The Corporate Income Tax: High Rates, Low Revenue

Internal Revenue Service Commissioner Douglas Shulman and Assistant Treasury Secretary for Tax Policy Emily McMahon are sworn in prior to testifying before the Senate Homeland Security and Governmental Affairs Committee

Photograph by Win McNamee/Getty Images.

This afternoon, the Obama administration is going to be formally rolling out its corporate income tax reform proposal, bringing to the front of public debate my very least favorite tax policy issue. But for the record, the deal with the corporate income tax is that it’s leveled at a high rate (35 percent!) but it doesn’t actually raise very much revenue because only suckers actually pay that rate.

Only suckers pay the rate because there are lots and lots and lots and lots of available deductions. This in turn creates two problems. One is that if you’re in a line of business that isn’t well established and hasn’t already created lots of loopholes for itself, you’re now paying a much higher tax rate than other kinds of firms. This discourages capital from flowing into entrepreneurial activities. The second is that it gives firms a very large incentive to focus time and resources on tax avoidance. A great productivity-enhancing innovation might boost profits by 3 percent, but that may be peanuts compared to the return on lobbying for a new loophole that shelters your existing profits from taxation.

So what we ought to do is close loopholes and lower rates. But of course there wouldn’t be any loopholes if not for the fact that there were large blocks of members of congress who wanted to create them. And in the American political system it’s much harder to change things than to block change, so change tends not to happen.

The other problem is that voters have confused ideas about this. “Make the corporations pay!” sounds good to people, even though “the corporations” as such don’t end up paying. But conversely, creating a tax credit for each individual thing a company might realistically do also sounds good. Research and development! Hiring workers! Investing in capital goods! Who doesn’t like that stuff? So nobody actually wants to lower the rate and nobody actually wants to eliminate loopholes even though everyone agrees that we ought to lower the rate and eliminate loopholes. Got it? An interesting theoretical question is who actually does pay the corporate income tax? Does it fall on workers? On owners of land? On owners of capital? I can assure you that after reading a few papers on this thanks to the National Bureau of Economic Research’s search tools that the answer is credible researchers disagree and the answer is highly sensitive to modeling assumptions!

Fun, right?