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New CBO Report Shows Declining Share of C Corporations

2 min readBy: Alan Cole

The Congressional Budget Office (CBO) this week released its latest Budget and Economic Outlook, a document that includes projections about the U.S. economy and fiscal situation over the next decade. One interesting prediction highlighted in the report was the CBO’s belief that corporate income 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. revenues, as a percentage of GDP, would fall over the next decade.

Corporate Income Revenues as a Percentage of GDP

























The 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. system is the third largest source of federal revenues, behind only 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 the payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. . However, the CBO projects it to become less and less important, as a source of revenue as time goes on.

One key reason for this change? The declining share of businesses using the traditional C corporation structure and the rising share of businesses using the pass-through structure. (For more on this tax structure, where taxes are paid by the owners of the business rather than at the entity level, see an overview here.)

This trend is one of two corporate strategies the CBO mentions as reducing corporate income tax receipts. (The other strategy is profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. , which also makes it difficult to raise revenue at the high U.S. rate.)

As the CBO puts it:

One such strategy is to decrease the share of business activity that occurs in C corporations (which are taxed under the corporate income tax) while increasing the share that occurs in pass-through entities, 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 (which are taxed directly under the individual income tax rather than the corporate tax, increasing individual income tax receipts).

We have highlighted this issue since report a year ago. The central problem is that the United States has relatively reasonable individual income tax rates, but the highest corporate income tax rate in the developed world. But it’s not just this: a C corporation pays both the high corporate income taxes and the individual income taxes.

This is remarkably thoughtless policy. Some businesses (but not all businesses, just those with a disfavored legal structure) pay a 35% rate at the entity level, followed by taxes of up to 23.8% at the shareholder level. Others, like partnerships and sole proprietorships, have taxes paid by their owners commensurate with their owners’ income in a single layer of taxation. Of course nobody wants to be a C corporation.

The answer to this problem would be a system of corporate integration, where all businesses end up having a pass-through structure. Senator Orrin Hatch (R-UT) is currently looking into such a system.

In any case, in the near term, expect corporations to continue to restructure themselves as partnerships and other kinds of pass-through entities over the near future.