Research Paper on Corporate Tax: Source of Income for Governments Since Time Immemorial

Introduction

Corporate tax has been one of the major sources of income for governments since time immemorial. Just like any other corporation, governments require finances to foster growth and development and ensure that they adequately meet the needs and expectations of their citizens. As a way of raising the finances, a nation sets a tax policy that aims at imposing taxes on the profits that companies, both public and private, earn. The taxes that countries impose on profits earned by corporations vary greatly. Until 2018, the United States was imposing the highest corporate tax, 35%, as compared to other industrialized countries (Tax Foundation, 2019). While high tax rates have the potential of generating high incomes for the government, it jeopardizes the operations of the corporations, which, due to low retained income, are likely to experience a slow growth rate. As such, some corporations might seek creative ways to avoid paying their legally required tax shares. It is critical, therefore, for the government to implement tax reforms that not only aim at maximizing the collectible taxes but also to establish a sustainable economy where investors feel safe and comfortable to invest.

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Background to the US Corporate Taxes

How the US Tax System Works

The US tax system is multifaceted with numerous tax components. Major tax components include the individual income tax, corporate tax, payroll tax, and excise tax. Taxation Individual income targets individual wages and salaries as well as pass-through businesses such as sole proprietorships, partnerships, limited liability companies, and unregistered corporations (Beer, Klemm, & Matheson, 2018). The profits of pass-through businesses are taxed as the income of the owners. The individual income tax rate varies depending on the level of disposable income and family status. People who earn more and are married tend to pay more individual income taxes.

Corporate income tax, previously charged at 35% and currently 21%, targets the income of regular corporations rather than individual shareholders (Tax Foundation, 2019). Corporate profit can be defined as the total income earned by a corporation minus all the expenses and costs that led to the generation of the income. Therefore, the amount that a corporation pays as tax is the corporate profit multiplied by the tax rate. However, the actual amount that corporations pay as taxes is sometimes low primarily due to tax credits, special deductions, or tax preferences. By 2017, the US corporate tax system was operating on a worldwide tax system where incomes of corporations were taxable irrespective of where the income is derived (Organization for Economic Cooperation and Development, 2019). As such, the profits of both local and foreign corporations were taxed at the same rate.

The country also imposes payroll taxes on incomes and salaries with a specific objective of funding particular programs such as Social Security and Medicare. It also levies excise taxes on the consumption of particular goods and services. Despite the involvement of states, the US taxation processes are majorly carried out by the federal government.

The US Corporate Tax Rates through History

Before the 1984 Revenue Act, the Unites States levied taxes on individual business owners rather than corporations and separate and autonomous entities. Amended in 1909 by the Tax Act, the law became recognizing the autonomy of corporations, thereby levying taxes directly to the corporations rather than its owners (Mckenzie & Smart, 2019). The corporate tax rate was 1%, which remains the lowest through American History. However, it increased steadily to all times high of 52.8% in 1968, primarily escalated by the need to support the country during the world wars (Mckenzie & Smart, 2019). The Tax Reform Act of 1987 reduced the corporate tax rate to 40% and set the stage for further reduction (Mckenzie & Smart, 2019). It plateaued at 35% between 1993 and 2007 after the Omnibus Reconciliation Act of 1993 (Mckenzie & Smart, 2019).

Comparison between the US Corporate Tax Rates and other OECD Countries

2017 statistics reveal that the United States levied the second-highest corporate taxes compared to other advanced countries. The United States leads OECD bloc, which is a group of highly developed nations, in terms of the rate of corporate tax. While the countries' corporate tax rates averaged at about 26%, the Unites States combined corporate tax rate was 38.9%, which is second to France imposing corporate taxes at a rate of 44% (Organization for Economic Cooperation and Development, 2017).

Switzerland levies the lowest corporate taxes at a rate of 8.5%. Other OECD nations including the United Kingdom, Germany, and Canada levy the taxes at 19%, 15.8%, and 15%, respectively (Organization for Economic Cooperation and Development, 2017).

Contribution of US Corporate Tax to the Country's National Tax Revenues

Total National Tax revenues constitute all the incomes that the government collects by taxing its citizens and their businesses as well as corporations that operate both within the US territories as well those that are operating abroad yet have links to the US. As described in a previous section, the United States collects its tax-based revenues from various tax components, including individual income tax, corporate income tax, payroll tax, and excise tax. The federal government raised a total of $3.3 trillion in tax revenues in 2017 (Gale & Samwick, 2017). The following chart summarizes the major sources of the country's revenues.

From the chart, the federal government collected the highest revenues from individual income taxes, which contributed 49%, equivalent to $1.6 trillion, of the total revenues (Gale & Samwick, 2017). Payroll taxes provided 36%, equivalent to $1.2 trillion. Corporate income tax and excise contributed 6% and 3% respectively to the nation's total revenues equating to $198 billion and $99 billion, respectively (Gale & Samwick, 2017). The US revenue as a percentage of Gross Domestic Product in 2017 was 17.3%. Gross domestic product is the total value of all goods and services that are produced within the territories of a country within a specific period, usually one year. Generally, it indicates the economic health of a nation. The country's corporate income tax revenue is one of the lowest among OECD countries. Revenue that the US collects from corporate income taxes accounts for 1.5% of the total revenue.

The Problems with US Corporate Taxes

It is paradoxical how the US imposes the highest taxes compared to other OECD nations (35%) yet collects the lowest corporate tax revenues as a percentage of gross domestic products (1.5%). It is also worth asking why the revenues that the country collects from corporate income tax is much low compared to other revenue components such as individual income tax and payroll tax. Various reasons can explain the phenomena. First, numerous business entities resort to operating as partnerships and S corporations that are not liable for corporate income tax (Beer et al., 2018). Incomes earned from such business are taxed as individual incomes rather than corporate income. Generally, taxes imposed on individual incomes are much lower than the taxes imposed on individual income, making such business entities to pay less in taxes.

Secondly, the US has currently experienced a wave of inversion where corporations relocate their headquarters from the United States to a low tax country such as Switzerland and Ireland as a way of avoiding high taxation. At least 50 corporations have moved to tax havens within the last two decades, with the rate currently rising sharply (David, 2016). A report published in CNBS shows that the United States loses at least $100 billion in corporate tax revenues annually due to tax inversions (David, 2016). The primary reason that explains why a company may resort to inversion is the need to minimize tax expenses as a way to maximize retained profits.

Corporate Tax Reconsideration

From the analysis and problem presented in the above section, it is inappropriate to directly link low corporate tax collections with the current corporate tax rates. In fact, there is a clear inverse relationship between the two. High corporate tax rates are highly likely to lead to low revenues collected from corporate taxes. The adverse effect of high taxation rates calls for the need to reconsider the current tax system and implement tax reforms that would improve the country's competitiveness in the global platform and ensure that corporations operating in the US feel that they are not exploited but taxed fairly and equitably. Through such reforms, the businesses would feel less threatened to register as C corporations and will find it less necessary to invert.

Recent Changes to the US Corporate Tax

Fortunately, the country is already committing efforts towards implementing reforms that would precipitate the low corporate income tax rate. The Tax Cut and Jobs Act (TCJA) which became operational on January 1, 2018 was signed by President Trump on December 22, 2017 (Beer et al., 2018). The law aims at reducing both individual income tax rates as well as corporate tax rates and increasing standard tax deductions and family tax credits.

Specifically, it reduced the corporate income tax rate by 14 points from 35% in which it plateaued for over two decades to 21%, bringing the US rate below the OECD average for the first time since 1940 (Mckenzie & Smart, 2019). As such, the US corporations would pay less in taxes as compared to what they were contributing before the enactment of the law. Their tax contribution would also be low compared to the amount that corporations in other OECD countries contribute. Nonetheless, there has been an intensifying contention, especially among the political class, as to whether the law is beneficial or detrimental.

Benefits and Limitations of TCJA to Corporations and Corporate Taxes

The apparent advantage of the TCJA tax reform is that it sets the pace for creating a sustainable environment for businesses to operate and thrive. With the corporate tax rate reduced to 21%, the cost of registering and operating a company shall drastically reduce due to the relaxed tax burden. It is anticipated that, with the new tax reform, more businesses will register as corporations as the rate of inversion is to reduce drastically. Besides, the tax reform targets increasing business incentives, which shall help corporations save on taxes and channel more resources on growth. The US is to experience increased local and foreign direct investment as well as repatriation of corporations, which would foster economic growth. This is likely to translate into higher revenue collections from corporate taxes leading to high net incomes and GDP. Although there is insufficient data to discern the current and future impacts of TCJA, evidence proves the impacts are optimistic.

However, TCJA has the potential of increasing national deficit, making it difficult for the government to efficiently carry out its political, economic, and social roles. Reports by Tax Foundation show that the future of the tax reform is clouded with uncertainty, which is likely to lead to increases in budget deficits precipitating into a shrinking US economy. However, optimists are convinced that the projected increase in economic growth will offset the reduced revenue collection. Cobham and Jansky (2018) argued that reduced corporate taxes boost the vitality and productivity of corporations and minimize tax aversion. I...