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The Corporate Tax Headache
Tax competitiveness affects economic growth. The statutory corporate income tax in the U.S. is high relative to other countries. “Statutory” means the tax rates that appear on the tax table. However, many people argue that the statutory rate does not tell the whole story and prefer to look at the effective rate, which is the rate after accounting for all exemptions in the tax code. The debate over statutory and effective corporate tax rates leaves many non-experts scratching their heads. What do these different rates mean? What are the percentage rates in the U.S.? And how do these U.S. rates compare to the rates in other countries? The statutory rate is the legally defined rate at which corporations must pay taxes on their taxable income. According to U.S. tax law, this rate begins at 15% for taxable income up to $50,000 and increases to a maximum of 35% for taxable income in excess of $10,000,000. Many U.S. states also charge a corporate income tax, and these rates are written into law as well. According to data from the Tax Foundation, Iowa’s maximum statutory rate of 12% is the highest among the 50 states, followed by Pennsylvania at 9.99% and Minnesota at 9.8%. Many people believe that within the U.S., state tax rates are an important factor businesses consider when deciding where to locate. Much research also shows that states with lower rates seem to have stronger economic growth. Overall, the top U.S. statutory corporate income tax comes to 39.2% when the federal, state, and local rates are combined. As I discussed in a previous post, this top rate is significantly higher than the weighted average of OECD countries. During the past decade, several OECD countries lowered their statutory rates, but the U.S. did not follow their lead. By 2010 the OECD’s top statutory rate of 29.6% was nearly 10 percentage points lower than the rate in the U.S. Of course the effective overall corporate tax rate provides a more realistic estimate of how much a company actually pays in income tax. The effective corporate tax rate is calculated by dividing the amount a firm actually pays in corporate taxes by its unadjusted total taxable income. This rate is often lower than the statutory rate for two reasons. The first is that it accounts for deductions, exemptions, and tax credits that reduce the actual tax burden on a corporation. The second is that companies pay different rates on different levels of income. The effective rate accounts for this progressivity by reporting the overall average tax rate that is paid, not just the top rate that is paid. Estimating the effective rate is more difficult than simply reporting the statutory rate. However, several scholars provide estimates for the U.S. and other countries. Analyzing financial statements for 10,642 corporations from 85 different countries, Kevin Markle and Douglas Shackelford find that between 2003 and 2007, U.S. headquartered firms paid an average effective tax rate of 29%, a rate higher than all major U.S. trading partners except for Germany and Japan. Similarly, Kevin A. Hassett and Aparna Mathur report a 2010 U.S. average effective tax rate of 29%, compared to only 20.5% in the OECD. Clearly the U.S. average is quite higher, at least according to these estimates. However, a study published by the Congressional Research Service reaches an alternative conclusion. In this study Jane G. Gravelle provides several different effective rate estimates and concludes that the average effective tax rates for the U.S. and other major countries are “about the same.” Although this is a more positive conclusion than is offered by others, it hardly suggests the U.S. is a leader when it comes to corporate tax rates favoring growth. The U.S. tax system is complex, and sorting through all the definitions and rates can be a daunting task. Corporate tax reform appears to be on the agendas of both Congress and the Obama Administration. While lower rates are crucial for increased economic growth, we shouldn’t forget the great benefit in having a simple and predictable tax system. For the sake of entrepreneurs trying to make strategic business decisions, as well as everyday citizens just trying to understand the issues, let’s hope both lower rates and simplicity are hallmarks of any reform.
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