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Thursday, June 10, 2010

Corporate Tax Reform: Issues for Congress

Jane G. Gravelle
Senior Specialist in Economic Policy

Thomas L. Hungerford
Acting Section Research Manager

H.R. 3970, introduced in the 110th Congress by then-Chairman Charles Rangel of the House Committee on Ways and Means, includes corporate tax revisions, trading a lower rate for a broader tax base as part of the revenue neutral reform package. S. 3018, introduced by Senators Ron Wyden and Judd Gregg in the 111th Congress, also provides for a lower corporate tax rate in exchange for a somewhat broader corporate tax base. Some discussions by economists in opinion pieces suggest there is an urgent need to lower the corporate tax rate, but not necessarily to broaden the tax base.

Arguments for lowering the corporate tax rate include the traditional concerns about economic distortions arising from the corporate tax and newer concerns arising from the increasingly global nature of the economy. Some claims have been made 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 have also been 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 data. Claims that behavioral responses could cause revenues to rise if rates were cut do not hold up on either a theoretical basis or an empirical basis. Studies that purport to show a revenue maximizing corporate tax rate of 30% (a rate lower than the current 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. Similarly, claims that high U.S. tax rates will create problems for the United States in a global economy suffer from a misrepresentation of the U.S. tax rate compared to other countries and are less important when capital is imperfectly mobile, as it appears to be.

Although these new arguments appear to rely on questionable methods, the traditional concerns about the corporate tax appear valid. While 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. Moreover, it is difficult to lower the corporate tax without creating a way of sheltering individual income given the low rates of tax on dividends and capital gains.

A number of revenue-neutral changes are available that could reduce these distortions, allow for a lower corporate statutory tax rate, and lead to a more efficient corporate tax system. These changes include base broadening, reducing the benefits of debt finance through inflation indexing, and reducing the tax at the firm level offset by an increase at the individual level. This report will not be updated. 

Date of Report: May 25, 2010
Number of Pages: 44
Order Number: RL34229
Price: $29.95

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