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Is the corporate tax rate too high?

A frequent gripe from companies is that the top statutory corporate tax rate of 35 percent is too high, at least compared to this country's economic peers. The table below from the report by the Economic Recovery Advisory Board tells the story, or at least part of it:

corporate tax rates.bmp

As the report also points out, the effective federal tax rate on new investments by companies winds up being lower because of tax credits and deductions. According to the Treasury Department, the overall rate is about 29 percent.

Still, that rate results in a few things that experts say are less than optimal. One, many businesses choose not to incorporate to avoid triggering the taxes that come with that category. The report includes an interesting fact: in 2004, out of a sample of OECD countries, the United States had the highest share of businesses with profits topping $1 million that were not incorporated. The percentage is 66 percent here, compared to 26 percent in Britain. Also, the high rate exaggerates the differences between the ways certain business activities are treated by the tax code. For instance, the cost of investing with debt versus investing with equity is much lower.

The report presents two options. One is to reduce the statutory corporate rate of 35 percent.

The advantage, says the report, is that lowering the overall tax on capital would encourage new investment. It would also reduce the advantages of picking some investments over others, reducing the tax code's distorting effects on business behavior.

Of course doing so would not come without a cost. As the report says: "Each percentage point decrease in the corporate tax rate reduces corporate tax revenues by about $120 billion over 10 years."

Another idea: lower the tax rate, but only on new investments. The report suggests: "Businesses could be allowed to 'expense' all or a portion of their new investment immediately--i.e. to deduct the cost of investment against taxable income in the year the investment was made instead of recovering it gradually over many years."

One problem with this idea, however, is that it would favor companies that are capital-intensive, as opposed to tech companies that are more interested in intellectual property.

Tomorrow, we continue our tour of corporate tax policy via the board's report. Next stop: how to broaden the corporate tax base.

By Jia Lynn Yang  |  August 31, 2010; 8:11 PM ET
Categories:  Corporate taxes  
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Next: Obama's tax plan for business: Will companies start spending?

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