Corporate income taxes in U.S only 11% of government tax revenue?

Question

(I had initially asked this on Money.SE, but was advised this would be a better question for Politics.SE.)

I'm having a hard time understanding why corporate income taxes form such a small part of total U.S. government tax revenue. Given that corporations seem to generate most of the wealth in the United States, shouldn't they account for a larger portion of the tax base in the United States?

In 2014, individual income taxes accounted for 46%, and payroll taxes 34%, for a combined total of 80% of the tax revenue.

Corporate income tax? 11%.

From this image: , which is sourced from: President Obama Proposes 2014 Budget

Answer 1

The basic theory behind U.S. income taxation is to tax all income earned one time to the beneficial owners of that income. Under this theory, there is no theoretically valid reason to tax income both when it is earned by the corporation with a corporate tax, and when it is distributed to the shareholder.

One way to do that would be to tax dividends received by shareholders (the beneficial owners of a corporation) as income and to tax liquidation or redemption of stock proceeds as de facto sales of the stock equivalent to a third party sale of stock by the shareholder. And, U.S. tax law does that for publicly held corporations.

But, there is a huge loophole in that plan. If you didn't tax profits when they were earned by the company, they could be deferred indefinitely leading to massive tax losses (and indeed, multinational companies do just that by parking profits in foreign tax havens so they won't be taxed until they are repatriated to the U.S.). Shareholders could simply take out loans to access the value of their shares and dividends would never be paid and the profits would never be taxed.

Corporate taxes prevent the deferral of taxation on corporate profits until they are actually realized by the beneficial owners of the corporation. But, corporate taxes in the U.S. aren't well designed. Because dividends are not tax free (as they are in pass through entities once tax on entity level earning has been paid by the owners - which would look politically ugly in a publicly held company context letting people receive millions in dividends and pay not taxes on it), and there is no deduction for dividends paid to the corporation (in most contexts), and there is no tax credit for taxes paid at the corporate level against income tax liability on dividends, the end result is that there is double taxation of corporate profits both when the profits are earned by the corporation and again when they are distributed to shareholders. This creates a powerful incentive (which corporate management likes but investors do not) to not pay dividends. (Tax experts will note that I am glossing over the accumulated income tax which is mostly toothless, to simplify the analysis.)

Rather than solve this problem honestly, Congress and businesses have come up with a kludge that addresses the problem in an unprincipled way. This has several parts:

1. Public corporations refrain from paying dividends so double taxation is not incurred (except for utilities and related corporations which can get dividend paid deductions).

2. Tax rates on capital gains (and for parts of the history of the corporate tax, on dividends) have been preferential on the assumption that they largely reflect gains that are already taxed (and exceptions to favorable tax rates like depreciation recapture impose higher rates in circumstances when double taxation isn't a factor in most cases). Also, tax avoidance or deferral devises like tax favored retirement, education and health savings accounts eliminate capital gain and dividend taxes entirely on stock transaction or defer them until the beneficial owner wants to spend the money for a non-preferred purpose. The step up in basis for capital gains at death provides an end run that can turn deferral of shareholder level taxation by not selling stock and having corporations not pay dividends into tax avoidance rather than mere tax deferral.

3. Tax breaks at the corporate level, meanwhile reduce the effective tax rate at the corporate level to make up for the portion of double taxation that shareholder level tax breaks don't eliminate. For example, taxing dividends and capital gains on the sale of stock at about 71% of the hypothetically fair tax rate at the shareholder level, and taxing corporate profits at about 71% of the hypothetically fair tax rate at the corporate level, is economically equivalent to not having double taxation.

4. Equally important, almost all closely held companies are now taxed on a pass through basis in which entity profits are directly taxed to the beneficial owners when they are earned whether the profits are distributed or not. This works in closely held companies because the identity between ownership and management and effective political power of the owners in corporate governance is sufficient to make sure that the entity distributes enough money to allow the owners to pay taxes on profits that are earned. But, in a publicly held company where shareholder power is weak, this can't be counted upon to happen, so shareholders of public companies are taxed when they get the actual benefit and corporate taxes, screwed up as they are, limits the harm of indefinite deferral of income. Tools like private equity funds and increased wealth concentration in the U.S. have made it possible to raise huge amounts of money and take public companies private to avoid corporate taxes by this means, in ways that were simply impossible in earlier days, and this has been fostered by lax regulation of private offerings relative to public offerings by the SEC.

Many foreign countries in the developed world, instead tax corporate profits at a higher rate, resulting in higher corporate taxes collected, but credit corporate taxes paid against the tax due on dividends distributed, eliminating double taxation. Essentially, they make corporate tax collection greater and reduce individual income taxation to make up for the higher corporate tax rates.

Many foreign countries also use Value Added Taxes to provide a different tax regime for raising taxes from business that uses a different theory to operationalize the amount of profits that should be taxed than an income tax does that has proven harder for corporations to evade.

Answer 2

Corporate profits vs. salaries

If you compare corporate profits to employee compensation, employee compensation is about four times as large. Corporate income tax is on an alternative measure of profits. Personal income and payroll taxes are on a modified version of employee compensation.

Payroll taxes

Payroll taxes used to be evenly divided between an employer and employee share. More recent changes (Obamacare) changed that slightly, but corporations still pay a significant portion of payroll taxes. The implication of the graph seems to be that those are all individual taxes.

Note that not all of the employer share is paid by corporations. But all of the corporate share would show up in the general bucket.

Dividends as personal income

Corporations pay dividends to shareholders who are then taxed on them. This is clearly corporate generated wealth, but it shows up in the graph as individual income. Capital gains on stocks are similar. The wealth may be generated by the corporation, but the profit goes to some individual who pays the tax.

Subchapter S corporations

Subchapter S corporations, partnerships, and sole proprietorships have profits that are passed through to the individual(s) as income. So they'd show under personal income taxes not corporate taxes.

US rates

The United States has a particularly high corporate tax rate, nominally one of the highest in the world. As a result, US corporations are exceptionally aggressive about structuring their income so as to avoid income. The net result is that the US effective tax rate is slightly lower than average among OECD countries (27.1% to 27.7%).

You can use this either way. Corporations in the US pay a similar rate to corporations elsewhere or corporations in the US have more incentive to make income not show at all (which wouldn't show in the statistics if it were happening).

Corporate taxes as individual taxes

Corporations are a legal fiction. They do not actually exist. We use them as a convenience because some interactions are difficult to describe without them. For example, corporate ownership is much more complicated than a typical partnership. Legal liability is deliberately simpler than a partnership (owners of a corporation have limited liability). And employment relations would be well nigh impossible to describe.

Consider a typical employee of a GM factory. That person only contributes a fraction of the labor for each car. And the compensation is complicated. A paycheck, healthcare, retirement, other benefits, overhead, income tax withholding, unemployment, worker's compensation, Social Security tax, and Medicare tax. Isn't it simpler to just write one check to your local dealer who pays GM who pays hundreds of workers involved? But that hides the complexities involved. Who pays taxes? The purchaser of the car (all the money comes from them). The employees who get the lion's share (more than half) of the purchase price? The owners? The fictional entity we call GM?

How much of a difference does it make?

Note that it is unclear how much of a difference this makes. For example, if we assume that 80% of corporate wealth creation goes to employees and only 20% to shareholders (who may also be employees), that in and of itself would justify more taxes paid by individuals. But it wouldn't explain an 80 to 11 discrepancy.

Moving half of the payroll taxes from the individual bucket to the corporate bucket would overweight corporate taxes, 63 to 28. That's a 9:4 ratio but should be 4:1 by the previous thesis. However, payroll taxes are no longer evenly divided. And not all employers are corporations. But all corporate taxes are paid by corporations. So all of the 11% is paid by corporations plus some of what appears in the payroll and individual wedges.

We certainly can't tease out this effect by looking at the graph, even with knowledge of what each pie wedge means. I don't know of a public data source that breaks down the information in the necessary way. Perhaps it exists. Perhaps not. Certainly private data would cover this. The IRS knows who pays what tax.

Summary

I would reject the assertion that most wealth is created by corporations. To the extent that is true, some of the wealth is passed to individuals before being taxed. Thus leaving the graph showing more taxes paid by individuals than corporations. This is particularly true since it counts the employer share of payroll taxes against the individual employee.