Income Tax, Corporate

Income Tax, Corporate

INCIDENCE

EFFECTS

THE CORPORATE INCOME TAX IN MAJOR INDUSTRIAL COUNTRIES AND DEVELOPING COUNTRIES

BIBLIOGRAPHY

The corporate income tax is levied on the profits of incorporated businesses. Taxable income is defined as the gross income of a corporation minus its costs of doing business. Whereas the costs of labor and raw materials as well as interest payments are deducted from taxable income at the time they are incurred, the costs of capital assets are recovered only over time in the form of deductions for depreciation. To assess their tax liability, corporations apply a statutory tax rate to their taxable income and then subtract any deductions and other credits. The corporate income tax is mainly a central (federal) government tax, but subnational governments also apply the tax in many countries, although at a lower rate.

INCIDENCE

The effective tax rate differs from the statutory rate mainly because of the treatment of depreciation and interest payments. The effective tax burden is smaller the shorter the recovery period is and the more accelerated the rate of depreciation is. The effective burden is smaller the greater the use of debt relative to equity in financing investment is because interest payments, unlike dividend payments, are expensed. The extent of the “double taxation” of dividends, first as part of corporate taxable income and then as income received by individual taxpayers, and how to address it is subject to theoretical and empirical debate.

Because labor costs are excluded in calculating taxable income, the corporate income tax generally is viewed as a tax on capital income. However, some of the tax burden can be shifted from firms to consumers through higher prices or to workers through lower wages, depending on the structure of the product and labor markets. The closer such markets are to competitive conditions, the harder it is for firms to shift the tax burden. The empirical literature is inconclusive about the extent of that shifting.

EFFECTS

The corporate income tax can influence economic growth through its impact on economic behavior, including saving and investment. The effect on saving is ambiguous in both the theoretical and the empirical literature. The tax could affect the level and composition of capital formation by raising the cost of capital and imposing a relatively higher burden on equity versus debt financing. It also may induce firms to organize in unincorporated forms (which are not subject to corporate income tax) that may not be the economically optimal forms of organization apart from tax considerations. Moreover, tax compliance and the tax planning that businesses undertake to minimize tax liabilities, such as transfer pricing, and entail costs. The estimated costs of the distortions associated with the U.S. corporate tax fall in a wide range of one-quarter to nearly two-thirds of revenues. The tax can influence income distribution directly because taxes on capital income tend to be progressive relative to taxes on labor income and indirectly through its impact on the cost of capital.

THE CORPORATE INCOME TAX IN MAJOR INDUSTRIAL COUNTRIES AND DEVELOPING COUNTRIES

In 2003 revenue from the corporate income tax averaged around 3.5 percent of gross domestic product (GDP) among Organisation for Economic Cooperation and Development (OECD) countries. The top statutory tax rate varied substantially from 12.5 percent to 41 percent. Among developing countries that revenue averaged around 3 percent of GDP. Over the last decade or so there has been a general tendency for countries to reduce the statutory tax rate. Some countries offer corporate tax incentives in an effort to attract investment. The effectiveness of those incentives is open to debate, but incentives that provide for faster recovery of investment costs generally are considered preferable to those involving the tax rate.

SEE ALSO Capital; Corporations; Distortions; Government; Income Distribution; Investment; Taxes

BIBLIOGRAPHY

Auerbach, Alan. 2006. Who Bears the Corporate Tax? A Review of What We Know. In Tax Policy and the Economy, vol. 20, ed. James M. Poterba, 1–40. Cambridge, MA: MIT Press.

Bernheim, B. D. 2002. Taxation and Saving. In Handbook of Public Economics, vol. 3, eds. Alan J. Auerbach and Martin Feldstein, 1173–1249. Amsterdam and New York: Elsevier.

Congressional Budget Office. 2005. Corporate Income Tax Rates: International Comparisons. Washington, DC: Author.

Gordon, Roger M., and Jeffrey H. MacKie-Mason. 1995. Why Is There Corporate Taxation in a Small Open Economy? The Role of Transfer Pricing and Income Shifting. In The Effects of Taxation on Multinational Corporations, eds. Martin Feldstein, James R. Hines, Jr., and R. Glenn Hubbard, 67–91. Chicago: University of Chicago Press.

Gravelle, Jane. 1994. The Economic Effects of Taxing Capital Income. Cambridge, MA: MIT Press.

Harberger, A. C. 1966. Efficiency Effects of Taxes on Income from Capital. In Effects of the Corporate Income Tax, ed. M. Krzyaniak, 107–117. Detroit: Wayne State University Press.

International Monetary Fund. Various years. Government Finance Statistics. Washington, DC: Author.

Musgrave, Richard A., and Peggy B. Musgrave. 1989. Public Finance in Theory and Practice, 5th ed. New York: McGraw-Hill.

Tanzi, Vito, and Howell Zee. 2000. Tax Policy for Emerging Markets: Developing Countries. National Tax Journal 53 (2): 299–328.

Zee, H., J. Stotsky, and E. Ley. 2002. Tax Incentives for Business Investment: A Primer for Policy Makers in Developing Countries. World Development 30 (9): 1497–1516.

Vivek Arora