Corporate Income Tax, Its History and the Effective Rate

How the Tax Act Changes Corporate Taxes

corporate tax
••• The U.S. Robin Hood Tax Campaign protest outside JPMorgan Chase Corporate Headquarters on June 19, 2012 in New York City. Photo by Neilson Barnard/Getty Images for Robin Hood Tax

Corporate income taxes are levied by the U.S. federal government and by states on business profits. Understandably, companies try to use everything in the tax code to lower the cost of taxes paid by reducing taxable income.

The Effective Tax Rate Is 18 Percent

The 2017 U.S. tax rate is around 40 percent. That includes:

  • Federal tax rate of 35 percent for the highest income brackets. Beginning in 2018, Trump's tax cut lowers that to 21 percent.
  • State and local tax rates ranging from 0 percent to 12 percent. It averages out to 7.5 percent.
  • Companies deduct state and local tax expenses. That averages out to around 40 percent. 

But corporations don't actually pay the top federal tax rate. The effective rate is around 18 percent. In 2015, the Treasury Department collected $390 billion. That's just 18 percent of U.S. corporate profits of $2.1 trillion, according to Table 1.12 of the National Income and Products Accounts.

That's about half the effective rate the government received in 2007, the year before the recession. Corporate taxes were $395 billion on a profit of $1.5 trillion. 

How Corporations Avoid Paying Taxes

How do corporations avoid paying taxes? First, almost half of all corporations are "S" Corporations. These pass-through firms pay no corporate taxes. Instead, they pass corporate income, losses, deductions, and credits through to their shareholders.

The shareholders are then taxed on these profits or losses at their income tax rates. 

A second reason is that companies reinvest profits earned overseas into those markets. They might prefer to bring the cash home, but are deliberately avoiding U.S. taxes. It's actually cheaper for them to borrow at current low interest rates in the United States than to bring earnings home.

As a result, corporations are debt-heavy in the United States, and cash-rich in overseas operations.

The Tax Cut and Jobs Act seeks to change this by adopting a "territorial" system. Corporations will not longer be taxed on that foreign profit. It also allows companies to repatriate the $2.6 trillion they hold in foreign cash stockpiles. They would just pay a one-time tax rate of 15.5 percent on cash and 8 percent on equipment. 

Some corporations won't welcome the change. They've become so adept at avoiding U.S. taxes that it's become a competitive advantage. They can make more money in U.S. markets than foreign competitors because of their knowledge of the tax code and how to get around it. 

History of Corporate Taxes

Before the 1894 Revenue Act, taxes were levied on the individual owners of businesses, but not on the corporations themselves. Although the Act was ruled constitutional, it was replaced by a Tax Act in 1909, the first year that corporate taxes were levied.

The maximum tax rates below are the rates paid on the highest income levels. Please note that the definition of income changes frequently, so keep that in mind when comparing rates. 

Until 1936, all companies paid the same rate, regardless of income.

The current system is more progressive.

Year ChangedMax Tax RatePresident

Comments

 1909   1%Taft.
 1916   2%Wilson 
 1917   6%  
 1918 12%  
 1919 10% WWI began.
 1922 12.5%HardingFinance WWI
 1925 13%Coolidge 
 1926 13.5%  
 1928 12%  
 1929 11%HooverTax cut triggered stock market crash.
 1930 12% Tax hikes to stop speculation worsened depression.
 1932 13.8% 
 1936 15%FDR Hike revived depression.
 1938 19% Hike to finance WWII.
 1940 24%
 1941 31% Pearl Harbor attack triggered more hikes.
 1942 40%
 1950 38%TrumanCut to fight recession.
 1951 50.75% Hike to fund Korean War.
 1952 52%EisenhowerNo cuts, despite 1953 and 1957 recessions.
 1964 50%LBJ ​Implemented JFK's tax cut.
 1965 48% Cut boosted economy.
 1968 52.8% Hikes paid for Great Society and Vietnam War.
 1970 49.2%NixonCut to fight recession.
 1971 48%
 1979 46%CarterCut to offset high interest rates.
 1987 40%ReaganTax Reform Act
 1988 34% Cut to fight recession.
 1993 35%ClintonOmnibus Budget Reconciliation Act
 2018 21%TrumpCut goes into effect.

(Sources for Table: "Corporate Tax Rates 1909-2002," IRS.  "Corporate Tax Rate and Jobs," ProCon.org.)