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New CBO Projections Understate the Average Corporate Tax Rate

2 min readBy: William McBride

People can disagree about whether corporations pay too little or too much taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. , but first we have to know what they pay. Unfortunately, in a report released today the Congressional Budget Office (CBO) has vastly understated a measure of the effective tax rate paid by corporations. The main issue is that there are two types of corporations: C corporations that pay the corporate tax and S corporations, which are pass-through entities that pay the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. and are not subject to the corporate tax. The C corporations are what we generally think of as "corporations" in most discussions, but the CBO has mixed and matched the two in an inconsistent way, counting C corporation taxes but C plus S corporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). profits.

Figure 4-3 (shown below) from the CBO report depicts the "average corporate tax rate" from 1974 to today and projected out to 2024, indicating the average corporate tax rate was 16.47 percent last year, 12.83 percent in 2011, and otherwise around 15 percent since 2009.

However, according to the latest IRS data the average corporate tax rate is about 50 percent higher in those years, when the data is restricted to just C corporations. The second chart below shows the average corporate tax rate based on IRS data, calculated as C corporation taxes paid divided by C corporation taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. . The average corporate tax rate was 22.3 percent in 2009 and 21.0 percent in 2010.

The main difference between the CBO and IRS numbers is that the CBO has included the pass-through businesses in their measure of profits, even though those businesses are not subject to corporate taxes but rather pay under the individual tax code. Particularly, the CBO is using as their corporate tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. measure domestic economic profits from the BEA, which includes both C and S corporations, even though S corporations are pass-through entities not subject to the corporate tax. This matters more and more, as S corporations have been growing relative to C corporations for over 20 years. It is now the case that about 30 percent of the profits measure used by CBO and BEA is due to S corporations. Hence, any calculation of the average corporate tax rate based on these numbers will be about one-third too low.

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