SPECIAL
REPORT
• The marginal effective tax rate (METR) on corporate investment
(i.e., the tax impact on capital investment as a portion of the cost
of capital) is 35.3 percent in the U.S.—higher than in any other
developed country.
• The U.S. has maintained the highest METR in the OECD since
2007, when Canada’s multiyear program of corporate tax reform
brought its METR below the G-7 average.
• Nonetheless, the White House and Treasury Department
continue to assert that the U.S. has a lower METR than Canada
by failing to properly account for sales and property taxes.
• The U.S. METR varies by industry, from 26.7 percent for
transportation to 39.3 percent for communications.
• The U.S. average effective tax rate on corporations (AETR) is
irregular from year to year due to the complexity and instability
of the corporate tax code.
• Excessively high U.S. corporate tax rates have shrunk the U.S.
corporate sector and reduced corporate tax revenues.
Key Findings
The U.S. Corporate Effective
Tax Rate: Myth and the Fact
& Duanjie Chen
Feb. 2014
No. 214
By Jack Mintz
Director and Palmer Chair in School of Public Policy, University of Calgary
Research Fellow, School of Public Policy, University of Calgary
2
e statutory corporate income tax rate of the United States is infamously one
of the highest in the world, while effective tax rates on capital investments
appear to be high and dispersed.
For businesses, it is not unusual to see their effective tax rates, regardless of how
these are defined, being lower than their statutory tax rates. is results from
tax preferences (“loopholes,” if using a pejorative term) that are more generous
than the economic costs of generating taxable income.
For economists, it is also commonly understood that effective tax rates follow
the trend of statutory tax rates in the long run. e long-run divergence
between these two rates is not caused by the economic cycle but by irregular
provisions of various conditional tax preferences. ese irregular conditional tax
allowances or credits narrow the tax base, which often goes hand in hand with
rather high statutory tax rates.
e combination of a narrow tax base and an otherwise unnecessarily high tax
rate hurts business investment in general by benefiting only those investors who
can use available tax preferences. is creates an uneven playing field, resulting
in a misallocation of capital toward tax-favored activities as well as making the
tax system more complex to comply with and administer. e U.S. government,
moreover, puts itself at a disadvantage with high statutory corporate tax rates,
since businesses are encouraged to shift profits out of the U.S. with transfer
pricing and tax-efficient financing structures to low tax rate jurisdictions,
thereby reducing revenues that could be used to finance federal government
services.
is paper evaluates the U.S. corporate effective tax rate by two general
methods: one is the marginal effective tax rate (METR) on new investments
and the other is the average effective tax rate (AETR). We conclude that the
problem with the U.S. corporate income tax system is much broader than the
high federal-state combined statutory tax rate of over 39 percent. e corporate
tax system also undermines economic growth with a non-neutral treatment of
business activities.
The Corporate Marginal Effective Tax Rate
Marginal effective tax rate (METR) analysis has been a well-documented and
extensively applied analytical tool for measuring tax impacts on investment
and capital allocation distortions since the 1980s.
1
We have applied this
analysis systematically since 2005 for the purpose of ranking Canadian business
1 For the classic introduction to the METR concept and methodology, see R. Boadway, N. Bruce, & J. M. Mintz,
Taxation, Ination, and the Effective Marginal Tax Rate in Canada, 17 62-79
(1984). See also M. A. King & D. Fullerton,
3
tax competitiveness among the G-7, the OECD member countries, and an
expanding list of other countries.
2
Tax competitiveness is relevant due to the increased capital mobility across
borders associated with globalization. Taxes that impinge on investment reduce
the economy’s capacity to produce goods and services in the future, which can
be referred to as the “inter-temporal” distortion arising from capital taxation.
Taxes that vary by business activity also cause inter-sectoral, inter-asset,
financial, and organizational distortions that result in a less than optimal use
of capital resources in the economy. A more level playing field among business
activities shifts resources from investments earning low pre-tax rates of return
on capital to those earning higher pre-tax returns, thereby improving the
allocation of capital in the economy.
erefore, a country’s competitiveness is hurt by taxation that undermines
productivity through investment. ere is no doubt that the free-market system
of the U.S. has been a beacon for entrepreneurs and capital investors. But it
can do better with multinational companies if its corporate tax system can be
reformed to combine a lower tax rate with a broader tax base that facilitates
capital investment in general rather than benefiting only a few who are able to
navigate through a complex tax structure.
Marginal Effective Rate Calculation
e marginal effective tax rate measures the tax impact on capital investment
as a portion of the cost of capital. In considering a new investment, a firm will,
like any rational investor, allocate capital to maximize profit. e assumption
that firms are profit maximizers provides a starting point for calculating the
METR. Firms increase investment when marginal returns cover marginal costs
and reduce scale when marginal returns are less than marginal costs. Since it is
only the marginal cost of investment, rather than the marginal return, that is
directly observable, the METR uses marginal cost to calculate the measure. e
METR is evaluated as the effective tax cost as a share of marginal investment
costs net of economic depreciation and risk,
3
which is also the pre-tax rate of
return on capital. For example, if the pre-tax rate of return on capital (i.e., the
tax-inclusive cost of capital) is 20 percent at the profit-maximizing point and
the post-tax rate of return on capital (i.e., the tax-exclusive cost of capital) is 10
percent, the METR is 50 percent.
2 To update our cross-border tax comparison annually, we not only incorporate the legislated tax changes on an
and policy decisions. Applying these updated non-tax parameters to all the years contained in our latest model
see Duanjie Chen & Jack Mintz,
2013 Annual Global Tax Competitiveness Ranking: Corporate Tax Policy at a Crossroads
.
not be the case. For a discussion, see J. Mintz, The Corporation Tax: A Survey, 16 23-68 (1995).
4
U.S. among Least Competitive on Marginal Effective Tax
Rate
In our annual business tax competitiveness ranking,
4
which is based on our
calculation of marginal effective tax rates by country, the U.S. has been among
the least tax-competitive countries for capital investment over the past nine
years (see Table 1). e Canadian METR has been lower than that in the
U.S. since 2007 thanks to the steady reduction in corporate income tax rates,
elimination of the capital tax on non-financial corporations, and provincial sales
tax harmonization that eliminated sales taxes on purchase of capital goods, all
of which were a concerted effort made by both the federal and most provincial
governments under different political parties over the past decade.
The U.S. Model is Out of Line with other METR
Computations
Noting that our METR calculation has been in line with other METR
computations such as those by Finance Canada and the Oxford University
Center for Business Taxation,
5
it was a surprise to see that a recent METR
ranking presented by the White House and the U.S. Treasury (hereafter the
“U.S. model”) showed Canada having a higher METR (33 percent) than that
for the U.S. (29 percent) for 2011.
6
How can that be given Canada’s much lower statutory corporate income tax
rate (27.6 percent for 2011 and 26.1 percent for 2013) compared to that in the
State Business Tax Climate Index,
5 For the latest METR presentations by these two sources, see Finance Canada, Economic Action Plan 2012, Chapter
3.2 and Chart 3.2.1, . See also
CBT Corporate Tax Ranking 2012 (June 2012).
6 SeeThe President’s Framework for Business Tax Reform (Feb.
2012) at Table 1,
.
Table 1. Corporate Tax Rates (%) on Capital Investment, Various Country Groups, 2005-2013
Marginal Effective Tax Rate
Statutory Corporate Income Tax (CIT) Rate
2013 2012 2011 2010 2009 2008 2007 2006 2005
2013 2005 Change
in %
points
2005-13
# of countries
that have cut
the general
CIT rate
U.S. 35.3 35.3 35.3 35.3 35.6 35.6 35.6 35.9 35.9
39.13 39.3 -0.21 n/a
Canada 18.6 17.3 18.7 19.8 27.3 28.0 30.5 36.2 38.8
26.1 34.2 -7.9 n/a
G-7 27.6 27.9 28.6 28.9 30.1 30.2 32.9 33.7 34.2
31.1 35.7 -4.6 5
G-20 24.5 24.5 28.0 28.0 28.0 28.1 33.5 33.5 33.5
31.1 35.7 -4.6 12
OECD
(34)
19.6 19.5 19.7 19.6 19.8 20.1 21.0 21.6 22.4
25.5 28.2 -2.7 22
U.S. ranking by METR (highest to lowest) within various groups of countries
G-7 1 1 1 1 1 1 1 2 2
G-20 2 2 2 2 2 3 3 4
6
OECD 1 1 1 1 1 1 1 2
2
5
U.S. (39.1 percent)?
7
e answer lies in the difference between our coverage of
taxes and that of the U.S. model.
In theory, all the taxes affecting corporate income and payable by corporations
should be included in calculating METR. ese taxes include direct taxes,
ranging from income taxes to asset-based taxes such as capital taxes and
property taxes, to indirect taxes on purchase of capital goods, such as asset
transaction taxes and sales taxes that are not based on value added. In practice,
however, some taxes are not consistently measurable across all the tax regimes
under study.
For example, for many of the OECD countries, including Canada and the U.S.,
the property tax is a sub-national tax that varies widely across localities and
uses of property (e.g., commercial or industrial) in both the tax base and rate.
It is extremely difficult, if not impossible, to come up with a national average
property tax rate that is applicable to each industry in a consistent manner.
Further, since many municipal property taxes are charges for services provided
to residents and businesses such as water, sewage, and roads, one would
typically need to net out related benefits from taxes for measurement purposes.
For these reasons, we exclude property taxes in our model to ensure that all tax
regimes are treated consistently.
The U.S. Model Inaccurately Depicts U.S. Property Tax Rate
Parameters
In contrast, the U.S. model casually, and inconsistently, includes such a
parameter across borders. For Canada, the U.S. model applied Toronto’s 4
percent property tax rate for industrial buildings in 2009 as the Canadian
“effective real estate tax rate” while using a 1 percent “net wealth tax rate” as the
U.S. counterpart.
8
is simplified assumption overstates Canadian property tax
rates while understating property taxes in the U.S. In fact, Toronto has one of
the highest property tax rates in Canada and its current comparable rate is only
3 percent
9
while the average urban commercial and industrial property taxes
in the U.S. is close to 2 percent. Note also that, unlike in Canada, business
property taxes in the U.S. are also applicable to machinery and equipment
and in some states to inventory.
10
is means that if the same national average
property tax rate was 2 percent—or any rate—in both countries, the METR
Corporate and Capital Income Taxes
Worldwide Corporate Tax Guide
Effective Tax Levels Using the Devereux/Grifth Methodology,
.
9 SeeProperty Tax, .
10 See50-State Property Tax Comparison
Study (Apr. 2011),
.
6
impact associated only with such a property tax would be much higher in the
U.S. than in Canada because of the broader property tax base in the U.S.
Furthermore, while Canadian provincial governments have completely
eliminated the capital tax on non-financial corporations, with the last two
provinces (Nova Scotia and Quebec) doing so by 2012, some states in the U.S.
still levy a tax based on corporations’ asset values.
11
In our model, this asset-
based tax is zero for Canada but close to 0.05 percent for the U.S., which added
about a half percentage point to the U.S. METR.
The U.S. Model Excludes Effective Sales Tax Rates on
Capital Goods
Finally, our model includes the effective sales tax rates on capital goods based
on national statistics while the U.S. model does not. Sales taxes in most
Canadian provinces for 2011 were harmonized with the federal Goods and
Services Tax (GST) (only British Columbia, Saskatchewan, and Manitoba
continue to have retail sales taxes today). e federal GST is a value-added tax
that generally refunds the sales tax on capital goods thereby having little impact
on capital investment. On the other hand, the majority of the state sales taxes
in the U.S. constitute a direct cost on capital goods. erefore, including the
effective sales tax rate in METR calculations reflects more closely the reality that
sales taxes not based on value added impose a tax burden on capital investment.
e impact of sales taxes on METR of capital investment is an important
reason why the U.S. ranks as the most tax unfriendly regime towards capital
investment among OECD member countries (see Table 2).
Dispelling the Myth: Excluding Effective Sales Taxes and
Inaccurately Depicting Property Tax Rates Gives the U.S.
an Artificially Low Marginal Effective Tax Rate
at is, the U.S. model, by excluding the effective sales tax rate on capital
goods, which is included in our METR model, and by including an artificially
high property tax rate for Canada and an artificially low counterpart for the
U.S., produced a much lower METR for the U.S. than for Canada. is result
naturally surprised many analysts because the aggregated statutory corporate
income tax rate of Canada is only two-thirds that of the U.S. To resolve this
myth, Figure 1 below reconciles our METR calculation with that produced by
the U.S. model.
e U.S. model excludes the U.S.’s subnational capital taxes and U.S. sales
taxes, which are sub-optimally designed for business investment when
7
Table 2. Marginal Effective Tax Rate on Capital Investment, OECD Countries, 2005 – 2013
Marginal Effective Tax Rate
Reference: Statutory
Company Income Tax
Rate*
2013 2012 2011 2010 2009 2008 2007 2006 2005
2013 2005 Change
in %
points
U.S. 35.3 35.3 35.3 35.3 35.6 35.6 35.6 35.9 35.9
39.1 39.3 -0.1
France 35.2 35.2 35.2 34.0 35.1 35.1 35.1 35.1 35.4
34.4 35.0 -0.5
Korea 30.1 30.1 30.1 30.1 30.1 32.8 32.8 32.8 32.8
24.2 27.5 -3.3
Japan 29.3 31.5 31.5 31.5 31.5 31.5 31.5 31.5 31.5
37.0 39.5 -2.6
Austria 26.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2 26.2
25.0 25.0 0.0
Spain 26.0 26.0 26.0 26.0 26.0 26.0 28.2 30.3 30.3
30.0 35.0 -5.0
Australia 25.9 25.9 25.9 25.9 25.9 25.9 25.9 25.9 25.9
30.0 30.0 0.0
UK 25.9 26.9 27.1 29.1 29.0 28.8 30.0 30.0 30.0
23.0 30.0 -7.0
Italy 24.5 24.5 28.0 28.0 28.0 28.1 33.5 33.5 33.5
27.5 33.0 -5.5
Germany 24.4 24.4 24.4 24.4 24.4 24.4 34.0 34.0 34.0
30.2 38.9 -8.7
Norway 24.4 24.4 24.4 24.4 24.4 24.4 24.4 24.4 24.4
28.0 28.0 0.0
Portugal 22.9 22.9 20.8 20.8 18.8 18.8 18.8 19.6 19.6
31.5 27.5 4.0
New Zealand 21.6 21.6 21.6 18.2 18.2 18.2 20.5 20.5 20.5
28.0 33.0 -5.0
Denmark 19.1 19.1 19.1 19.1 19.1 19.1 19.1 21.7 21.7
25.0 28.0 -3.0
Canada 18.6 17.4 18.7 19.8 27.3 28.0 30.9 36.2 38.8
26.3 34.2 -7.9
Belgium 18.5 18.5 18.5 18.5 18.5 18.5 18.0 18.0 23.5
34.0 34.0 0.0
Greece 18.1 11.3 11.3 13.2 13.7 13.7 13.7 15.8 17.5
26.0 32.0 -6.0
Finland 17.5 17.5 18.7 18.7 18.7 18.7 18.7 18.7 18.7
24.5 26.0 -1.5
Switzerland 17.5 17.5 17.5 17.5 17.5 17.5 18.0 18.0 18.0
21.1 21.3 -0.2
Netherlands 17.5 17.5 17.5 17.5 17.5 17.5 17.5 20.7 22.3
25.0 31.5 -6.5
Mexico 17.4 17.4 17.4 17.4 16.0 16.0 16.0 16.7 17.4
30.0 30.0 0.0
Luxembourg 17.3 17.0 17.0 16.8 16.8 18.5 19.4 19.4 19.9
29.2 30.4 -1.2
Estonia 17.1 17.1 17.1 17.1 17.1 17.1 18.1 19.1 20.2
21.0 24.0 -3.0
Hungary 16.1 16.1 16.1 16.1 16.6 16.6 16.6 15.3 14.7
19.0 16.0 3.0
Sweden 16.1 19.5 19.5 19.5 19.5 20.9 20.9 20.9 20.9
22.0 28.0 -6.0
Slovak Rep. 15.7 12.7 12.7 12.7 12.7 12.7 12.7 12.7 12.7
23.0 19.0 4.0
Israel 15.0 15.0 14.3 15.0 15.8 16.5 18.0 19.5 19.5
25.0 34.0 -9.0
Poland 14.6 14.6 14.6 14.6 14.6 14.6 14.6 14.6 14.6
19.0 19.0 0.0
Iceland 14.2 14.2 14.2 12.6 10.4 10.4 12.6 12.6 18.0
20.0 18.0 2.0
Czech Rep 12.7 12.7 12.7 12.7 13.5 14.2 16.5 16.5 18.0
19.0 26.0 -7.0
Ireland 10.1 10.1 10.1 10.1 10.1 10.1 10.1 10.1 10.1
12.5 12.5 0.0
Slovenia 9.8 10.5 11.8 11.8 12.4 13.1 13.8 14.5 15.2
17.0 25.0 -8.0
Chile 7.7 7.7 7.7 6.7 6.7 6.9 7.1 7.3 7.3
20.0 17.0 3.0
Turkey 5.7 5.7 5.7 5.7 5.7 5.7 5.7 5.7 10.9
20.0 30.0 -10.0
OECD Average:
Weighted* 28.5 28.8 29.0 29.1 29.5 29.6 30.8 31.2 31.5 32.9 35.5 -2.6
Unweighted 19.6 19.5 19.7 19.6 19.8 20.1 21.0 21.6 22.4
25.5 28.2 -2.7
Note: G-7 countries are in bold.
* Weighted by the average GDP for 2005-2011 in 2005 constant U.S. dollars.
8
and a tax on either tangible property that is not subject to local taxation or net worth (0.26 percent). Other
compared to the predominately VAT-based sales taxes in Canada. As Figure 1
shows, starting from our METR calculation for 2013 that includes effective
subnational capital taxes (0.05 percent in the U.S. and zero in Canada) and
effective sales taxes that are not on a valued-added base (2.3 percent in the U.S.
and 0.6 in Canada), the Canadian METR is 18.6 percent and the U.S. 35.3
percent. By excluding the effective subnational sales taxes and capital taxes, the
METR dropped to 15.7 and 27.2 percent for Canada and the U.S. respectively.
is METR gap of 11.5 percentage points is very close to the gap (13
percentage points) in statutory corporate tax rates between the two countries
(26.1 percent in Canada versus 39.1 percent in the U.S.).
is gap may shrink to 10.7 percentage points if we further exclude the non-
temporary investment tax credits (ITC), which in aggregate are more generous
in Canada than in the U.S., making the METR 17.4 percent for Canada
and 28.1 percent for the U.S. e remaining difference between this 10.7
percentage point METR gap and the 13 percentage point gap in statutory
corporate tax rates is due to Canada’s depreciation regime that more accurately
reflects true cost of investment.
12
18.6
15.7
17.4
32.7
35.3
27.9
27.2
28.1
31.2
0
5
10
15
20
25
30
35
40
2013* Excl.
provincial
sales tax
CIT only/
excl. ITC
Incl. a 4%
real estate
tax**
2011-2013* Excl. state
sales tax
Excl. state
capital tax
CIT only/
excl. ITC
Incl. a 1%
net-wealth
tax**
Figure 1. Marginal Effective Tax and Royalty Rate (in percent)
2013 Canada vs. USA
The US Canada
*Authors’ original calculation.
**Parameters that are used by the White House and U.S. Treasury but do not reflect national realities
consistently.
9
From this baseline, if we add the 4 percent real estate tax and the 1 percent
net wealth tax to our METR model for Canada and the U.S. respectively and
apply them only to real estate (i.e., buildings and land), we arrive at METRs of
32.7 percent for Canada and 31.2 percent for the U.S., which are close to those
presented by the White House and the U.S. Treasury for their 2011 METR
ranking.
Note that, like any asset-based taxes, the real estate tax has a much higher
METR impact compared to the income tax when it is a significant share of
pretax rates of return. For example, if the pre-tax return on structures and
land, net of risk, is 6 percent, a 4 percent real estate tax is equivalent to a
66.7 percent effective tax rate. Given the significant share of structures of
total investment, this explains why the 4 percent real estate tax rate raised the
Canadian METR by over 15 percentage points while the 1 percent real estate
tax raised the U.S. METR by 3 percentage points.
We have thus solved the myth in METR ranking for Canada versus U.S.
produced by the official U.S. model.
13
at is, the myth was a combined result
of excluding the retail sales taxes on capital inputs and a rushed application of
inconsistent assumptions of “national” property tax rates.
Dispersion in Marginal Effective Tax Rates in the United
States
e U.S. corporate tax system is not only uncompetitive with high statutory
and effective rates but it is also non-neutral with effective rates varying by asset
and industry. With unequal tax burdens on business activities, the tax system
distorts the allocation of capital in the U.S. economy with some businesses
bearing more tax than others on capital investment. A more level playing field
would result in capital flowing from preferentially treated business activities
with low marginal returns to those earning higher marginal returns to cover tax
costs.
Differing Tax Treatment across Industries Creates
Economic Distortions
Table 3 provides a breakdown of our estimated marginal effective tax rate by
major asset and industry for the U.S. economy. e U.S. corporate tax system
imposes a heavier tax burden on most services compared to forestry, utilities,
and transportation and storage. is inter-industry dispersion is in part due to
the preferential corporate income tax rate applied to manufacturing and other
profits. Given the importance of the services sector in terms of its share of the
13 A technically more serious reconciliation requires checking through the non-tax data applied to the METR
10
economy’s production and job creation, this anomaly is significant, because it
potentially impedes economic growth.
Even though we leave out property taxes on real estate, it is clear that structures
are most heavily taxed followed by machinery and equipment investments.
In large part, the dispersion in effective tax rates results from U.S. state
retail sales taxes falling heavily on machinery and structure purchases. Inter-
asset dispersion also arises from some limited tax preferences for targeted
investments. Tax depreciation rates vary from economic depreciation rates
in some cases although they are not a major source of dispersion (not shown
in Table 3). Inventory costs are partly based on last-in-first-out accounting
methods that tend to protect the impact of inflation on costs, unlike for other
assets except for land. e variation in METRs on assets discourages businesses
from adopting techniques that require more heavily taxed inputs. It also
discourages the growth of those industries that are more intensive users of these
heavily taxed assets.
Finally, we should note that a significant reduction in statutory corporate
income tax rates across all industries would reduce the dispersion in effective tax
rates.
The Corporate Average Effective Tax Rate
e conventional concept of the corporate average effective tax rate (AETR) is
the tax paid (or payable) divided by the relevant tax base. For a given amount of
tax paid or payable, the associated AETR can vary widely because the tax base
defined as the denominator can vary widely.
14
In this brief paper, we do not
intend to specify such a tax base and the associated corporate AETR; instead,
we draw our observations on the corporate AETR based on macro corporate
financial statistics published by the appropriate government agencies.
Table 3. Marginal Effective Tax Rates By Industry and Asset for 2013 in the United States
Forest Public
Utilities
Construction Manufacturing Wholesale
Trade
Retail
Trade
Transportation Communication Other
Services
Aggregate
Buildings 47.5 25.9 37.7 47.7 43.0 43.7 17.2 37.1 42.7 40.4
M&E 22.3 53.1 41.2 26.4 47.3 45.0 32.0 40.2 47.6 35.9
Land 16.7 18.6 16.6 16.8 18.5 18.5 18.4 18.4 18.3 18.0
Inventory 27.1 29.7 27.0 27.2 29.6 29.5 29.5 29.5 29.3 28.3
Aggregate 30.4 29.8 35.6 33.5 37.8 37.0 26.7 39.3 41.9 35.3
14 See, e.gEconomic Analysis: Behind the GAO’s 12.6 Percent Effective Corporate Rate,
11
Figure 2. The U.S. Corporate Income Tax: Rate vs. Revenue (as % of GDP)
Based on Bureau of Economic Analysis, Tables 1.14 and 7.16
0
5
10
15
20
25
30
35
40
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Taxable income as % of GDP
CIT as % of GDP
Profit as % of GDP
Statutory CIT rate
Average Effective CIT rate*
*Estimated as the ratio of “taxes on corporate income” net of “payments by the federal reserve banks” to “corporate
profits” net of “income organizations (including federal reserve banks) not filing corporate tax returns.”
0
5
10
15
20
25
30
35
40
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
CIT revenue as % of GDP
Taxable income as % of GDP
Average Effective CIT rate*
Net profit as % of GDP
Statutory CIT rate
* Obtained from Cansim Database, v21584924-Income taxes to taxable income; Total all industries.
Figure 3. Canadian Corporate Income Tax: Rate vs. Revenue (as % of GDP)
Based on Statistics Canada, Financial and Taxation Statistics for Enterprises
12
Figure 2 provides statutory corporate income tax rates along with an effective
corporate income tax rate and corporate profits, taxable income and corporate
income tax revenue as a share of GDP.
15
As a comparison, Figure 3 provides
Canadian counterparts of the U.S. indicators shown in Figure 2.
Note that while the Canadian effective corporate income tax rate is an official
estimate published by Statistics Canada, the U.S. effective corporate income
tax rate is our estimate of the ratio of “taxes on corporate income” (net of the
payment made by the Federal Reserve banks) to “corporate profits without
inventory adjustment,” which is net of income of organizations, including
Federal Reserve banks, that do not file corporate income tax returns. It is
important to remember that this simplified calculation of AETR underestimates
the effective corporate income tax rate in the U.S. since the tax base (i.e.,
corporate profits without inventory adjustment) used in our calculation is a
mixture of profits made by both C and S corporations, which are not subject to
corporate income taxes.
16
e three following observations can be drawn from a comparison between
the U.S. (Figure 2) and Canada (Figure 3) with respect to their corporate
income tax structures, as indicated by the relationship between the effective and
statutory corporate income tax rates and other tax indicators.
High Corporate Tax Rates Do Not Necessarily Bring in
High Corporate Tax Revenues
First, if revenue collection is the main purpose of taxation, then an excessively
high corporate income tax rate does not necessarily bring in high corporate
tax revenue; an excessively high tax rate can even be accompanied by large
fluctuations in tax revenue. For example, despite the fact that the statutory
corporate income tax rate barely changed over the past ten years (from 39.3
to 39.1 percent) in the U.S., the corresponding corporate income tax revenue
as a share of GDP fluctuated significantly between 1.8 percent (2002) and 3.4
percent (2006).
In contrast, the Canadian statutory corporate income tax rate has dropped from
42.4 percent (2000) to 29.4 percent (2010), and the corresponding tax revenue
as a share of GDP was rather stable, swinging only between 3.1 percent (2002)
and 3.8 percent (2006). It is also interesting to note that the low and high years
(2000 and 2006) for corporate tax collection are the same in both countries,
which indicates that, aside from the tax structure, the economic cycle, and thus
the profit cycle, is the main determinant of corporate tax revenue.
BEA data.
13
Low Rates and Broad Bases Lead the Statutory and
Effective Tax Rates to Converge
Second, a tax structure featuring a low rate and a broad base can lead to
convergence between the statutory and the effective tax rates and vice versa.
For example, as its statutory corporate income tax rate has dropped steadily,
the Canadian average effective corporate income tax rate appears to converge
with its statutory tax rate over time, partly reflecting base changes and the using
up of the carry forward of past losses. In contrast, the U.S. effective corporate
income tax rate, regardless of how it is defined, does not show any correlation
with its statutory corporate tax rate.
Note that the statutory corporate income tax rate shown in Figures 2 and 3 is
the top corporate tax rate, and both Canada and the U.S. provide reduced tax
rates for small corporations. erefore, it is reasonable to see an overall effective
corporate income tax rate as being below the top statutory corporate income tax
rate. However, when the effective tax rate does not follow the pattern of the top
statutory tax rate but diverges from it considerably, it indicates a swing related
to irregular policy changes (e.g., temporary, discretionary, or both types of
income tax credits on a large scale), new tax planning that succeeds in reducing
tax liabilities on a given taxable income, or both.
Excessively High U.S. Corporate Tax Rates Have Led to a
Smaller U.S. Corporate Sector
Finally, the excessively high corporate income tax rate in the U.S. appears
to have led to a smaller corporate sector in relation to the overall economy.
Canadian corporate net profit has been well above 10 percent of GDP since
2003 when the corporate tax rate dropped to below 36 percent, and Canadian
corporate taxable income also moved steadily to above 10 percent of GDP
even during the recent period of financial crisis. is possibly reflects a reduced
incentive to shift profits out of Canada. It could also reflect more use of the
corporate form by small businesses, because Canada avoids double taxation of
corporate income passed on to shareholders with its dividend tax credit and
partial exclusion of capital gains from taxation (in other words, an integrated
corporate and personal income tax system).
In contrast, there were only three years during period of 2000 to 2010 when
corporate net profits in the U.S. reached above 10 percent of GDP and there
was only one year (2006) when U.S. corporate taxable income reached 10
14
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times yearly by the
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independent 501(c)(3)
organization chartered
Columbia.
The Tax Foundation
is a 501(c)(3) non-
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analysis is guided
simplicity, neutrality,
transparency, and
stability.
©2014 Tax Foundation
Editor, Donnie Johnson
Tax Foundation
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percent of GDP. It is no wonder that U.S. corporate tax revenue as a share
of GDP has been below that of Canada. It seems reasonable to suggest that
the high statutory corporate income tax rate encouraged corporations to shift
profits to other jurisdictions, including Canada. It also reflects the actions of
discouraged U.S. entrepreneurs from incorporating their business activities by
choosing instead limited liability partnerships and other organizational forms
that avoid double taxation at the corporate and personal levels; such actions
have been dubbed “distorporation” in a recent issue of e Economist.
17
Conclusion
Unlike in Canada where income earned and taxes paid by corporations appear
to correlate with each other along with explainable economic interruptions,
U.S. business taxation is distorting. e excessively high corporate income
tax rate has become a cause of tax inefficiency and ineffectiveness by
leading businesses to excessive tax planning and tax-induced avoidance of
incorporation. We are aware that both the government and the business sector
in the U.S. are interested in reforming their corporate tax system. We want to
point out, however, that the messy picture of U.S. effective corporate tax rates
only reflects the inefficiency and complexity of the U.S. corporate tax system; it
should not be used as an excuse for delaying its reform.
17 The New American Capitalism: Rise of the Distorporation, , Oct. 26, 2013,
.
