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A Primer on the Corporate Income Tax: Incidence, Efficiency and Equity Issues

2 min readBy: Michael L. Marlow

Download Background Paper No. 38

Background Paper No. 38

Executive Summary
Paul H. O’Neill, [former] Secretary of the Treasury provided the following commentary on the confusing and complex nature of how the federal government collects 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. es from corporations:

“For a long time we’ve maintained what I think is clearly a fiction – the idea that somehow corporations and businesses pay taxes. The clear economic truth is that businesses and corporations don’t pay taxes, they just collect them for the government …”

Unfortunately, most Americans have serious misperceptions about the actual burden of 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. , which produces over $200 billion annually in federal collections, or roughly $727 for each American. But economists have long understood that corporations simply collect taxes for the government, while people ultimately bear the cost. Most economists agree on the following facts about the corporate tax.

All Americans bear the burden of the corporate income tax. Our analysis of the economic incidence of the corporate income tax demonstrates that individuals— workers, consumers, and investors—bear the cost of the tax. Corporations are legal structures that provide the nexus for individuals acting in different capacities to accomplish their goals. These people actually shoulder the burden of paying the
corporate income tax.

The corporate income tax lowers standards of living. Economists have estimated that for every dollar collected by the federal government through the corporate income tax, an additional one and a half dollar’s worth of economic resources are consumed. This means a lower standard of living for all Americans. One study estimates that elimination of the corporate income tax would increase the average American’s lifetime standard of living by the equivalent of $10,000.

The corporate income tax is a double-tax. The federal government first collects taxes on corporate profits and then taxes shareholders through the personal income tax code on either their dividend income or their capital gain. Accounting for this double tax, shareholders face a total tax on their income of anywhere from 45 percent to 60.7 percent.

The sharp rise in the number of 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 reflects business owners fleeing the corporate income tax. The total number of S corporations, which are exempt from the corporate income tax, has grown to over 2.7 million. The average annual growth in the number of S corporations since 1986 is 10.3 percent, versus a 1.1 percent decline in the number of C corporations over the same period.

The corporate income tax becomes less progressive as more Americans invest in pensions, real estate, mutual funds and direct stock holdings. More than 50 percent of American households now own equities either outright or through personal retirement plans. Gains in capital ownership by lower-income individuals will be increasingly punished by double-taxation as their holdings grow.

As a share of all federal tax payments, corporate income tax receipts have increased by 64.5 percent from 1983 to 2001. Coupled with the rapid rise in stock market participation by American families, the sharp rise in corporate income tax collections highlights the importance of having a firm understanding of the issues surrounding this important levy.