Is Corporate Income Tax Progressive or Regressive?
Examines the economic debate over who truly bears the burden of the corporate income tax, moving beyond its on-paper structure to its real-world effects.
The question of whether the corporate income tax is progressive or regressive is a subject of debate among economists. At its core, the corporate income tax is a levy on a company’s profits. Understanding its economic effect requires looking beyond the initial payment and examining who truly bears the financial cost, which involves exploring tax incidence.
Defining Progressive and Regressive Taxation
To understand the debate, one must first grasp the concepts of progressive and regressive taxation. A progressive tax is one where the tax rate increases as income increases. The U.S. federal individual income tax system is an example, with tax brackets imposing higher rates on higher levels of personal income. For instance, an individual with a taxable income of $45,000 pays a lower percentage of their income in taxes than an individual with an income of $500,000.
In contrast, a regressive tax is one where the tax rate decreases as the taxable amount increases, taking a larger percentage of income from low-income individuals than from high-income ones. Sales taxes on essential goods are often cited as a regressive tax. A person earning $30,000 a year and a person earning $300,000 a year both pay the same sales tax rate on a gallon of milk, but the tax represents a much larger proportion of the lower-income person’s earnings.
Between these two is a proportional tax, often called a flat tax, which applies the same tax rate to all income levels. Under this system, every taxpayer pays an identical percentage of their income in taxes.
The Structure of Corporate Income Tax
The Tax Cuts and Jobs Act of 2017 (TCJA) changed the U.S. federal corporate income tax by replacing a tiered structure with a single, flat rate. Since January 1, 2018, corporate profits have been subject to a 21% federal tax rate. This marked a departure from the previous system, which had multiple brackets with rates that increased with income.
Before the TCJA, the graduated rates functioned similarly to individual income tax brackets. This structure had a progressive element, as more profitable firms faced a higher statutory tax rate. The shift to a flat 21% rate eliminated this feature.
Based solely on this statutory design, the current federal corporate income tax appears to be proportional. This on-paper view, however, only tells part of the story. The true economic impact depends not on who writes the check to the Internal Revenue Service (IRS), but on who ultimately bears the financial burden.
The Concept of Tax Incidence
The discussion of whether a tax is progressive or regressive moves beyond its statutory rate to the economic concept of tax incidence. Tax incidence is the analysis of who ultimately bears the economic burden of a tax. The entity legally responsible for remitting the tax is often not the one that bears the full economic cost, as the burden can be shifted to others through changes in prices, wages, and investment returns.
In the context of the corporate income tax, economists identify three primary groups that may bear the burden: shareholders, workers, and consumers. The corporation itself is a legal entity, so the money used to pay the tax must come from one of these groups. This shifting occurs as a business responds to the tax to protect its after-tax profits.
For example, a company might increase product prices, passing the cost to customers. Alternatively, it might reduce its budget for employee compensation, leading to lower wages. Finally, the tax might directly reduce the profits available to the company’s owners, the shareholders, through lower dividends or stock values.
Arguments for a Regressive Impact
The argument that the corporate income tax is regressive hinges on the belief that its burden is shifted to workers and consumers. When the tax burden falls on these groups, it disproportionately affects lower- and middle-income households. These households spend a larger percentage of their income on goods and services and derive most of their income from wages.
The burden can shift to workers through the tax’s impact on business investment. Corporate taxes reduce the funds available for companies to invest in new equipment, technology, and expansion. This can lead to lower productivity growth, which in turn suppresses wage growth.
Some economic models suggest that in a globalized economy where capital is highly mobile, companies will invest in lower-tax countries. This reduces the domestic capital available per worker and thereby lowers wages at home.
The burden can also be passed to consumers through higher prices. To maintain their profit margins, companies may increase the prices of the goods and services they sell. Because consumption makes up a larger share of the budget for lower-income families, any tax-induced price increase functions like a regressive sales tax.
Arguments for a Progressive Impact
Conversely, the argument for the corporate income tax being progressive is that the burden falls predominantly on the owners of capital, namely the shareholders. This viewpoint holds that the tax directly reduces corporate profits, which translates into lower dividend payments and a decrease in the value of corporate stock. Since the ownership of stocks is heavily concentrated among high-income households, a tax that reduces returns on this capital is progressive.
According to this perspective, the primary impact is on capital owners. The Urban-Brookings Tax Policy Center, for example, allocates 80 percent of the corporate tax burden to capital income and only 20 percent to labor. This model assumes that capital is not perfectly mobile and that shareholders must accept a lower after-tax rate of return on their investments.
The tax on corporate profits reduces the money available for dividends or reinvestment to grow the company’s value, both of which harm shareholders. Because the wealthiest households receive a disproportionate share of their income from capital gains and dividends, they bear the brunt of this cost. The precise division of the tax burden remains difficult to measure and depends on various economic factors.