Increase the Corporate Income Tax Rate 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.
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Following the enactment of the 2017 tax act, corporations that are subject to the U.S. corporate income tax face a single statutory rate of 21 percent. A corporation computes its taxable income by subtracting certain deductions from its gross income—for example, wages and the costs of goods sold, as well as depreciation for investment and most interest paid to the firm's bondholders. Corporations may also apply allowable tax credits against the amount of taxes they owe. After paying the corporate income tax, corporations can either retain their remaining profits or distribute them to shareholders. Some distributed profits are then taxed again under the individual income tax system as dividends or capital gains.
In general, the 21 percent tax rate applies to the taxable income of corporations earned from conducting business within the United States. Some income earned abroad is also taxed by the United States. The tax treatment of foreign income depends on its characteristics. Some income is taxed at the full U.S. statutory rate, and some is taxed at a reduced rate. In either case, taxpayers may claim a foreign tax credit that limits the extent to which that income is subject to both foreign and U.S. taxation. The foreign tax credit is subject to limits that are designed to ensure that the total amount of all credits claimed does not exceed the amount of U.S. tax that otherwise would have been due.
In 2017, when corporations were subject to a corporate income tax rate of up to 35 percent, receipts from corporate income taxes totaled $297 billion. Partly as a result of the 2017 tax act's reduction of that rate to 21 percent, tax receipts will decrease to $276 billion in 2019, in the Congressional Budget Office's estimation. Those receipts are projected to grow faster than gross domestic product through 2025 and then grow at the same rate thereafter.
This option would increase the corporate income tax rate by 1 percentage point, to 22 percent.
Effects on the Budget
The option would increase revenues by $96 billion from 2019 to 2028, the staff of the Joint Committee on Taxation estimates.
The estimate for this option reflects changes in the use of tax credits. An increase in the corporate tax rate would increase corporations' ability to use tax credits, rather than carrying them forward to a future year, to offset some of the additional corporate tax liabilities arising from the higher tax rate. That use of credits would reduce revenues from the higher corporate income tax rate.
The estimate also incorporates firms' responses to the higher tax rate. The option would increase corporations' incentives to adopt strategies to reduce the amount of taxes they owe. Those anticipated responses make the estimated increase in revenues smaller than it would be otherwise.
The estimate for this option is uncertain because the underlying projections of the economy, including corporate profits and taxable income, are uncertain. CBO's projections of the economy over the next decade and projections of taxable corporate income under current law are particularly uncertain because they reflect recently enacted changes to the tax system by the 2017 tax act. Additionally, estimates of how corporations would respond to the option are based on observed responses to prior changes in tax law, which might differ from the responses to the change considered here.
The major argument in favor of this option concerns its simplicity. As a way to raise revenues, an increase in the corporate income tax rate 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 owners of capital, who tend to have higher income than other taxpayers, bear the burden of the corporate income tax. (However, because the corporate 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. That effect on capital investment is not reflected in the revenue estimate.)
An argument against the option is that it would reduce economic efficiency by exacerbating tax-related distortions of firms' decisions. The corporate income tax distorts firms' choices about how to structure their organizations and whether to finance investment by issuing debt or by issuing equity. Increasing the corporate income tax rate would raise the overall tax rate on corporate income. As a result, it would be more advantageous for some firms to organize so that they were no longer subject to the corporate income tax (and were instead taxed only under the individual income tax as an S corporation or partnership) solely to reduce their tax liabilities. Raising the corporate tax rate would also increase the value of deductions. As a result, companies might 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.
Another concern that might be raised about the option is that it would make it less attractive to earn income in the United States relative to earning income abroad. Tax rate differences among countries can influence businesses' choices about how and where to invest; to the extent that firms shift their investment and activities to countries with low taxes with the goal of reducing their tax liability at home, economic efficiency declines because firms are not allocating resources to their most productive use. Tax rate differences among countries also create an incentive for businesses to shift reported income to lower-tax countries without changing their actual investment decisions or moving their activities. That practice, known as "profit shifting," erodes the corporate tax base and requires tax planning that wastes resources. Increasing the corporate rate would strengthen 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.