Most corporations that are subject to the corporate income tax calculate their tax liability according to a progressive rate schedule. The first $50,000 of corporate taxable income is taxed at a rate of 15 percent; income of $50,000 to $75,000 is taxed at a 25 percent rate; income of $75,000 to $10 million is taxed at a 34 percent rate; and income above $10 million is generally taxed at a rate of 35 percent.
Although most corporate income falls within the 35 percent tax bracket, the average tax rate on corporate income (corporate taxes divided by corporate income) is lower than 35 percent because of allowable deductions, exclusions, tax credits, and the lower tax rates that apply to the first $10 million of income. For example, corporations can deduct business expenses, including interest paid to holders of the firm’s bonds, from gross income to compute taxable income. (Dividends paid to shareholders, however, are not deductible.) Most income earned by the foreign subsidiaries of U.S. corporations is not subject to U.S. taxation until it is repatriated in the form of dividends paid to the parent corporation. To prevent income earned abroad from being subject to both foreign and U.S. taxation, the tax code gives U.S. corporations a credit that reduces their domestic tax liability on that income by the amount of income and withholding taxes they have paid to foreign governments. The foreign tax credit is subject to limits that are designed to ensure that the amount of credits taken does not exceed the amount of U.S. tax that otherwise would have been due.
This option would increase all corporate income tax rates by 1 percentage point. For example, the corporate income tax rate would increase to 36 percent for taxable income above $10 million. The option would increase revenues by $113 billion over the 2014–2023 period, the staff of the Joint Committee on Taxation estimates.
The major argument in favor of the option is its simplicity. As a way to raise revenue, increasing corporate income tax rates would be easier to implement than most other types of business tax increases because it would require only minor changes to the current tax collection system.
The option would also increase the progressivity of the tax system to the extent that the corporate income tax is largely borne by owners of capital, who tend to have higher incomes than other taxpayers. But the extent to which the financial burden of the tax ultimately falls on the owners of corporations, owners of all capital assets, or workers is unclear. The United States is an open economy, in which many firms engage in international trade. Because labor tends to be less mobile than capital in open economies, some of the corporate income tax burden might be passed back to workers through reductions in their compensation over a number of years—making an increase in corporate tax rates somewhat less progressive.
An argument against the option is that it would further reduce economic efficiency. The current corporate income tax system already distorts firms’ choices about how to structure the business (for example, whether to operate as a C corporation, an S corporation, a partnership, or a sole proprietorship) and whether to finance investment by issuing debt or by issuing equity. Increasing corporate income tax rates would make it even more advantageous for firms to expend resources to qualify as an S corporation solely as a way to reduce their tax liabilities. That is because net income from C corporations—those that are subject to the corporate income tax—is first taxed at the business level and then again at the individual level after it is distributed to shareholders or investors. By contrast, income from S corporations—which can have no more than 100 owners and are subject to other restrictions—is generally free from taxation at the business level but is taxed under the individual income tax, even if the income is reinvested in the firm. Raising corporate tax rates would also encourage companies to increase their reliance on debt financing because interest payments, unlike dividend payments to shareholders, can be deducted. Carrying more debt might increase some companies’ risk of default. Moreover, the option would discourage businesses from investing, hindering the growth of the economy. An alternative to this option that would reduce such incentives would be to lower the tax rate while broadening the tax base by, for example, reducing or eliminating some exclusions or deductions. That modification, however, would also reduce—and possibly even eliminate—the revenue gains from the option.
Another concern that might be raised about the option is that it would increase the tax rate that corporations—those based in the United States and those based in foreign countries—face when they earn income in the United States. Such an increase would cause the top marginal tax rate (that applied to an additional dollar of income) in the United States to be higher than the top marginal tax rates adopted by most other countries. Under current law, when the federal corporate tax is combined with state and local corporate taxes (which have a top rate averaging 4 percent), the U.S. tax rate on income in the highest bracket averages 39 percent—higher than that in any of the other 33 member countries of the Organisation for Economic Co-operation and Development. (The top statutory rates, however, do not reflect the differences in various countries’ tax bases and rate structures and therefore do not represent the true average tax rates that multinational firms face.) Those higher rates in the United States influence businesses’ choices about how and where to invest; to the extent that firms respond by shifting investment to countries with low taxes as a way to reduce their tax liability at home, economic efficiency declines because firms are not allocating resources to their most productive use. The current U.S. system also creates incentives to shift reported income to low-tax countries without changing actual investment decisions. Such profit shifting erodes the corporate tax base and leads to wasted resources for tax planning. Increasing the top corporate rate to 36 percent (40 percent when combined with state and local corporate taxes) would further accentuate those incentives to shift investment and reported income abroad. However, other factors, such as the skill level of a country’s workforce and its capital stock, also affect corporations’ decisions about where to incorporate and invest.
|(Billions of dollars)||2014||2015||2016||2017||2018||2019||2020||2021||2022||2023||2014-2018||2014-2023|
|Change in Revenues||7||11||11||12||12||12||12||12||12||12||53||113|
Source: Staff of the Joint Committee on Taxation.
Note: This option would take effect in January 2014.