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Special Report No. 107
Executive Summary
Several members of the Bush Administration, including Treasury Secretary Paul O’Neill and Council of Economic Advisors Chairman R. Glenn Hubbard, have mentioned their interest in corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.
reform. During an interview with the Financial Times in late May 2001, Secretary O’Neill stated, “So, it’s not just the direct amount of the [corporate income] tax, but the administrative cost of running the tax process through the businesses and corporations that we could effectively eliminate.” Politically, reform, reduction, or elimination of the corporate income tax will be very difficult. Economically, however, O’Neill is exactly right, the corporate income tax is one of the most burdensome and economically inefficient taxes in the code.
Fundamental reform of the corporate income tax deserves heightened attention given the current economic downturn. Simplifying, lowering, or eliminating this burdensome tax would provide immediate relief for all Americans, remove one very significant source of inefficiency from the capital markets, and promote economic growth.
The federal government currently collects around $200 billion a year from C corporations through the corporate income tax. State and local governments tap corporate America for an additional $40 billion in income taxes annually. Federal corporate tax rates and bases have been on a roller coaster ride over the past thirty years as rates have gone up and down and the 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. has expanded and contracted. Under current law, corporate 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. above $75,000 is subject to an income tax of 34 percent and corporate income above $10 million is subject to a tax of 35 percent.
Several other federal tax policies affect corporate tax collections. The corporate alternative minimum tax applied to 25,047 companies in 1997, the most recent year for which official data are available. These companies paid $3.9 billion in alternative minimum taxes that year. Despite meeting the stated goal of increasing revenues from corporations, several issues, including equity and complexity, are raised by the presence of this tax.
Although the vast majority of business activity in the United States occurs in C corporations, alternative legal constructs such as 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). s and sole proprietorships are increasingly popular. In 1998, there were 2.6 million S corporations and 17.4 million sole proprietorships in the United States. None of these businesses pay any corporate income tax. Instead, the owners of S corporations and sole proprietors report all income on their 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. returns. This is important for two reasons. First, income earned through an S corporation or sole proprietorship is taxed only once, whereas income earned through a C corporation is taxed twice: once through the corporate income tax, and again when investors pay individual income taxes on dividends. Second, as the percentage of business activity conducted through S corporations and sole proprietorships increases, an increasing amount of taxes will be collected through the personal income tax compared to the corporate income tax.
Numerous proposals to reform or modify the corporate income tax have been discussed since the last major change in 1993 when the top corporate income tax rate was increased from 34 percent to 35 percent. Most significantly, talk of fundamental tax reform in 1996 led to several proposals to replace the corporate income tax with a value-added tax or other consumption-based tax. Other proposals, dating back to at least 1992, call for the integration of the corporate and personal income taxes to simplify overall tax compliance and eliminate the double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. that currently exists on savings.
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