Corporate Rate Reduction

Professor Daniel Halperin has posted a working paper regarding corporate tax rates at the Tax Policy Center (full disclosure: I did help him with some of the research).

The abstract reads:

Since the statutory marginal U.S. income tax rate on corporate income is higher than the marginal rate imposed by all of our trading partners except Japan, there have been a number of proposals to reduce the U.S. marginal corporate rate. At the same time, it seems likely that the top individual rate will be increased. However, a differential between marginal corporate and individual rates could reduce the overall rate of tax on corporate distributions and enable higher-income taxpayers to shelter their income from services or investments. This paper suggests that we can mitigate these problems if the lower corporate rate is denied to income from services or passive investments and if there is always a second tax on distributed income. The latter requires reducing the step-up in basis at death and the deduction for charitable contributions by the amount of undistributed earnings to prevent taxpayers from permanently escaping tax on earnings retained in the corporation. Nonetheless lower corporate rates allow reinvested corporate profits to earn a permanent higher rate of return. Setting the combined individual and corporate rates on corporate distributions higher than the top individual rate offsets this advantage and also reduces the risk that corporations will be used to shelter income.

Halperin lays out the matter quite nicely. Corporate rate reduction can lead toward some strange arbitrage matters that a lawyer thinks about. While this matter has become the cats meow for economists, few think of how the code is structured.

Reducing the rate requires us then to think about these effects to prevent shell corporations for tax shelter purposes. The idea of looking ont only at the actual corporate income tax rate, but looking at distributiosn as well and comparing that to the individual rate makes sense. I do hope a few more policy makers read this article.