Increase Corporate Income Tax Rates by 1 Percentage Point
CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.
|Billions of Dollars||2017||2018||2019||2020||2021||2022||2023||2024||2025||2026||2017-2021||2017-2026|
|Change in Revenues||6.4||8.1||8.9||9.8||10.3||10.6||10.9||11.3||11.7||12.3||43.5||100.3|
Source: Staff of the Joint Committee on Taxation.
This option would take effect in January 2017.
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 taxable corporate 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 the firm’s bondholders, 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 dollar value of the 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 $100 billion over the 2017–2026 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 burden of the corporate income tax is largely borne by owners of capital, who tend to have higher income than other taxpayers. (Because the tax reduces capital investment in the United States, it reduces workers’ productivity and wages relative to what they otherwise would be, meaning that at least some portion of the economic burden of the tax over the longer term falls on workers—making an increase in corporate tax rates less progressive than it would be if that burden was fully borne by the owners of capital.)
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 organize in a manner that allows them to be treated as an S corporation or partnership 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 and partnerships 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.
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. 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—already higher than that in any of the other 33 member countries of the Organisation for Economic Cooperation 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 requires tax planning that wastes resources. 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.