CRS REPORT ANALYZES POTENTIAL
APPROACHES TO CORPORATE AND
INTERNATIONAL TAX REFORM
Click here for the text of CRS Report 7-5700, ³The Corporate Income
Tax System: Overview and Options for Reform.² [Link Omitted]
There is a growing consensus among politicians that the U.S.'s
corporate and international tax systems should be reformed, but there
are many differing perspectives and ideas on how to do so. A new
Congressional Research Service (CRS) report examines the current
structure of the corporate income tax and the effective tax rates paid
by corporations, compares the U.S. corporate income tax system to
those of other developed countries, examines the U.S.'s worldwidebased international tax approach, weighs options for reform, and
analyzes a number of specific proposals.
Current tax treatment of C corporations. The income of a C
corporation is subject to double taxation since it is taxed once at the
corporate level, then again at the shareholder level. (In contrast, the
income of non-corporate businesses such as partnerships is passed
through to the owners without an entity-level tax.) The general
procedure for computing corporate tax is basically the same as the
procedure for computing the tax of any other taxpayer. It involves
computation of taxable income, application of rates, and subtraction
of credits. Corporations are subject to graduated tax rates similar to
individuals, with a nominal top rate of 35%.
However, although much attention is paid to the top 35% tax rate,
many corporations pay significantly less due to the various available
deductions, credits, etc. According to the CRS report, the corporate
tax system ³contains a variety of incentives designed to encourage
certain types of behaviors and assist certain businesses.² These
include accelerated depreciation, the Code Sec. 199 domestic
production activities deduction, and the deferral of foreign-earned
income.
The treatment of losses also has a significant impact on corporate
income taxes. A corporation doesn't owe any corporate tax in years
that it has a net operating loss (NOL). Corporations are also allowed
to carry back NOLs and deduct them against two years of prior
taxable income, generating tax refunds, and carry forward any
remainder to reduce future tax liabilities for up to 20 years. The CRS
report characterizes this as effectively creating a partnership between
the government and taxpayers in which they both share the risks and
returns of the investment.
Another prominent feature of the U.S. corporate tax system is a taxinduced bias towards debt financing, stemming largely from the fact
that interest payments are deductible whereas dividend payments are
not.
Tax treatment of shareholders. When a corporation distributes its
after-tax profits to shareholders via dividends, the dividends are
currently taxed to the shareholders at a maximum 15% rate (0% if the
taxpayer is subject to an ordinary income tax rate of 15% or less).
The rates for dividends are scheduled to increase to ordinary income
tax rates after 2012 absent Congressional action.
Corporate shareholders also pay capital gains taxes when they sell
appreciated shares of stock. If the stock was held for less than a year
(short-term), the applicable rate is the taxpayer's ordinary income tax
rate. If the stock was held for greater than a year (long-term), then the
gain is currently taxed at the 0/15% rate currently applicable to
dividends. If the EGTRRA sunsets go into effect, for years after 2012,
long-term capital gain will be taxed at a maximum rate of 20% (18%
for assets held more than five years); and for lower-income
taxpayers, the maximum rate will be 10% (8% for assets held for
more than five years).
Current international tax regime. U.S. corporations are generally
taxable on income from outside the U.S. just as they are on income
from inside the U.S. (Code Sec. 862) This is known as the
³worldwide² tax system. This system theoretically eliminates any
advantage that a U.S. corporation would receive from doing business
in a low-tax country because all income, whether U.S. or foreign
source, is taxed at the same U.S. rate. (The U.S. corporation's tax
liability is generally reduced to reflect a credit for taxes paid to other
countries under Code Sec. 901.) However, this system has been
undermined in a number of ways, including the deferral by U.S.
corporations of U.S. taxes on certain foreign income.
In contrast, many countries use a ³territorial² system, which generally
taxes only the income of a multinational business that is derived from
within the country's borders. The CRS report noted, however, that no
country realistically has a purely worldwide or territorial system.
Who pays what. By industry, in 2008, the types of firms that pay the
largest shares of corporate tax are manufacturing (32%), wholesale
and retail trade (17%), and the finance and insurance industry (16%).
However, these types of businesses only represented 29% of the
total number of C corporations, reflecting the fact that most corporate
business activity is conducted by a ³rather small number of large
firms.²
Industries that are more likely to make large investments or make
significant expenditures on research and development (tax-favored
activities) are likely to have lower effective tax rates, such as
biotechnology and semiconductor industries. Industries such as retail,
food services, and utilities tend to pay higher effective tax rates.
Corporate income tax revenues. Corporate tax revenues as a
share of gross domestic product (GDP) have generally been declining
after reaching their peak in '52 (6.1%). In 2010, the corporate tax
revenue reflected 1.3% of GDP. Corporate tax revenue has also
decreased as a share of all federal tax revenue, from 32.1% in '52 to
8.9% in 2010. The CRS report attributes this to a number of factors,
including a decrease in the effective rate paid, an increase in the
amount of business activity carried out by pass-through entities, and
declining corporate-sector profitability.
U.S. vs. international corporate tax systems. According to the
CRS report, although many focus on the statutory rate when
comparing the corporate tax rates of the U.S. and those elsewhere,
economists ³generally prefer to compare effective tax rates when
making international comparisons.² This is because the rate is just
one part of each country's system and thus offers an incomplete
picture.
Although the U.S. maximum statutory tax rate is about ten
percentage points higher than the average for other OECD
(Organization for Economic Co-operation and Development)
countries, its effective rate is comparable to that of other countries.
The corporate tax revenues of the U.S. (1.9% in 2009) are also lower
than the average of the other OECD member countries (2.8%). The
report attributes this to a number of factors, including the overall
decline of corporate tax revenue in the U.S. and the fact that other
countries have adopted base broadening policies to offset tax rate
decreases, such as reduced investment credits and limitations on
interest deductibility and depreciation.
Policy considerations. In evaluating the corporate tax system, and
potential changes to it or alternative systems, the CRS report lays out
the following factors to consider:
• Whether the tax system distorts economic decision making‹in other
words, whether it is economically efficient;
• Whether the tax system would provide an incentive for corporations
to avoid taxes by retaining earnings (such as if there was only a
shareholder-level tax and no corporate-level tax);
• Whether the tax system would allow corporations to be used to
shelter income;
• Who‹owners, workers, customers, etc.‹bears the burden of
corporate tax;
• The extent to which the corporate tax is progressive (the report
states that the existing corporate tax regime is ³highly
progressive²);
• Whether the tax system promotes or impedes competitiveness
(although the CRS report asserts that competitiveness is
questionable as a tax policy objective); and
• Simplicity and administrability (since complexity in the Code diverts
funds from other productive activities to tax preparation and
compliance).
Options for reform. As the CRS report notes, many of the corporate
tax reform proposals center around reducing the rate and broadening
the tax base. The Joint Committee on Taxation has estimated that by
eliminating tax expenditures (but not repealing deferral), the rate
could be reduced to 28% while maintaining revenue neutrality for ten
years. The rate could potentially be further reduced if other changes
were made in addition to eliminating tax expenditures‹such as by
restricting or eliminating the deductibility of interest and raising capital
gains rates. However, there could be non-tax consequences to
removing certain expenditures, most notably increasing marginal tax
rates on investment (resulting in a likely reduction in investment).
Additionally, revenue-neutral tax reform based on eliminated
corporate tax expenditures would likely have a disparate burden on
different industries. Corporate tax base broadening could also have
unintended consequences for pass-through businesses that wouldn't
benefit from the reduced corporate rates.
One possible way to reform the corporate income tax system is by
integrating the corporate and individual tax systems. One approach
would be to eliminate the corporate tax and allocate earnings directly
to shareholders, similar to pass-through entities. Another approach
would be to retain the corporate tax, but give shareholders a credit for
corporate taxes paid‹in effect, treating the corporate tax as a
withholding tax. However, the CRS report noted that administrative
challenges associated with both of these approaches would be
difficult to overcome.
Another way to reform the corporate income tax system would be to
allow corporations to claim a deduction for dividends paid. This
approach would reduce, but not eliminate, the double taxation of
corporate profits. A dividend deduction wouldn't affect the taxation of
capital gains and would make it more attractive for firms to distribute
their earnings. Alternatively, double taxation could be reduced by
eliminating taxes for shareholders on dividends and/or capital gains.
However, both of these approaches would reduce federal tax
revenues.
One concern in the area of corporate tax reform is the disparate
treatment of corporate and non-corporate businesses. A number of
policymakers, including the Obama Administration, have suggested
remedying this issue by subjecting certain large pass-throughs to
corporate tax. This would allow for lower tax rates because it would
broaden the corporate tax base. Although estimates indicate that only
a small percentage of firms would actually be subject to corporate
tax, the revenue generated could be significant.
The CRS report addresses the question of whether the U.S.'s
worldwide tax system is out of step with today's globalized business
environment and examines possible reforms. It states that a shift to a
territorial system wouldn't necessarily enhance economic efficiency
and could lead to more investment in low-tax countries. Another
proposal is a dividend exemption‹allowing corporations to repatriate
income from their foreign subsidiaries by making a dividend that is
significantly (e.g., 95%) exempt from tax‹but the stimulative effect of
dividend repatriation exemptions on domestic investment and
employment is questionable.
Comparison of current proposals. The CRS report closes with a
comparison of a number of corporate and business tax reform
proposals by the Obama Administration (in ³The President's
Framework for Business Tax Reform,² released earlier this year),
Ways and Means Chairman David Camp (R-MI), the 2010 Fiscal
Commission (³Simpson-Bowles proposal²), and the Bipartisan Tax
Fairness and Simplification Act of 2011 (S. 727, the ³Wyden-Coats
proposal²). The proposals are broken down by category, starting with
the current law, as follows. (When a proposal didn't explicitly address
or suggest changes to a category, none is listed)
• Top statutory corporate tax rate. The current top rate is 35%. The
President's proposal and the Simpson-Bowles proposal would
reduce the top rate to 28%. Rep. Camp would reduce the rate
to 25%, and the Wyden-Coats proposal would reduce it to 24%.
• Corporate tax expenditures. Under current law, there are dozens
of corporate tax expenditure provisions that, in 2011, had a total
value of $159 billion. The President's proposal would reduce
interest deductibility and eliminate the last-in, first-out (LIFO)
inventory accounting method, special depreciation for corporate
aircraft, and incentives for oil, gas, and coal. The Wyden-Coats
proposal would reduce interest deductibility and eliminate LIFO,
the Code Sec. 199 domestic production activities deduction,
and certain incentives related to oil and gas. The SimpsonBowles proposal would eliminate most corporate tax
expenditures.
• New or modified tax expenditures. The President's proposal
would expand the Code Sec. 199 deduction, make the research
and development credit permanent, and provide enhanced
incentives for small businesses.
• Cost recovery. Under current law, for 2012, costs are recovered
under the Modified Accelerated Cost Recovery System
(MACRS); 50% bonus depreciation applies; and there is a
$139,000 expensing allowance. President Obama would
change depreciation rules in order to broaden the corporate tax
base and allow small businesses to expense $1 million in
investments. The Wyden-Coats proposal would allow unlimited
expensing for businesses with gross receipts of $1 million or
less, and would generally limit depreciation allowances to
straight-line depreciation. The Simpon-Bowles would proposal
would eliminate or modify accelerated depreciation.
• International taxation. Under current law, there exists a worldwide
tax system with a tax credit for foreign taxes paid, the
opportunity for deferral, and general limits on deferring passivetype imposed by subpart F. The President's proposal would
impose a minimum tax on foreign profits with foreign tax credits,
provide a 20% tax credit for expenses associated with
relocating to the U.S., enhance transfer pricing rules, and delay
interest expense on foreign earnings until such earnings are
repatriated. Rep. Camp would adopt a territorial system that
exempts 95% of active foreign earnings of a U.S. company's
controlled foreign corporation (CFC), require U.S. multinationals
to pay 5.25% on all pre-existing earnings reinvested abroad
(allowing for a foreign tax credit), and enhance transfer pricing
rules. The Wyden-Coats proposal would tax income on a
worldwide basis but end deferral, allow foreign tax credits on a
per-country basis, and allow a deduction for earnings received
from a foreign subsidiary that reinvested domestically (in 2011).
The Simpson-Bowles proposal would adopt a territorial tax
system that exempts most (or all) of U.S. offshore earnings.
• Investment income. Under current law, long-term capital gains and
dividends are taxed at a maximum rate of 15%. President
Obama would tax carried interest as ordinary income. The
Wyden-Coats and Simpson-Bowles proposals would both tax
capital gains and dividends as ordinary income, but the WydenCoats proposal would also exclude 35% of certain dividend and
capital gain income from gross income.
References: For corporate income tax in general, see FTC 2d/FIN
¶ D-1000 et seq.; United States Tax Reporter ¶ 114 ; et
seq.TaxDesk ¶ 600,200 et seq.; TG ¶ 4000 et seq. For U.S. tax
treatment of foreign income in general, see FTC 2d/FIN ¶ O-1000 et
seq.; United States Tax Reporter ¶ 8644 et seq.; TG ¶ 30350 et
seq.