Corporate tax is any levy imposed on a corporation at the federal, state, or local level. Taxes are normally based on the net income companies earn while they are operational. For many years, the United States had the highest corporate tax rate of the developed, free-market nations that make up the Organization for Economic Cooperation and Development (OECD). But that changed after the Tax Cuts and Jobs Act (TCJA) was signed into law in December 2017. This new bill reduced the rate from 35% to 21%. The change was put in by the Trump Administration, which said it wanted to help bring jobs and profits back to the United States from overseas.
But tax rates are never static. There's always the possibility that they'll increase when a new administration is voted in or when the economy turns sour. So what happens if the corporate tax rate in the U.S. increases again and what did they do to corporations in the past? Keep reading to learn more about the impact of higher taxes on businesses and Americans.
- The corporate tax rate dropped from 35% to 21% following the passing of the Tax Cuts and Jobs Act in 2017.
- Higher corporate profits tend to move jobs and profits overseas.
- Companies generally spend more rather than save and invest when corporate tax rates are higher.
- Economists say lower tax rates may result in higher tax revenue for the government because companies are more likely to curb spending.
The History of U.S. Corporate Taxes
Corporate taxes have been in effect in the United States since the late 1800s. Most corporations—both foreign and domestic—pay taxes at the federal level for operations within the boundary of the U.S. There are certain corporations, though, that are exempt. For instance, S corporations pass corporate income to their shareholders, who claim this figure on their personal taxes.
As mentioned above, the marginal corporate tax rate in the United States was the highest among all developed nations in the OECD until the TCJA. Between 1993 and 2017, the marginal rate was steady at 35%. Keep in mind, this figure doesn't include any state or local taxes. Sure, it was a lot, but it certainly wasn't the highest corporate tax rate in American history. Between 1951 and 1964, U.S. businesses had to pay as much as 52% in corporate taxes. The corporate tax rate even went as high as 52.8% between 1968 and 1969. That's a far cry from the early days of the corporate tax, which hovered under the 10%-mark between 1909 and 1917.
Worldwide vs. Territorial Tax Systems
Under the Trump Administration's tax reform bill, the corporate tax rate dropped from 35% to 21%. The bill also eliminated taxation on certain forms of foreign-earned income, thereby reducing the tax liability of companies that do business abroad.
The passing of the Tax Cuts and Jobs Act in 2017 eliminated taxation on certain foreign-earned corporate income.
Prior to this, the U.S. government used a worldwide tax system, a system that taxes income regardless of where it's earned. This meant American corporations were taxed by the U.S government on the income earned domestically and abroad. But that's not all. Any company that operated outside the U.S. was also taxed by the countries where they operated as well. This meant many American companies were double-taxed—by the U.S. as well as by the country where they did business. Not only did this double tax put a burden on corporations, but it also put them at a disadvantage compared with foreign competitors that weren't subject to double taxation.
Most developed countries, though, don't use a worldwide tax system. Instead, they use what's called a territorial tax system, which only taxes companies on the profits they earn within a specific country. Under a territorial system, an American company would only pay taxes on income earned in France to that country, and would only give Uncle Sam a cut of the profits it earns at home.
Moving Jobs and Profits Overseas
Higher corporate taxes don't just hit corporations. They have a ripple effect on the economy as a whole as well as American workers. When they're forced to pay higher taxes at home, many U.S. companies relocate to countries with more favorable tax laws. When these companies move their headquarters or create foreign subsidiaries, jobs and profits also move overseas. In fact, the number of U.S. jobs at major multinational corporations tends to shrink when they move their operations to another country.
“(A) high corporate income tax rate puts the U.S. at a competitive disadvantage versus lower-taxed nations like Ireland and Canada in the effort to attract new corporate investment and jobs,” said John Boyd, Jr., principal of The Boyd Company, a Princeton, N.J.-based firm that counsels major corporations on where to locate their facilities and invest globally.
When companies pay more in taxes, they usually aren't spending enough on innovation or development. They also have to direct more of their money to other channels to help them save.
Because tax rates, corporate tax deductions, and credits have such a significant impact on the bottom lines of businesses, lobbying politicians to change or maintain the tax code in ways that benefit corporations becomes a valuable use of corporate income. If corporate taxes weren't such a burden, companies could instead spend the money they use for lobbying to develop new products and services, not to mention increase their sales. So not only do corporations lose, but their customers lose as well. That's because these products and services either take longer to get to market or never make it there at all.
Discouraging Saving and Investment
Another problem that comes with higher corporate taxes is the fact that they don't encourage corporations to save or to make major investments. Instead, they're more focused on spending.
“One big issue I have with high corporate taxes is that they encourage business owners to spend instead of save for the future,” said Jeff Kear, co-owner of Planning Pod, a comprehensive, online event-management application. The way the corporate tax code was structured, he explained, “if you spend your revenues in the current tax year on business-related expenses, you can effectively write many them off.”
Saving and investing revenues so more capital is available for future growth, or to sustain the business through hard times, would be the smarter decision for many businesses, but those saved and invested revenues incur more taxes. According to Kear, the higher the corporate tax rate, the more unstable the business world becomes.
The Argument for Lower Rates
According to the Tax Policy Center, federal government revenue comes from the following sources:
- individual income taxes: 48%
- payroll taxes: 35%
- corporate taxes: 9%
- other sources: 8%
The share of federal revenue attributable to the corporate tax was close to 40% in 1945 and has hovered around the current levels since the 1980s. Individuals have paid an increasing share of total taxes in recent decades, as corporations have paid a decreasing share, according to the Center on Budget and Policy Priorities, a public policy organization focused on budget and tax policies. This increase is mostly in the form of the payroll tax.
Corporate tax reform efforts aim to repeal corporate tax credits and deductions, reduce the corporate tax rate, and get companies to bring income from abroad back to the United States without reducing overall federal tax revenue. Many of these proposals are unpopular with corporations, who are often major contributors to politicians’ election campaigns. These contributions give politicians an incentive to keep corporations happy, which frequently means maintaining the status quo. Politicians can’t agree on reforms, so little changes. The proposals are also unpopular with the entities reformers propose raising taxes on to keep total government revenue the same. These groups fight change as well.
So why are lower tax rates great for corporations? Economists project that lowering corporate tax rates is a boon for the economy. That's because they would actually increase tax revenue. How? By lower tax rates, corporations could dedicate more resources to taxable, profit-generating activities rather than spending, putting more money back into the government's coffers rather than somewhere else. Jobs also come back to the U.S., employing more people. And more money is spent on innovation, which creates more products and services, putting more money back into the economy.
The Bottom Line
Higher marginal tax rates on U.S. corporations discourage them from earning profits domestically. This, in turn, sends jobs and taxable income overseas. Higher rates give businesses an incentive to spend rather than save and invest for the future, even when the latter may be the more prudent choice. They also waste corporate resources that could be better spent on developing new products and services.