The Incredible Shrinking Corporate Tax Bill

Corporations are paying a lot less in taxes than they used to. Let's figure out why.

Vanishing act.

Photographer: Timothy Fadek/Bloomberg

The second quarter of 2017 was another good one for corporate profits in the U.S. By one of the several measures tallied by the Bureau of Economic Analysis in its gross domestic product report last week, those profits poured in at an annualized rate of $2.27 trillion before taxes and $1.79 trillion after. 1  Neither of those quite match the all-time records set over the past three years, but they're not far off. 2

When you measure profits as a share of GDP and look back as far as the available data will take you, though, the picture is different. Pre-tax profits aren't anywhere near a record, are about as high as they were for most of the 1940s and 1950s, and are not far above the highs of the 1960s and 1970s. After-tax profits, on the other hand, have for most of the past decade-plus been markedly higher than at any time since 1929, when the top corporate income tax rate was just 11 percent.

Corporate Profits

As a percentage of gross domestic product

Source: U.S. Bureau of Economic Analysis

*2017 numbers are averages of first two quarters.

What this means is that corporations are paying a lot less in taxes (as a share of profits or of GDP) than they used to. Because reducing corporate tax rates is likely to be central to the tax reforms Congress will attempt this fall, this seems like a good time to go over how this came to pass.

First, here's the history of corporate federal income tax receipts, as tallied by the White House Office of Management and Budget:

Corporate Income Tax Receipts

As a percentage of gross domestic product, by fiscal year

Source: White House Office of Management and Budget


One cause of this decline is that corporate tax rates are lower than they used to be. After shooting up in the late 1930s and early 1940s, the top rate hovered around 50 percent for most of the 1950s and 1960s, then headed downward to its current rate, 35 percent, which has been in place since 1993. Still, that drop in the top rate is a lot smaller than the 73 percent decline in corporate tax receipts' share of GDP since the early 1950s. Also, that 35 percent rate, combined with an average state corporate tax rate of 3.9 percent, gives the U.S. the third-highest top marginal corporate tax rate on the planet; yet the U.S. is far from a world leader in generating revenue from corporate income taxes.

Corporate Taxes, International Edition

Tax on corporate profits as a percentage of gross domestic product

Source: Organization for Economic Cooperation and Development

So what has caused the decline in corporate tax receipts? One factor is the internationalization of big U.S. corporations. The corporate profit numbers cited above include all the profits earned overseas by U.S.-based companies (minus the profits earned in the U.S. by foreign companies). Almost uniquely among nations, the U.S. aims to tax all the profits of its corporations, regardless of where on earth they are earned. The tax bill isn't due, though, until the profits are repatriated to the U.S. This is why there is currently more than $2 trillion sitting in overseas accounts that has been counted as profits by the BEA but has yet to generate taxes for the IRS.

Still, even when one just looks at profits earned in the U.S., 3 it's clear that the gap between pre-tax and after-tax has shrunk since the 1960s:

Corporate Profits, Another View

Domestic corporate profits as a percentage of gross domestic income

Source: U.S. Bureau of Economic Analysis

Again, declining tax rates, and other breaks such as accelerated depreciation of business investments, are responsible for some of this shrinking of the tax wedge. But the biggest reason seems to be the explosion in corporation-like entities that are not, for tax purposes, corporations.

The rise of these "pass-through entities" started with the 1958 addition to the tax code of 1958 of subchapter S, crafted by a Democratic Congress and signed into law by Republican President Dwight Eisenhower, which enables "S corporations" with a limited number of shareholders (10 or fewer in 1958, 100 or fewer now) to pass their profits on to those shareholders without paying corporate income tax on them. Then, in 1960, Congress added (to the Cigar Excise Tax Extension Act, of all things) and Eisenhower signed into law a provision creating the real estate investment trust, which allows for similar pass-through tax treatment for larger groups of real estate investors. A few decades later came the limited liability company, pioneered in Wyoming in 1977 and available in every state by 1996, which gives certain partnerships, which were always pass-through entities, many of the liability protections of corporations. Meanwhile, limited partnerships, while they had existed all along, became increasingly prominent as the legal structure of choice for hedge funds, private equity and venture capital.

The Decline of the C Corporation

Percentage of total nonfarm business receipts

Source: Internal Revenue Service

The standard "C corporation," which pays corporate income taxes, has thus come to account for an ever-shrinking share of business income (and an even smaller share -- just 18 percent in 2012 -- of businesses). Meanwhile, the BEA counts the income of S corporations, REITs and some LLCs as corporate profits. The result is a smaller share of corporate profits being paid out as taxes.

Is this a bad thing? A long-standing complaint about the corporate income tax, dating back at least to economist Irving Fisher's famous 1937 article on "Income in Theory and Income Taxation in Practice," is that it is double taxation. Income is taxed once at the corporate level, and then again when it is passed on to shareholders as dividends or realized as capital gains when they sell shares. The current tax code partly addresses this by imposing lower tax rates on dividends and long-term capital gains than on regular income. But S corporations, LLCs and the like offer the arguably more elegant solution of simply bypassing the corporate income tax entirely and subjecting business owners to the individual income tax. These pass-through entities haven't entirely taken over the business world because they are subject to rules on ownership, taxation and other matters that C corporations aren't, but they do keep gaining ground. Publicly traded LLCs are becoming a thing now, for example.

Still, corporate income taxes remain an important fiscal pillar in the U.S. They may amount to just an estimated 1.7 percent of GDP this year, but that's 9.4 percent of federal tax revenue. Get rid of them, and the resulting increase in individual income tax receipts won't be enough to make up for it -- in part because so many corporate shares are owned by tax-exempt or tax-sheltered entities such as foundations, college endowments, pension funds and 401(k)s.

One argument for reducing the corporate tax rate is that it's so high now that it distorts behavior, encouraging U.S. corporations to take on foreign identities, keep money parked overseas -- or structure themselves as something other than C corporations. It is the only current U.S. tax of which I have heard an economist other than Arthur Laffer argue that it might be on the wrong side of the Laffer Curve, where reducing rates increases revenue. I doubt that is really the case, but the losses may not be huge and there is definitely an economic case to be made for cuts.

What doesn't seem to make so much sense in this context is reducing the tax rates faced by owners of pass-through entities, which the current administration seems to favor. These are businesses that are already being exempted from the corporate tax, and their growth has cut sharply into corporate tax revenue. More than three-quarters of the benefits of such a tax cut would flow to households in the top 1 percent of the income distribution. It just doesn't add up.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
  1. These are corporate profits without inventory valuation and capital consumption adjustment, which I use here because it's the measure most similar to the profits reported publicly by individual corporations and most often used in comparing profits to GDP, as I do in the subsequent chart.

  2. The record for pre-tax profits is $2.29 trillion, set in the fourth quarter of 2014. For after-tax profits it's $1.81 trillion, set in the first quarter of this year.

  3. This time I've gone with corporate profits with inventory valuation and capital consumption adjustment, because that's what the BEA does in its "Percentage shares of gross domestic income" table. Gross domestic income is, as it sounds, an income-derived measure that in a perfect world would be equal to gross domestic product but, because this isn't a perfect world, is always off by a few tens or hundreds of billions of dollars.

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Justin Fox at

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Tracy Walsh at

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