As Congress and the White House continue to plan for a 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. reform bill later this year, one of the most important unanswered questions is: “How will lawmakers pay for a corporate tax rate cut?” After all, there is widespread agreement among lawmakers that the current 35 percent U.S. statutory corporate tax rate is too high, but very little consensus about the best path to lowering the rate in a fiscally responsible manner.
For those who agree that the U.S. corporate rate is too high, the entire process can seem quite frustrating. Americans may justifiably wonder why lawmakers can’t just offset the cost of a lower statutory corporate rate by closing corporate tax loopholes and eliminating special preferences.
In fact, this approach – paying for a lower corporate rate by eliminating corporate tax expenditures – turns out to be less fruitful than one might expect. This is because there simply aren’t enough credits, deductions, and other targeted preferences in the corporate tax code to fund a large reduction in the corporate tax rate.
To illustrate this point, here is a thought experiment. Imagine that lawmakers are interested in putting together a corporate tax reform bill that satisfies the following three criteria:
- They would like the bill to be “revenue-neutral,” leaving total federal revenue unchanged. This means that the bill would pay for a lower corporate rate with other tax changes, rather than by cutting spending or increasing the deficit.
- They would like the bill to be “corporate-only,” paying for the full cost of a lower corporate rate by eliminating tax breaks for corporations. This means that the bill would not offset the cost of a corporate rate cut by raising revenue from other federal taxes or by eliminating tax breaks for individuals.
- Finally, they would like the bill to be “non-structural,” leaving the basic nature of the current 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. intact. This means that the bill would focus only on eliminating corporate tax expenditures (such as credits, exclusions, and other targeted provisions), rather than changing the structure of the corporate tax code.
Under these three constraints, how far would lawmakers be able to lower the corporate income tax rate? In other words, if Congress eliminated every corporate tax expenditureTax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit (EITC), child tax credit (CTC), deduction for employer health-care contributions, and tax-advantaged savings plans. , how low could they get the corporate tax rate?[1]
To answer this question, I modeled a scenario in which 54 corporate tax expenditures are eliminated, and the resulting revenue is used to pay for the cost of lowering the statutory corporate income tax rate.[2] To satisfy the “corporate-only” criterion, I only eliminated the portion of each tax expenditure that applies to C corporations, and not the portion that benefits pass-through businesses and households. To satisfy the “non-structural” criterion, I modeled the elimination of every corporate tax expenditure, except those that accelerate cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. , defer the taxation of gain, and affect the taxation of foreign-source income – all of which should be seen as attempts to shift the structure of the tax code, rather than targeted preferences.[3]
These 54 “non-structural” corporate tax expenditures, listed in the table below, are wide-ranging. They range from major components of U.S. industrial policy (like the domestic production deduction and the research and development credit) to sector-specific incentives (like the credit union exemption and the orphan drug credit). Combined, the corporate portions of these 54 provisions are expected to cost the federal government $766 billion in revenue over the next ten years.
It turns out that eliminating every single one of these corporate tax expenditures would raise enough revenue to lower the corporate tax rate to … 28.5 percent.
For context, this is not a particularly large rate cut, in the context of U.S. tax policy discussions. Congressional Republicans have long advocated for a corporate tax rate of 25 percent or lower. Last summer, Speaker Ryan set a 20 percent corporate rate as a goal for tax reform. And President Trump has recently called for a 15 percent corporate tax rate.
Eliminating corporate tax expenditures would not raise enough revenue to pay for a 15 percent corporate tax rate – or even a 25 percent rate. As a result, if lawmakers are interested in paying for a large corporate rate cut solely by “closing corporate loopholes” or “repealing special preferences,” then they will be greatly disappointed.
So, what paths are available to lawmakers who are interested in a more substantial corporate tax rate cut? I’d suggest that, in order to cut the corporate tax rate below 28.5 percent, lawmakers will have to relax at least one of the three criteria listed above:
- Lawmakers could decide to pass a bill that is not revenue-neutral. For instance, they could pay for the cost of a corporate rate cut by reducing federal spending, although this would be very politically difficult. Alternatively, Congress could choose not to pay for the cost of a corporate rate cut at all, and simply increase the federal deficit – but this would be a tough proposition in an era of high federal debt.
- Lawmakers could design a bill that is not corporate-only. Instead of only eliminating tax preferences for corporations, lawmakers could also consider eliminating tax breaks for households and non-corporate businesses to pay for a corporate rate cut. Or perhaps, lawmakers could offset the cost of a corporate tax cut by raising a different federal tax. The theory behind this approach is sound: if the corporate income tax is really the most harmful part of the federal tax system, then lawmakers should be willing to look for revenue in other parts of the tax code to reduce it. However, the optics here are not ideal: the public may not warm to the notion of raising taxes on households to cut taxes on corporations (even though all corporate taxes are ultimately paid by households).
- Finally, lawmakers could design a bill that makes structural changes to the corporate income tax, rather than just eliminating tax expenditures. A number of interesting ideas have been proposed on this front by lawmakers. For instance, the House Republican tax plan released last summer includes a proposal to flip the treatment of interest in the business tax code, eliminating the deductibility of interest paid and lowering taxes on interest received. Not only would this proposal reduce the bias toward debt in the tax code and cut off a method of corporate tax avoidance, but it would also raise over a trillion dollars over ten years, helping to pay for a large statutory rate cut. Another idea from the House Republican tax plan is to make the federal income tax border adjustable, which would improve the U.S. international tax system and also raise roughly a trillion dollars, to help pay for a lower corporate tax rate.
In conclusion, eliminating corporate tax expenditures only goes so far. To substantially lower the corporate income tax rate, lawmakers will have to think outside the box.
| Note: The 54 tax expenditures listed above represent all corporate tax expenditures listed by the Treasury Department, except those related to cost recovery, deferral of gain, and international income. The revenue loss figures presented above represent the amount of revenue that the federal government is expected to forgo over ten years due to the portion of each provision that is claimed by C corporations. The revenue loss figures do not represent the full cost of the tax expenditures in question (many of which are also claimed by pass-through businesses), nor do they necessarily represent the amount that federal revenue would increase upon repeal of each provision (which may be affected by behavioral, timing, and macroeconomic considerations). According to Tax Foundation estimates, the elimination of the corporate portion of these 54 provisions, in combination with a 28.5% corporate tax rate, would be revenue-neutral on a static basis. | |||
| Source: Treasury Department, Tax Expenditures, FY 2018 | |||
| Federal Revenue Loss from the Corporate Portion of 54 Selected Tax Expenditures, Millions of Dollars, 2017-2026 | |||
|---|---|---|---|
|
Domestic production deduction |
$152,150 |
Research and development credit |
$135,050 |
|
Low-income housing credit |
$89,910 |
Exclusion of interest on public purpose state and local bonds |
$87,570 |
|
Orphan drug credit |
$53,030 |
Exemption of credit union income |
$35,310 |
|
Deduction for charitable contributions |
$35,140 |
Energy production credit |
$28,190 |
|
Graduated corporate income tax rate |
$24,640 |
Special ESOP rules |
$22,690 |
|
Energy investment credit |
$18,220 |
Exclusion of interest on hospital construction bonds |
$10,540 |
|
Exemption of insurance income earned by tax-exempt organizations |
$8,590 |
New markets tax credit |
$7,410 |
|
Exclusion of interest on bonds for private nonprofit educational facilities |
$6,830 |
Credit for employer contributions to Social Security |
$5,930 |
|
Blue Cross/Blue Shield tax benefits |
$5,500 |
Work opportunity tax credit |
$4,600 |
|
Tax incentives for preservation of historic structures |
$4,340 |
Advanced nuclear power production credit |
$3,910 |
|
Exclusion of interest on owner-occupied mortgage subsidy bonds |
$3,640 |
Exclusion of interest on rental housing bonds |
$3,140 |
|
Reduced tax rate for nuclear decommissioning funds |
$2,690 |
Exclusion of interest for airport, dock, and similar bonds |
$2,070 |
|
Qualified school construction bonds |
$1,600 |
Exemption of certain mutuals’ and cooperatives’ income |
$1,600 |
|
Exclusion of interest on student-loan bonds |
$1,330 |
Exclusion of interest on bonds for water, sewage, and hazardous waste facilities |
$1,290 |
|
Credit for holders of zone academy bonds |
$1,190 |
Tonnage tax |
$970 |
|
Credit for investment in clean coal facilities |
$920 |
Credits for clean-fuel-burning vehicles and refueling property |
$840 |
|
Credit to holders of Gulf Tax Credit Bonds |
$690 |
Special rules for small property and casualty insurance companies |
$630 |
|
Exclusion of interest on small issue bonds |
$470 |
Small life insurance company deduction |
$450 |
|
Credit for employee health insurance expenses of small business |
$430 |
Industrial CO2 capture and sequestration tax credit |
$410 |
|
Recovery Zone Bonds |
$390 |
Exclusion of interest on bonds for Highway Projects and rail-truck transfer facilities |
$380 |
|
Exclusion of utility conservation subsidies |
$300 |
Credit for holding clean renewable energy bonds |
$200 |
|
Investment credit for rehabilitation of structures (non-historic) |
$100 |
Qualified energy conservation bonds |
$100 |
|
Employer-provided child care credit |
$100 |
Tribal Economic Development Bonds |
$100 |
|
Empowerment zones |
$90 |
Credit for employer differential wage payments |
$80 |
|
Credit for construction of new energy efficient homes |
$80 |
Indian employment credit |
$60 |
|
Exclusion of interest on energy facility bonds |
$60 |
Marginal wells credit |
$50 |
|
Credit for certain expenditures for maintaining railroad tracks |
$50 |
Biodiesel and small agri-biodiesel producer tax credits |
$10 |
[1] There have been a few attempts to answer this question in the past. For instance, in 2011, the Joint Committee on Taxation estimated that repealing all corporate tax expenditures would be sufficient to lower the corporate tax rate to 28 percent. However, its estimates included the repeal of a few provisions that probably shouldn’t be considered tax expenditures (such as accelerated depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. ). Furthermore, its estimates were based on the 2011 revenue baseline, which is significantly different than the current revenue baseline (largely due to the 2015 omnibus tax bill, which made several temporary tax expenditures into permanent law). In mid-2015, Tax Foundation President Scott Hodge also wrote a paper that addressed a version of this question, but it was also published before the passage of the 2015 omnibus. Given the timeliness of the issue, I decided to examine it myself, using the latest data and federal law baseline.
[2] For the purposes of this thought experiment, I’ve examined how much Congress could reduce the corporate income tax rate on a static basis if every tax expenditure were eliminated. If the economic effects of a corporate rate cut were considered, Congress would be able to reduce the corporate rate more on a revenue-neutral basis, although these effects are unlikely to be accounted fully by the official scorekeeper, the Joint Committee on Taxation.
[3] According to the Treasury, there are 86 corporate tax expenditures; according to the Joint Committee on Taxation, there are over 100. The 54 tax expenditures that I identified for the purpose of this thought experiment consist of all corporate tax expenditures on the Treasury’s list, except for those that appear to be efforts to move the 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. toward a different paradigm. I’ve excluded all tax expenditures that accelerate cost recovery and defer the taxation of gains, given that they move the corporate income tax closer to a cash-flow base. Additionally, I’ve excluded all tax expenditures dealing with foreign-source income, as they represent an attempt to move closer to a “territorial” paradigm for taxing income earned overseas.
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