The Corporate Tax Burden
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Special Report No. 107
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 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 base has expanded and contracted. Under current law, corporate taxable 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 corporations 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 tax 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 taxation that currently exists on savings.