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Corporate Tax Reform: Issues for Congress

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Corporate Tax Reform: Issues for Congress Corporate Tax Reform: Issues for Congress Updated June 11, 2021 Congressional Research Service https://crsreports.congress.gov RL34229 SUMMARY RL34229 Corporate Tax Reform: Issues for Congress June 11, 2021 In 2017, the corporate tax rate was cut from 35% to 21%, major changes were made in the international tax system, and changes were made in other corporate provisions, including Jane G. Gravelle allowing expensing (an immediate deduction) for equipment investment. Recently, proposals Senior Specialist in have been made to increase revenue from corporate taxes, including an increased tax rate, and Economic Policy revise the international tax provisions to raise revenue. These revenues may be needed to fund additional spending or reduce the deficit. Some level of corporate tax is needed to prevent corporations from becoming a tax shelter for high-income taxpayers. The lower corporate taxes adopted in 2017 made the corporate form of organization more attractive to individuals. At the same time, higher corporate taxes have traditionally led to concerns about economic distortions arising from the corporate tax and newer concerns arising from the increasingly global nature of the economy. In addition, leading up to the 2017 tax cut, some claimed that lowering the corporate tax rate would raise revenue because of the behavioral responses, an effect that is linked to an open economy. Although the corporate tax has generally been viewed as contributing to a more progressive tax system because the burden falls on capital income and thus on higher-income individuals, claims were also made that the burden falls not on owners of capital, but on labor income—an effect also linked to an open economy. The analysis in this report suggests that many of the concerns expressed about the corporate tax are not supported by empirical evidence. Claims that behavioral responses could cause revenues to rise if rates were cut do not hold up on either a theoretical or an empirical basis. Studies that purport to show a revenue-maximizing corporate tax rate of 30% (a rate lower than the prior statutory tax rate) contain econometric errors that lead to biased and inconsistent results; when those problems are corrected the results disappear. Cross-country studies to provide direct evidence showing that the burden of the corporate tax actually falls on labor yield unreasonable results and prove to suffer from econometric flaws that also lead to a disappearance of the results when corrected, in those cases where data were obtained and the results replicated. Many studies that have been cited are not relevant to the United States because they reflect wage bargaining approaches and unions have virtually disappeared from the private sector in the United States. Overall, the evidence suggests that the tax is largely borne by capital. Similarly, claims that high U.S. tax rates created problems for the United States in a global economy suffer from a misrepresentation of the U.S. tax rate compared with other countries, because the comparisons focus on statutory rate. Tax rates are less important when capital is imperfectly mobile, as it appears to be, and because these concerns did not address the fundamental issues of efficiency in international taxation. Although these new arguments appear to rely on questionable methods, the traditional concerns about the corporate tax appear valid. Although an argument may be made that the tax is still needed as a backstop to individual tax collections, it does result in some economic distortions. These economic distortions, however, have declined substantially over time as corporate rates and shares of output have fallen, even before the 2017 tax cut. Lower corporate taxes also create a way of sheltering individual income given the low tax rates on dividends and capital gains. In addition to higher tax rates, a number of revisions could be made to increase corporate tax revenue, including eliminating preferences in the corporate tax that mismeasure income or lead to economic inefficiencies, revising the tax treatment of foreign source income, and changing shareholder level taxes. Congressional Research Service Corporate Tax Reform: Issues for Congress Contents Introduction ..................................................................................................................................... 1 The Corporate Tax as a Revenue Source ......................................................................................... 4 Magnitude and Historical Pattern .............................................................................................. 5 The Role of the Corporate Tax in Backstopping the Individual Tax ......................................... 6 Behavioral Responses and Revenue-Maximizing Tax Rate ............................................................ 8 Theoretical Issues .................................................................................................................... 10 Revenue Feedback from a General Equilibrium Model to Illustrate Likelihood of a Laffer Curve Near Pre-2017 Rates ....................................................................................... 13 Reduced Form Empirical Analysis .......................................................................................... 13 Brill and Hassett Study ............................................................................................................ 13 Clausing Study ........................................................................................................................ 14 Cross-Country Investment Estimates: The Djankov Study ..................................................... 16 Theoretical Issues .................................................................................................................... 16 Empirical Analysis .................................................................................................................. 17 Distributional Effects ..................................................................................................................... 18 The Harberger and Randolph Studies ..................................................................................... 20 The Hassett and Mathur Study ................................................................................................ 22 Other Empirical Wage Studies ................................................................................................ 26 Other Cross-Country Studies of General Burden ............................................................. 26 Cross-State Regressions .................................................................................................... 28 Rent Sharing Studies ......................................................................................................... 29 What Should Be Concluded About Incidence? ....................................................................... 35 Economic Efficiency Issues .......................................................................................................... 35 Allocation of Capital Within the Domestic Economy ............................................................. 35 Savings Effects ........................................................................................................................ 40 International Capital Flows ..................................................................................................... 40 Potential Revisions in the Corporate Tax ...................................................................................... 41 Corporate Tax Expenditures .................................................................................................... 42 CBO Budget Options .............................................................................................................. 43 Biden Administration’s Proposals ........................................................................................... 43 Congressional Proposals ......................................................................................................... 45 Other Options Proposed in Prior Congresses .......................................................................... 46 Evaluating Tax Revisions ........................................................................................................ 48 Increasing Individual Level Taxes; Shifting Between Corporate and Individual Form .......... 49 Conclusion ..................................................................................................................................... 50 Tables Table 1. Effective Tax Rates for Alternative Forms of Organization Under Alternative Rate Structures, Individual at 39.6% (43.4%) Rate ................................................... 8 Table 2. Revenue-Maximizing Tax Rates and Share of Variance Explained in the Clausing Study ................................................................................................ 10 Table 3. Coefficient Estimates: Dependent Variable is Corporate Revenues as a Percentage of GDP (Brill and Hassett Model) .................................................................... 14 Congressional Research Service Corporate Tax Reform: Issues for Congress Table 4. Coefficient Estimates: Dependent Variable is Corporate Revenues as a Percentage of GDP (Clausing Model) ................................................................................. 15 Table 5. Coefficient Estimates: Key Independent Variable
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