Business tax codes can often be viewed impersonally, unlike individual tax codes. Who are the workers, consumers, and shareholders who interact with U.S. businesses? What forms do these businesses take? How do business taxes impact people's lives?
For a business tax system that is simple, efficient, and allows economic growth, these questions must be answered for tax business support
The following posts aim to provide taxpayers and lawmakers with the facts and data necessary to understand business taxes in America better and to engage in an open and productive debate.
Not All Tax Expenditures Are Equal
The debate in Washington, D.C. often revolves around tax expenditures, so-called corporate loopholes. However, not all tax expenditures are created equal. Some of them are neutral tax treatment and should be left alone, while others are distortionary and should be repealed. Understanding what a tax expenditure means is essential for understanding how our tax code works for businesses and individuals.
Tax expenditures provide preferential treatment to certain types of economic activity, reducing the tax base and making the tax code less neutral. However, some broad-based changes play an essential role in moving the U.S. toward a different tax system. Hence, eliminating expenditures across the board would be ill-advised.
It is further complicated by the fact that what constitutes a tax expenditure depends on what qualifies as "normal" taxation. As an example, the Joint Committee on Taxation considers depreciation a cost, but this is a questionable treatment based on the Haig-Simons definition of income, which is common but flawed.
Businesses Must Pay Taxes on Income Due to Depreciation
Tax rates matter to businesses, but so do the income levels to which those tax rates apply. The corporate income tax is a tax on profits, generally defined as revenue minus costs. The current tax code does not allow businesses to deduct the total cost of certain expenses, such as capital investments, which means the tax code is not neutral and increases investment costs.
Under the U.S. tax code, businesses are generally permitted to deduct ordinary business expenses from their earnings. However, this is not always the case when businesses make capital investments, such as when they purchase equipment, machinery, and buildings.
Businesses typically deduct capital investment costs over several years according to predetermined depreciation schedules rather than subtracting them immediately in the year the investment occurs. The Tax Cuts and Jobs Act of 2017 reduced the tax code's bias against short-lived capital investments. The full expensing provision, however, is temporary and does not apply to long-term investments.
As a result of delaying deductions, the present value of the write-offs (adjusted for inflation and time value of money) is less than the original investment cost. The rate of inflation and discount rate determines how much less valuable it is. Since businesses cannot fully deduct their costs, the delayed tax burden effectively shifts the tax burden forward in time, resulting in a lower after-tax return on investment.
Capital Income Taxes Are Not Just Corporate Income Taxes
The United States now has a corporate income tax rate more aligned with other nations. Taxes on capital income, or corporate investment, go beyond corporate income tax. Dividend taxes and capital gains taxes at the shareholder level affect incentives to save and invest.
According to the Organisation for Economic Co-operation and Development (OECD), the combined tax rate on corporate profits in the United States is above average. For example, in 2018, the first tax year after passing the Tax Cuts and Jobs Act, the U.S. rate was 47.25 percent, compared to the OECD average of 41.7 percent. However, the U.S. corporate tax rate has significantly decreased since the Tax Cuts and Jobs Act was passed. In 2017, the corporate tax rate in the United States was 56.32 percent.
Combined State and Federal Corporate Income Tax
Since state corporate income taxes are deducted from federal taxable income, the effective federal corporate income tax rate is lower. As an example, a corporation in Kentucky can deduct the tax paid at a flat rate of 5 percent from the federal corporate income tax of 21 percent, reducing its federal rate to 19.95 percent.
In four other states, corporations can deduct some of their state corporate income tax against federal corporate income tax. Alabama and Louisiana allow a full deduction of federal corporate income tax from state tax liability, whereas Iowa and Missouri allow a 50 percent deduction. Consequently, corporations in these states face a lower effective rate of corporate income tax.