Corporate Income Tax Needs Structural Reform

April 14, 2014

The U.S. corporate income tax needs structural reform, say Alan Viard and Eric Toder in a report for the American Enterprise Institute.

In the United States, most corporate income is taxed (at the federal level) at a 35 percent rate. Combining state and federal taxes, the average corporate tax rate is 39.1 percent.

Currently, the United States taxes corporate income on two bases: residence (which looks at whether the corporation is incorporated in the United States) and source (which looks at whether the United States was the source of the corporation's profits).

  • All corporations operating in the United States are subject to the corporate income tax, even if they are based abroad.
  • For U.S.-based corporations that operate overseas through subsidiaries, that overseas income is generally not subject to the corporate income tax in the United States unless those profits are paid back in the form of dividends to the subsidiary's parent company in the United States.
  • Multinational U.S. corporations can claim tax credits on taxes paid to foreign governments, reducing their taxes owed to the United States.

Viard and Toder explain that residence and source can each be manipulated -- residence is measured solely by place of incorporation, regardless of whether a business operates largely in the United States. Similarly, corporations operating internationally can shift income around through a variety of techniques that allow them to manipulate the "source" of that income.

To remedy this, Viard and Toder propose a restructuring of the tax system:

  • One option would be that the United States could enter into an international agreement among states on how to allocate corporate income. The United States could then do away with its tax on the dividends repatriated back to U.S. resident corporations.
  • Under the second option, the United States could get rid of the corporate income tax entirely. Instead, shareholders of publicly traded corporations could be taxed on dividends and capital gains at ordinary income tax rates. Capital gains would need to be taxed as they accrue, not through sales. This system would tax based upon the residence of the shareholder.

Our current tax system is unsustainable. While these two proposals need further development and discussion, they address the major shortcomings of the current tax system.

Source: Alan D. Viard and Eric Toder, "Major Surgery Needed: A Call for Structural Reform of the U.S. Corporate Income Tax," American Enterprise Institute, April 4, 2014.

 

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