Among the arguments being made for higher taxes under President Biden’s agenda to drastically increase spending, one that stands out is about corporate income taxes. Back in February the Tax Foundation evaluated his proposal to raise the tax rate back to its pre-Trump reform of 28 percent:
An increase in the federal corporate tax rate to 28 percent would raise the U.S. federal-state combined tax rate to 32.34 percent, highest in the OECD and among Group of Seven (G7) countries, harming U.S. economic competitiveness and increasing the cost of investment in America. We estimate that this would reduce long-run economic output by 0.8 percent, eliminate 159,000 jobs, and reduce wages by 0.7 percent. Workers across the income scale would bear much of the tax increase. For example, the bottom 20 percent of earners would on average see a 1.45 percent drop in after-tax income in the long run.
Later, a rate hike to 25 percent was floated, but it now looks like the Democrats have given up on that idea as well, at least for now. However, the calls for higher taxes on corporations are not likely to go away, especially if the ideological battle currently raging within the Democrat party continues into next year’s mid-term election season. Therefore, I decided to set the record straight on corporate taxes in America.
The best way to do so is to not look at the tax rate per se – it is subject to all kinds of deductions and corporate-welfare programs – but to instead look at actual tax payments. I already wrote an article with this approach back in September:
I calculated tax payments as a share of total revenue, gross profit and earnings before taxes. Using the last one as the actual tax base, here is what I found:
Amazon paid $2.37 billion in income taxes in 2019, more than three times what it paid in 2017; as a share of earnings before taxes, these tax payments fell from 20 percent to 17 percent, a marginal reduction compared to the significant expansion in their tax payments;
Apple reduced its tax payments from $15.7 billion in 2017 to $10.5 billion in 2019, cutting its effective tax rate from 24.6 percent to 15.9 percent; at the same time, Apple repatriated well over $200 billion in foreign assets and made significant investments in several places around the country, including a $1 billion new campus outside Austin, Texas; these investments would not have happened without the Trump tax reform;
Citigroup paid a substantial amount of taxes in 2017, with its $29.4 billion check to the IRS amounting to a 129.1 percent effective tax rate (again over earnings before taxes); in 2019 they paid $4.4 billion, an effective tax rate of 18.5 percent;
Coca Cola also made an enormous tax payment in 2017, with its $5.6 billion equaling 81.4 percent of their earnings before taxes; by 2019 their tax payments had fallen to $1.8 billion but that still amounted to an effective tax rate of 16.7 percent;
Exxon went in the exact opposite direction, from a negative tax rate of 6.3 percent in 2017 (and tax deductions exceeding payments by almost $1.2 billion) to paying 26.3 percent of earnings before taxes – or $5.3 billion – in 2019;
Ford, a struggling car manufacturer, only paid $402 million in 2017 and ended up with a negative tax payment of $724 million two years later; by contrast, in 2018 they shipped $650 million into the federal, state and local government coffers, which amounted to 15 percent of their earnings before taxes;
Microsoft paid $19.9 billion in income taxes in 2017, equal to 54.6 percent of earnings before taxes; two years later they only paid 16.5 percent, but it still came out to almost $8.8 billion;
Tesla is a tax dwarf compared to the rest of this sample: in 2017 they paid $32 million, which is still impressive given that their earnings before taxes were negative at $2.2 billion; by 2019 their taxes had increased to $110 million, even though earnings before taxes were still in the red at -$665 million;
Walmart is the most consistent taxpayer in this sample: in 2017 they paid $4.6 billion; in 2018 $4.3 billion; in 2019 $4.9 billion; and in 2020 almost $6.9 billion; on average, they paid 31.4 percent of their earnings before taxes.
In total, these corporations paid $74.7 billion in income taxes in 2017. By 2019 that number had fallen to almost exactly half, just below $37.5 billion. During the same period of time, however, the federal government only lost 11.6 percent of its revenue from the corporate income tax. This indicates that other corporations delivered more tax revenue in ’19 than they did two years earlier. Or, put differently,
In 2017 the ten corporations in my sample paid 25 percent of all corporate-tax revenue, federal, state and local;
In 2019 they accounted for only 13 percent.
In other words, U.S. corporations pay a lot of taxes. But is there any truth to the allegations that corporate taxes have become more lenient, in other words that they aren’t contributing according to some “fair share”?
There is merit to this question, especially since the Biden administration is floating changes to our tax code that would raise taxes on middle-class families while reducing them for the highest-earning taxpayers. Even with a hike in the corporate tax rate off the agenda, this kind of tax-burden shift only reinforces the need for more clarity as to what our tax system actually looks like from the “output” side. In other words: what tax revenue does it actually produce, and who pays those taxes?
To begin with, it is true that corporate taxes have become a bit more lenient over time, but not in the traditional sense: it is not the case that Congress now lets corporations get away with an across-the-board lower tax burden, by historic comparison. However, if we look at the corporate income tax from the other side, namely how important the revenue is that it yields, things look a bit different.
To start with its role in the federal budget, its share of total tax revenue has certainly declined. In 1949 the corporate income tax accounted for 29.4 percent of all federal tax revenue. It remained at that level until the late 1960s, when its share fell below 25 percent. In 1989, when the Reagan tax reforms were fully implemented, the corporate share of total federal tax revenue was down to 16 percent. Another 20 years and one more big tax reform later, the rate had declined to 12 percent.
By 2019, the last year of the actual Trump economy (with 2020 being the year of the artificial economic shutdown), the corporate income tax only contributed 10.2 percent of all federal tax revenue.
Is this long-term trend the result of an increasingly lenient taxation of corporations? With all the changes that have been over time to such intricate variables as the rules for how fast you can deduct investment costs, or how foreign revenue is to be counted, it is de facto impossible to answer this question at a detailed level without an exhaustive review down to individual corporate finances. However, if we look at actual taxes paid, and look at them in the aggregate, businesses appear to have been given a more lenient tax burden. That, however, has not come without compensating changes to other items in our vast tax code. Figure 1 reports total income taxes paid to both the federal government and to states and local governments, as share of U.S. GDP. As the green function suggests, revenue from corporate income taxes have become less important: counted as a percentage of GDP, their share has declined from about four percent in the 1950s to three percent in the 1960s, to somewhere in the vicinity of 1.5-2 percent today.
At the same time, though, taxation has shifted to individual income. Back when John F Kennedy was president, revenue from individual income taxes equaled approximately 8.5 percent of GDP; in 2019, after the Trump tax reform, that share was 10.3 percent. (During the Obama presidency it averaged 9.5 percent.) In other words, from a revenue perspective it is clear that our lawmakers, regardless of party affiliation, have shifted the aggregate tax burden from corporations onto individuals:
That’s not all, though. While individuals now pay 80 percent of all federal taxes, that burden is not evenly spread. The tax burden on individual income earners is heavily concentrated to those who make big paychecks. Figure 2 reports the Fair Share Value by income group: the Fair Share Value compares taxpayers’ share of taxable income to their share of total federal income taxes. If a given group of taxpayers make five percent of all taxable income and pay five percent of all personal income taxes, their Fair Share Value is 1; the tax burden on their income is fair. If the Fair Share Value is less than one, their tax burden is unfairly low and they are not contributing their fair share to funding government; if the value is higher than one, their tax burden is unfairly high and they are paying for a larger share of government than they should.
Based on IRS income and tax data for 2018 – after the Trump tax reform – it is clear that the federal personal income tax is designed very unfairly:
Moreover, this unfair profile of the tax code is not new, but has been around for a long time. Figure 3 reports the Fair Share Value for the top-20 percent income earners from 2001 through 2018. They consistently carry a tax burden that is about 50 percent higher than it would be if the tax code was fair:
Isolating the top-one percent gives an even more pronounced picture of the unfairness in our tax code:
Plain and simple, over the past several decades, Congress has gradually shifted its taxation from corporations to individuals, but it has also made sure to place an unfairly high portion of the individual income taxes on the shoulders of a small group of taxpayers. This unfair profile was exacerbated by the Trump tax reform, after which the top-20 percent income earners pay two thirds of all federal taxes.
Does that mean we would be better off taxing corporations instead? No. Corporate taxes are more complex than individual taxes, with deductions and amortizations that can make the tax burden differ significantly between taxpayers. Furthermore, the tax burden that already applies to corporations differs vastly between industries, with manufacturing corporations contributing the largest share of corporate tax revenue (28.7 percent); a close second is finance and insurance (20.7 percent) and the information industry following in third place (11.6). It is unlikely that these three industries, and especially manufacturing, can carry a higher burden without significantly negative repercussions.
If we want a more fair tax code, a much better option is to reduce government spending. That gives Congress room for long-term, permanent reductions in the unfairly high taxes on high-earning individuals, and would eventually open for a completely flat income tax rate.