Tax Analysts Blog

The Highest Corporate Tax Rate Should Be Zero

Posted on May 6, 2015

The Tax Foundation recently released a report detailing the state corporate tax rates around the country. The highest statutory rate is in Iowa at 12 percent. Others in the top 10 are Pennsylvania (9.99 percent), Minnesota (9.8 percent), Alaska (9.4 percent), the District of Columbia (9.4 percent), and Connecticut and New Jersey (9 percent each). The states with the lowest top marginal rates are North Dakota (4.53 percent), Colorado (4.63 percent), and Mississippi, North Carolina, South Carolina, and Utah (5 percent each).

Washington, Nevada, Texas, South Dakota, Ohio, and Wyoming do not impose this awful tax. Of course, several of these states impose an equally bad tax in its stead. The Tax Foundation compilation reminded me of the reasons we should not tax corporate income at the state level. Since 2002 I have been saying that states should repeal their corporate income taxes. I speak practically and am not furthering some ideological agenda. I said then that (1) the corporate income tax did not raise a lot of money; (2) without combined reporting and other safeguards, it would never make a lot of money; (3) it consumed an inordinate amount of resources (planning, litigating, auditing); and (4) it does not matter and we should stop pretending that it does.

So I ask again, why are states taxing corporate income? Is it because they need the money? States certainly need the money. But the state corporate income tax does not raise a lot of money relative to other taxes. In 2014 it raised about $46 billion out of total state taxes of about $870 billion. Logically, if we're keeping the tax because we need the money, we should impose it the right way. Stop watering down apportionment formulas and handing out tax incentives, and adopt combined reporting. However, states will not take steps to strengthen the tax.

Do we want a corporate tax because corporations derive benefits from the government? Businesses enjoy the benefits of the state public safety apparatus, infrastructure, courts, and schools. Those are valid reasons for taxing corporate income. But if it's true, why do we use single-sales-factor or double-weighted sales apportionment formulas? Those formulas encourage corporations to invest and employ more without incurring higher taxes. That's not the definition of a benefits tax -- and as we know, the trend has been toward more single-sales-factor apportionment formulas.

Finally, many want to tax corporate profits as a means of redistributing wealth. That is, we tax corporations to increase the overall progressivity of the system. In the era of endless debate over income inequality, this is a potent argument. That, of course, assumes that the corporate tax burden falls squarely on the heads of fat-cat shareholders. But many, if not most, American workers are shareholders through 401(k) or pension plans. Besides, there has been a 40-year discussion over the incidence of the tax. Some economists believe the burden falls on owners of capital in the form of lower returns. Some think the burden falls on consumers in the form of higher prices. But lots of people think the burden falls on labor in the form of lower wages, especially in a global economy. If the burden is falling on labor, the corporate income may be exacerbating income inequality.

Why we tax corporate income is a question worth answering. States do need the money -- and corporate profits have steadily risen over the decades while corporate tax revenue has not kept pace. Moreover, corporate tax burdens matter in the world economy -- as evidenced by the fact that politicians trip over themselves to hand out tax breaks to encourage investments. We still spend an inordinate amount of resources dealing with the tax. But most important, state corporate taxes will increasingly come under attack in this country. Those who favor the tax will need to do a better job of explaining why.

This is an excerpt of an article that first appeared in State Tax Notes.

Read Comments (2)

emsig beobachterMay 6, 2015

I agree wholeheartedly. The one area of disagreement is the characterization of
the corporate income tax as a benefits tax; it is not. Property taxes, special
excise taxes, and even the sales/use tax on business inputs are better measures
of the resources used by businesses.Businesses that are in a loss position
consume resources as do profitable corporations. Corporate income taxes may
serve as a backstop to the individual income tax.

The incidence of the corporate income tax depends on the openness of the
economy, the competitive structure of the industry, the demand for the output
of the industry, and other factors. For these reasons, and for the ideological
bent of the persons trying to estimate the incidence of the tax the question of
the incidence of the corporate income tax will remain unanswered. The actual
incidence of the corporate income tax may actually be firm specific.

robert goulderMay 7, 2015

David: Politicians at the state level have a practical reason for retaining the
corporate income tax on their books; and it has little to do with revenue, as
you suggest. The CIT provides a convenient chip to be tossed on the table when
the Governor's commercial development delegation is negotiating with some large
firms about their relocation decision. In short, the tax exists for the sake
being bartered away (theoretically in exchange for job creation, but evidence
indicates that itself is a dubious claim).

Also, if the state-level corporate income tax is rendered toothless by the
absence of combined reporting ... then couldn't the same argument be made about
CIT at the federal level? I think the competitive dynamics are similar; just
substitute Luxembourg for Wyoming and it starts to make a bit of sense. I
suspect that's what the OECD's BEPS project is really about -- pushing the G-20
nations to adopt something that looks like the profit-split transfer pricing
without overtly calling it formulary apportionment.

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