Business Taxation: What are the statutory and effective corporate tax rates?
The statutory corporate tax rate is the rate that is imposed on taxable income of corporations, which is equal to corporate receipts less deductions for labor costs, materials, and depreciation of capital assets. In contrast, the effective corporate tax rate (ETR) measures the taxes a corporation pays as a percentage of its economic profit. Taxable income is less than economic profit when firms can exempt some income from tax, write off the cost of assets faster than their actual decline in value, or claim tax credits for certain business purchases. When taxable income is less than economic profit, a firm’s effective tax rate is less than its statutory rate. A third tax measure is the marginal effective tax rate (METR) on new investment, which assesses how much the corporate tax reduces the rate of return on new investment and is consequently the best measure of how taxes affect a firm’s incentive to invest.
- Under the federal income tax, the statutory corporate tax rate ranges from 15 percent on the first $50,000 of taxable income to 35 percent on income over $18.3 million, with higher rates (up to 39 percent) in some income ranges that phase out the benefits of the lower rates (See table). Most corporate income is taxed at the 35 percent rate.
· State governments also impose corporate income taxes, with a median top rate of 7.0 percent. Because state corporate income taxes are deductible against the federal tax, the median combined state and federal statutory corporate tax rate is 39.6 percent.
· ETRs may differ from statutory rates for several reasons. Exemptions and deferral of some sources of income lower taxable income relative to economic profits and thus reduce the ETR. Because they lower tax liability, tax credits also lower the effective rate. Other factors, such as the failure to adjust depreciation deductions for the effects of inflation, can raise the effective rate relative to the statutory rate.
· Economists further distinguish between the average ETR on a corporation’s entire income and the marginal effective rate (METR) on income from a new investment. The METR measures how much the corporate tax reduces the rate of return on new investments—as a share of the pretax return—and provides the best measure of how the corporate tax affects the incentive to invest.
o The METR depends on the statutory tax rate, the timing of capital recovery allowances (depreciation and, for minerals, depletion), and the availability of investment credits.
o If there are no investment credits and capital purchases can be fully expensed (deducted) in the year purchased, then the corporate METR is zero because the pretax and after-tax returns to an investment are equal. In effect, the government is a partner in the investment, contributing a share of the capital through the deduction of investment and then capturing the same share of returns.
o If there are no investment credits and annual depreciation exactly matches the annual decline in the real value of assets, then the corporate METR is equal to the statutory rate because taxable income in any year is equal to economic profits.
o The Congressional Budget Office (CBO) recently estimated an average corporate-level METR of 30.6 percent, slightly below the 35 percent maximum statutory rate because favorable depreciation rules lower taxable income. The rate varies considerably among assets and industries. Taking account of individual-level taxes on corporate income, CBO estimated that the combined individual/corporate METR on new corporate investments ranges from 36.9 percent on computers and peripheral equipment to 9.2 percent on petroleum and natural gas structures, with an average of 26.3 percent for corporate investments in all industries.
o Changes in the top statutory rate, depreciation provisions, and inflation rates have caused the average METR on corporate investments to vary considerably over the last half century. In recent years, the METR has been close to a historical low. (See chart).