Putting U.S. Corporate Taxes in Perspective
PDF of this report (3pp.)
By Chye-Ching Huang and Chad Stone
October 27, 2008
Related Areas of Research
Tax — Federal
The U.S. corporate tax burden is smaller than average for developed countries. Corporations in 19 of the member states of the Organization for Economic Co-operation and Development paid 16.1 percent of their profits in taxes between 2000 and 2005, on average, while corporations in the United States paid 13.4 percent.
Nevertheless, some have argued that U.S. corporate tax rates unduly burden U.S. companies by pointing to the country’s top statutory tax rate, which is 35 percent. For example, a recent Wall Street Journal editorial calling for corporate tax cuts noted that this is the second highest top statutory tax rate among developed countries. While true, this gives the false impression that the corporate tax burden is greater here than in other developed countries. Because the U.S. tax code offers so many deductions, credits, and other mechanisms by which corporations can reduce their taxes, the actual percentage of profits that U.S. corporations pay in taxes — or what analysts refer to as their effective tax rate — is not high, compared to other developed countries.
Because the average U.S. corporate tax burden is low, many economists believe a revenue-neutral corporate tax reform that reduces statutory corporate tax rates, while broadening the tax base by eliminating costly tax breaks, could improve economic efficiency and likely benefit the U.S. economy.
Effective tax rate much lower than top statutory rate. Government and independent researchers have long pointed out that the top statutory corporate tax rate is an incomplete measure at best of the burden of corporate taxes. It does not take into account the generous depreciation rules, exemptions, deductions, and credits (some of which are sometimes termed “loopholes”) that corporations may be eligible for. Those special provisions lower corporations’ effective tax rate, or the share of their profits they actually pay in taxes, and do so in a way that creates different tax rates for different industries. These differential tax rates across industries are generally regarded as more harmful to economic efficiency than any burden due to the current top statutory rate.
The United States has plethora of generous corporate tax breaks. As the Treasury Department has noted, the United States’ low effective tax rate reflects its “narrow corporate tax base,” which is the result of “accelerated depreciation allowances [and] special tax provisions for particular business sectors … as well as debt finance and tax planning.”
These tax breaks lead to very low tax rates on certain types of investments — even negative rates in some cases. For example, a 2005 Congressional Budget Office study found that the effective marginal corporate rate — the rate paid on the last dollar of income earned and arguably the tax rate most relevant for investment decisions — on debt-financed investment in machinery was negative, estimated at -46 percent. This means that the total value of the deductions that companies may claim for such investment is much larger than the tax they pay. (Put another way, it means that other taxpayers effectively subsidize the investment.) A recent Government Accountability Office study similarly found wide variation in effective tax rates across corporations.
The Treasury Department estimates that various corporate tax breaks will cost the federal government more than $1.2 trillion over the next ten years (2008-2017), a period during which total corporate revenues are projected to equal $3.4 trillion.
Many smaller corporations do not face the top statutory corporate tax rate. For small corporations, another reason that the top statutory corporate tax rate is an inaccurate measure of the U.S. corporate tax burden is that many of these companies do not face the top rate. In contrast to many other developed countries, which apply the same tax rate to all taxable corporate income, the United States has a graduated corporate tax structure, in which corporations with smaller incomes are taxed at rates below 35 percent. While a very large share of taxable corporate income is earned by corporations large enough to face the top rate, in terms of numbers, most U.S. corporations face a statutory rate lower than the 35 percent top rate.
Broaden the base, reduce the rate. Corporate tax reform that eliminates a portion of the existing tax breaks and uses the savings to offset the cost of reducing statutory corporate tax rates would likely improve economic efficiency without increasing deficits and debt.