broader reform
option, drafting a new set of rules for taxation of non-publicly traded businesses. Other proposals
in the small business discussion draft would increase expensing allowances and allow larger-sized
firms to use cash accounting.
In February 2012, the Obama Administration released “The President’s Framework for Business
Tax Reform.” The Administration’s proposal would eliminate a number of corporate tax
expenditures, and provides options for other corporate reforms.110 The Administration claims that
eliminating tax expenditures, while adopting other base-broadening reforms, could result in a
revenue-neutral reduction in the corporate tax rate to 28%. The Administration’s proposal would
also provide enhanced tax incentives for manufacturers, small businesses, research activities, and
clean energy.
The Administration’s proposal also seeks to make changes to the current international tax system.
Specifically, subsidiaries of U.S. corporations operating abroad would be required to pay a
minimum tax on foreign-source income.111 The Administration’s proposal would also deny certain
deductions associated with moving business operations abroad, provide tax credits for expenses
associated with moving business activities back to the United States, and strengthen international
tax rules that may allow firms to shift profits overseas or reduce U.S. taxes by taking deductions
associated with overseas investment.
The Bipartisan Tax Fairness and Simplification Act of 2011 (S. 727), often referred to as the
“Wyden-Coats proposal,” proposes substantial changes to the U.S. corporate tax system.112 The
Wyden-Coats proposal would enact a flat corporate tax rate of 24%, while also enhancing
expensing allowances for small businesses. The legislation proposes repealing a number of
corporate tax expenditures, including the Section 199 production activities deduction, certain
incentives for oil and gas, certain inventory accounting methods, and depreciation of equipment
in excess of the alternative depreciation system, among others.
The Wyden-Coats bill also proposes a number of changes to the U.S. international tax system.
Specifically, this legislation would increase taxation of foreign source income—eliminating both
deferral of active foreign earnings while enacting per country foreign tax credit limits.113 Thus,
the Wyden-Coats bill would move the United States’ international tax system more in the
direction of a worldwide system.
110
Other reforms that could be considered under the Administration’s proposal include adjusting depreciation
schedules, reducing tax-induced preferences for debt financing, and treating large pass-through entities as corporations.
111
Foreign tax credits would be allowed for any taxes paid to a host country.
112
Several other proposals for fundamental tax reform have been introduced in the 112th Congress. For more
information, see CRS Report R43060, Tax Reform in the 113th Congress: An Overview of Proposals, by (name red
acted).
113
For additional information, see CRS Report R42624, Moving to a Territorial Income Tax: Options and Challenges,
by (name redacted).
Congressional Research Service
30
The Corporate Income Tax System: Overview and Options for Reform
In December 2010, the National Commission of Fiscal Responsibility and Reform (also known as
the Fiscal Commission or Simpson-Bowles) released a report outlining a plan for achieving longrun fiscal sustainability. Tax reform was one part of this comprehensive proposal. This Fiscal
Commission’s illustrative plan recommended reducing the corporate tax rate to 28%, eliminating
corporate tax expenditures, including the Section 199 production activities deduction. The plan
also proposed moving to a territorial tax system, continuing to tax passive foreign source income
under Subpart F. Details on the specific structure of this territorial tax system were not provided.
There are some areas of general consensus with respect to goal of corporate tax reform. Each of
the four corporate tax reform proposals summarized in Table 5 would reduce statutory corporate
tax rates (currently at 35%).114 Part of the revenue cost of rate reduction would be offset by
eliminating corporate tax expenditures (which corporate tax expenditures should be eliminated is
not an area of broad agreement). There is also general agreement that changes should be made to
the current treatment of foreign-source income. There is not, however, a consensus on how a
reformed corporate tax system should treat foreign-source income.
One of the most fundamental differences in the corporate tax reform proposals surveyed in Table
5 is in the proposed treatment of foreign-source income. Some proposals would move towards a
territorial tax system, effectively exempting income earned abroad from U.S. taxation. The
Obama Administration’s and the Wyden-Coats proposals both contain provisions that would
strengthen the current worldwide system of foreign-source income taxation, reducing the ability
for U.S. companies to avoid U.S. taxation through overseas operations.
114
Chairman Baucus did not specify how much the corporate rate would be reduced, but did state that rate reduction
was part of the goal of tax reform. See http://www.finance.senate.gov/newsroom/chairman/release/?id=536eefeb-2ae2453f-af9b-946c305d5c93.
Congressional Research Service
31
Table 5. Comparing Business and Corporate Tax Reform Proposals
Current Law
Chairman Baucus’s
Proposals
(2013)a
Chairman Camp's
Proposals
(2011 / 2013)b
President Obama’s
Proposal
(2012)c
Wyden-Coats
(2011)d
Simpson-Bowles
(2010)e
Top Statutory
Corporate Tax
Rates
35%
Not specified
25%
28%
24%
28%
Corporate Tax
Expenditures
Dozens of corporate tax
expenditure provisions;
Total value of $149.5
billion in 2013
See below
Not explicitly addressedf
See below
See below
See below
Provisions to
Eliminate Tax
Expenditures
(Base-Broadening)
Provisions to
Modify or Add Tax
Expenditures
CRS-32
Many existing tax
expenditures, particularly
those related to cost
recovery and energy,
eliminated as part of
broader reform options.
Last-in, first-out (LIFO)
inventory accounting
rules repealed.
Last-in, first-out (LIFO)
inventory accounting
methods; incentives for
oil, gas, and coal; special
depreciation for
corporate aircraft;
reduce interest
deductibility
Create new “technology
neutral” incentives for
clean energy technologies
Expand Section 199
domestic production
deduction; make R&D
tax credit permanent;
enhanced incentives for
small businesses (cash
accounting, increased
start-up cost deduction,
health insurance tax
credit)
Lower of cost or market
inventory rule; Section
199 production activities
Eliminate most corporate
deduction; certain
tax expenditures
incentives related to oil
and gas; reduce interest
deductibility by indexing
for inflationg
Current Law
Chairman Baucus’s
Proposals
(2013)a
Chairman Camp's
Proposals
(2011 / 2013)b
President Obama’s
Proposal
(2012)c
Wyden-Coats
(2011)d
Simpson-Bowles
(2010)e
Cost Recovery
Eliminate the modified
accelerated cost recovery
Unlimited expensing for
Costs recovered under
system (MACRS),
Changes to depreciation
businesses with gross
the Modified Accelerated enacting instead a system
rules may be used to
receipts of $1 million or Accelerated depreciation
Cost Recovery System that uses asset pools and Small business discussion
broaden corporate tax
eliminated or modified
less; depreciation
(MACRS); 50% bonus
longer lives. Certain
draft proposes increased
base; allow small
f
(details not specified)
allowances generally
depreciation in 2013;
intangibles would be
expensing allowances
businesses to expense $1
limited to accelerated
$500,000 expensing capitalized and amortized.
million in investments
depreciation
allowance in 2013
Small-business expensing
allowances would be
increased.
International
Taxation
Adopt a territorial tax
Tax passive and highly
system that exempts 95% Impose minimum tax on
mobile forms of foreignof active foreign earnings
foreign profits with
Tax income on a
earned income, as well as
of a U.S. company's
foreign tax credits;
worldwide basis but end
income from goods
controlled foreign
provide 20% tax credit deferral; allow foreign tax
consumed in the U.S., at
Adopt a territorial tax
Worldwide tax system
corporation. Require U.S. for expenses associated credits on a per-country
full U.S. rate. Require U.S.
system that exempts
with foreign tax credit,
multinationals to pay
with relocating to the basis; allow a deduction
multinationals to pay 20%
most or all of U.S.
deferral, and subpart F
5.25% on all pre-existing U.S.; enhance transfer
for earnings received
on undistributed foreign
offshore earnings
earnings reinvested
pricing rules; delay
from a foreign subsidiary
earnings. Options put
abroad (allowing for a
interest expense on
that are reinvested
forward for taxing
foreign tax credit).
foreign earnings until
domestically in 2011
earnings from products
Options put forward to
repatriation
and services sold abroad.
address profit shifting.
Investment
Income
Financial products
discussion draft proposes
derivatives be marked-toLong-term capital gains
market; repeal rules that Tax carried interest as
and dividends taxed at a Not explicitly addressed
allow securities dealers to
ordinary income
h
top rate of 20% in 2014
pay capital gains taxes on
60% of their derivatives
income
Source: CRS analysis of various tax reform plans and proposals.
Notes:
CRS-33
Tax capital gains and
dividends as ordinary
income; exclude 35% of
certain dividend and
capital gain income from
gross income
Tax capital gains and
dividends as ordinary
income
a.
Senate Finance Committee Chairman Max Baucus has released several tax reform discussion drafts on topics related to international taxes, tax administration, cost
recovery and accounting, and energy tax issues. The discussion drafts and related materials can be found at http://www.finance.senate.gov/issue/?id=7D222262-D5894D5E-A2AB-1504273E2E61.
b.
House Ways and Means Committee Chairman Dave Camp has released discussion drafts related to international tax reform, financial products, and small businesses.
These discussion drafts, as well as other resources related to comprehensive tax reform, can be found at http://waysandmeans.house.gov/taxreform/.
c.
The White House and the Department of the Treasury, The President’s Framework for Business Tax Reform, Washington, DC, February 2012, http://www.treasury.gov/
resource-center/tax-policy/Documents/The-Presidents-Framework-for-Business-Tax-Reform-02-22-2012.pdf.
d.
The Bipartisan Tax Fairness and Simplification Act of 2011 (S. 727).
e.
The National Commission on Fiscal Responsibility and Reform, The Moment of Truth, Washington, DC, December 2010, http://www.fiscalcommission.gov/sites/
fiscalcommission.gov/files/documents/TheMomentofTruth12_1_2010.pdf.
f.
Representative Camp’s proposal involves a discussion draft for international tax reform, that could be enacted as part of a broader tax reform designed to reduce the
corporate tax rate to 25%. Specifics regarding base-broadening measures and other reforms that would accompany the proposed rate reduction may be released as
part of future discussion drafts.
g.
A list of tax expenditures that would be repealed as part of the Wyden-Coats proposal can be found at http://www.wyden.senate.gov/imo/media/doc/
Offsets%20handout.pdf.
h.
As of 2013, certain higher-income taxpayers are also subject to an additional 3.8% tax on unearned income, including net investment income.
CRS-34
The Corporate Income Tax System: Overview and Options for Reform
Author Contact Information
(name redacted)
Specialist in Economics
[redacted]@crs.loc.gov, 7-....
Congressional Research Service
(name redacted)
Specialist in Public Finance
[redacted]@crs.loc.gov, 7-....
35
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