Corporate taxation is likely to be a major issue for the 113th Congress. Many Republicans and Democrats are concerned with our relatively high corporate tax rates and have already advanced proposals for reforming our corporate tax system. Why are policy makers concerned about our current system for taxing corporate income?
Among the most economically advanced countries in the world, the United States has the highest total statutory corporate tax rate, which currently stands at 39.1 percent. That tax rate includes the federal tax on corporate income — 35 percent in the United States — as well as taxes imposed at the state and local levels. By contrast, corporate tax rates were only 26.1 percent in Canada, 24 percent in the United Kingdom, and 25.4 percent on average among the 34 advanced countries in the Organisation for Economic Co-operation and Development (OECD).
Many economists and business leaders have raised concerns about these high tax rates because they make the U.S. a less attractive place to conduct business and thus affect multinational corporations' decisions about locating facilitates and jobs here.
Despite our high statutory rates, the United States collects less revenues from corporations than many other advanced countries do. In 2010, the latest year for which data is available for international comparison, the United States corporate tax revenues accounted for only about 2.7 percent of gross domestic product (GDP). By contrast, corporate tax revenues in Canada were 3.3 percent of GDP, even though their corporate tax rate is significantly lower than the U.S. rate. Among the countries in the OECD, corporate revenues were 2.9 percent of GDP on average.
Why aren't U.S. corporate tax revenues higher when we have the highest tax rate? The reason is tax expenditures. Although nearly all corporations are nominally subject to the statutory tax rate, the rate that companies actually pay is significantly lower because of numerous exclusions, deductions, exemptions, and credits available to corporations to reduce their taxable income. These tax preferences contribute to an effective tax rate, the portion of income a corporation will actually pay in taxes, that is for many companies much lower than the rate written into the tax code.
Corporate tax expenditures are big — their cost adds up to a substantial sum relative to the revenue collected from the corporate tax system. In fact, corporate tax expenditures at the federal level were $181 billion in 2011 — the same amount that the federal government collected in corporate income tax revenues.
These tax preferences are referred to as "tax expenditures" because many of them provide financial assistance and are functionally the same as spending programs, except that they are carried out through the tax code. However, tax expenditures are politically protected in an important way — most are not subject to the annual congressional review that spending programs funded through annual appropriations are. Once enacted, tax expenditures can be very difficult to remove from the tax code.
Some of the largest corporate tax expenditures include: the depreciation of machinery and equipment, the deferral of income from U.S.-controlled foreign corporations, deductions for U.S. production activities, exclusions for state and local bonds, and credits for increasing research activities.
Corporate tax expenditures can distort businesses' economic decision-making because they create disparities in the tax treatment of different types of business investments. For example, the tax code includes generous tax breaks for certain types of depreciation, but the value of these breaks varies widely depending on which type of investment is being depreciated[i]. The tax code also includes a host of industry-specific tax preferences that create further disparities in the taxes paid by different companies. And last, by making interest payments on borrowings deductible, the corporate tax system also encourages businesses to use debt, rather than equity, to finance investments.
The wide variation in effective tax rates for various types of corporate activity creates a system of implicit subsidies that skew the allocation of resources in our economy and reduce its efficiency. They also cause companies to pay too much attention to taxes when making investment decisions—and create incentives for business to spend more resources lobbying Congress to maintain and expand their existing tax preferences.
In the minds of many experts, our corporate tax system is ill-equipped to address the economic and budgetary challenges our country is facing today. First, high statutory rates encourage corporations to look overseas at a time when we badly need investment at home. Second, billions of dollars of revenue are lost every year on corporate tax expenditures in the face of unsustainable projected budget deficits and debt. Finally, these expenditures create subsidies that distort the allocation of resources in the economy and reduce its productivity.
[i] Depreciation rules affect how fast a company can write off the cost of an investment over time for tax purposes.