Corporate Tax History in the United States

Corporate taxation in the United States is a levy on the profits of corporations. It serves as a source of government funding and a tool for influencing economic behavior. The framework for this taxation has evolved, shaped by the nation’s economic conditions, political ideologies, and social demands.

The Genesis of Corporate Taxation

The concept of taxing corporations separately from their owners was first introduced in the Revenue Act of 1894. This initial attempt was short-lived, as the Supreme Court declared it unconstitutional the following year in Pollock v. Farmers’ Loan & Trust Co. The court’s decision argued that the tax was a direct tax that was not apportioned among the states according to population, as then required by the Constitution.

In response to the Supreme Court’s decision, Congress passed the Corporation Excise Tax Act of 1909. This law framed the tax as an excise tax on the privilege of doing business as a corporation, with the tax itself measured by income. The initial rate was set at 1% on corporate net income over $5,000.

The legal landscape shifted with the ratification of the 16th Amendment in 1913. This amendment granted Congress the power “to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States.” With this constitutional authority, the Revenue Act of 1913 was enacted, which formally established the modern corporate income tax alongside the individual income tax at a modest 1% rate.

The entry of the United States into World War I created a need for government revenue, leading to increases in corporate tax rates. Following the war, the 1920s saw a reversal of this trend. Under the influence of Treasury Secretary Andrew Mellon, a series of tax cuts were implemented with the goal of stimulating economic growth.

The economic collapse of the Great Depression brought another shift in tax policy. As government revenues plummeted, both the Hoover and Roosevelt administrations enacted tax increases to address budget deficits. The Revenue Act of 1932, for instance, raised the corporate rate as part of a broader effort to restore fiscal stability.

The World Wars and the High Tax Era

The onset of World War II ushered in an era of high corporate taxation to meet the financial demands of the war effort. Lawmakers introduced an “excess profits tax” designed to capture the windfall profits that companies earned as a result of war-related production. This tax, levied in addition to the regular corporate income tax, was calculated based on a company’s earnings relative to a pre-war baseline. While the excess profits tax rate reached as high as 95%, the law included a cap that limited a corporation’s total tax liability to a maximum of 80% of its income.

Following the war, corporate tax rates did not return to their pre-war levels. Instead, they remained high throughout the post-war economic boom of the 1950s and 1960s, with the top statutory rate generally hovering around 50%. This period was marked by a consensus that supported these high rates, viewing them as a fair way for profitable corporations to contribute to society.

The economic challenges of the 1970s began to erode this consensus. The United States experienced a period of “stagflation,” a combination of stagnant economic growth, high unemployment, and high inflation. This environment led many economists and policymakers to question the existing high-tax paradigm, arguing that the rates were discouraging investment and hindering economic competitiveness.

The Great Tax Reform of the 1980s

The 1980s witnessed a transformation in U.S. tax policy, beginning with the Economic Recovery Tax Act of 1981 (ERTA). Signed by President Reagan, ERTA enacted tax cuts for corporations, including accelerated depreciation schedules, to stimulate business investment and combat the economic stagnation of the previous decade.

A major overhaul of this era was the Tax Reform Act of 1986 (TRA 86). The core philosophy of TRA 86 was to broaden the tax base while lowering the marginal tax rates. This meant eliminating numerous deductions and credits, which allowed for a steep reduction in the top corporate tax rate from 46% to 34%.

A feature of TRA 86 was its focus on economic neutrality. By removing many of the special tax breaks that favored certain industries or types of investment over others, the act aimed to ensure that business decisions were driven by economic merit rather than tax considerations. This resulted in a system with a more consistent application of tax rules.

The framework established by TRA 86 largely endured for the next three decades. For instance, the Revenue Reconciliation Act of 1993, under President Clinton, included a modest increase in the top corporate rate to 35% to address budget deficits. Legislation in the early 2000s under President George W. Bush provided some tax relief, but these changes operated within the structure that the 1986 reform had put in place.

The Modern Shift to a Territorial System

Leading up to 2017, a consensus grew that the U.S. corporate tax system was becoming uncompetitive. The 35% federal statutory rate, in place since the 1990s, was now one of the highest among major developed economies. This created an incentive for U.S. multinational corporations to hold their foreign earnings offshore, as those profits would be subject to the high U.S. rate if repatriated.

The Tax Cuts and Jobs Act of 2017 (TCJA) addressed the competitiveness issue directly by replacing the graduated corporate tax structure with a single, flat rate of 21%. This reduction was intended to bring the U.S. rate more in line with the international average and reduce the incentive for companies to move profits to lower-tax jurisdictions.

A fundamental change introduced by the TCJA was the shift from a “worldwide” tax system to a modified “territorial” system. Under the previous worldwide system, U.S. corporations were taxed on their entire income, regardless of where it was earned. The new territorial system largely exempts foreign-source income from U.S. taxation, fundamentally altering how American multinational corporations are taxed on their international operations.

To manage the transition to this new system, the TCJA implemented a one-time mandatory repatriation tax. This provision required U.S. companies to pay a tax on their accumulated offshore earnings that had not yet been subject to U.S. tax. The tax was set at a reduced rate, payable over several years, clearing the slate of untaxed foreign profits that had built up under the old system.