Should the Corporate Income Tax Be Raised?

Negotiations among lawmakers of both parties over President Biden’s infrastructure plan have centered on two issues. First, the Biden administration sticks to a large $2.3 trillion spending program that includes not only many broadly-defined infrastructure spending items but also spending items that can hardly be regarded as spending on infrastructure (e.g., spending on elderly care). Senate Republicans are pushing for a much smaller program of $568 billion that focuses on more traditional infrastructure items: roads, bridges, public transit systems, or broadband internet. Second, the administration’s preferred revenue source is an increase in the rate of federal corporate income tax from the current 21% to 28%. Republicans suggest looking at alternative ways of financing, including the gas tax, based on the user-pay principle. 
 
We would argue that raising the rate of the corporate income tax, or CIT, is a very inefficient way of generating revenue, and will harm the competitiveness of the U.S.
 
In a highly integrated world economy in which capital can move relatively freely, corporations tend to move their production to countries with lower corporate income taxes. For example, many U.S. firms have invested heavily in Ireland, and a major draw for those firms is Ireland’s low CIT rate of 12.5%.[1] Critics of Ireland’s low CIT rate acknowledge that the low rate has helped Ireland attract businesses and achieve a GDP per capita that in 2019 was $78,661 per person according to World Bank statistics. Compare that to the U.S. at $65,298 per person, or the U.K. at $42,330 per person. No, the critics' complaints are that Ireland’s CIT is too low and attracts businesses away from other countries!  Perhaps it is not surprising that the (unweighted) average CIT rate for OECD countries has fallen from 47% in 1981 to 24% in 2017. [2] Given all this, why would the U.S. want to raise its CIT rate and swim against the tide?
 
At the federal level, the current CIT rate for the U.S. is 21% following the 2017 comprehensive tax reform. However, forty-four states levy a CIT with rates ranging from 2.5% in North Carolina to 11.5% in New Jersey,[3] and many local governments impose their own CIT.  Therefore, the overall CIT rate for the U.S. can exceed the OECD average of 24%.  In comparison, China imposes a standard CIT rate of 25%, but has a lower concession rate of 15% for high-tech companies. India has a range of CIT rates with the highest being 25.17% and the lowest being 17.01%.[4]  
 
Increasing the CIT rate is also an inefficient way to raise revenue. First, corporate investment responds negatively to such a rate increase, and hence puts a downward pressure on corporate profits – the very base of the CIT. Second, with capital formation at the center of economic activities, any policy that impedes capital formation would also slow down economic activities in general, reducing the tax bases for other taxes (e.g., the personal income tax). The integration of the world economy in recent decades has made investment (and by extension, the tax base) in a country much more responsive to a CIT rate increase in that country.  In response, countries have opted for competitive CIT rates in order to attract foreign investment or retain their own capital. 
 
It is often argued that large corporations should pay their fair share of taxes. However, at the end of the day it is people who ultimately shoulder the burden of all taxes. Individuals receive the benefits of corporate profits either through dividend payments on the stocks they own or capital gains on those stocks. These benefits arrive either directly from stocks and mutual funds they own, or indirectly via their retirement accounts, be they 401k-type defined contribution plans or more traditional defined benefit plans. The corporate income tax is in fact a double taxation of corporate profits, as these profits are first subject to the CIT, and then the stockholders are taxed via the individual income tax on their receipt of corporate dividends or their capital gains. 
 
Perhaps most troubling is the impact on growth and wages. A higher corporate income tax leads to a lower capital stock than would otherwise exist, and a lower capital stock reduces the demand for labor, hence leading to lower wages than would otherwise exist (or fewer jobs in corporations). In this sense, workers bear some burden from the CIT rate increase in the form of lower future wages.
 
To summarize, both the appropriate size and the appropriate financing are important issues in the administration’s infrastructure plan. As we have argued, raising the CIT rate to finance the proposed spending program is not the way to go, especially in this global economy where capital is highly mobile across borders. It would be more prudent to focus on the more traditional infrastructure projects and to finance the spending increase with more efficient and equitable revenue instruments. One such revenue instrument could be user fees. For example, an increase in the gas tax is arguably a more appropriate way to finance increased spending on roads and bridges. Indeed, a gasoline tax -- or a more basic carbon tax -- would seem to help President Biden’s initiatives to reduce carbon emissions while raising revenue for his infrastructure spending, so it is surprising that he is instead proposing to increase the CIT.
 

References

McDonald, Henry (2015). “700 US companies now located in Ireland as direct investment soars,” The Guardian, Thursday 5 March 2015 https://www.theguardian.com/world/2015/mar/05/ireland-attracts-soaring-level-of-us-investment

OECD (2018). “The role and design of net wealth taxes in the OECD,” OECD Tax Policy Studies, No.26, OECD Publishing, Paris. http://www.etudes-fiscales-internationales.com/media/01/01/2671881366.pdf
 
Tax Foundation (2021). “State corporate income tax rates and brackets for 2021.” https://taxfoundation.org/publications/state-corporate-income-tax-rates-and-brackets/
 
Wikipedia (2021), “List of countries by tax rates.”   https://en.wikipedia.org/wiki/List_of_countries_by_tax_rates
 
 
[1] See McDonald (2015).
[2] See OECD (2018, page 17).
[3] See Tax Foundation (2021).
[4] See Wikipedia (2021).

Posted: April 26, 2021 by Dennis W. Jansen, Liqun Liu, Andrew J. Rettenmaier