By Jack Mintz, Duanjie Chen (Tax Foundation):
Key Points
- 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.
The 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. This 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. The long-run divergence between these two rates is not caused by the economic cycle but by irregular provisions of various conditional tax preferences. These irregular conditional tax allowances or credits narrow the tax base, which often goes hand in hand with rather high statutory tax rates.
The 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. This 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. The 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.
This 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. The corporate tax system also undermines economic growth with a non-neutral treatment of business activities.
The full study can be found here.