A common argument for raising the corporate income tax rate is that collections as a share of gross domestic product (GDP) fell after the rate was reduced to 21 percent as part of the Tax Cuts and Jobs Act (TCJA) in 2017. But that argument is incomplete, as the U.S. also has a large pass-through business sector where taxes are collected through the individual income tax system.
When including those tax collections, it becomes clear that the U.S. is within the historical norm for business tax collections. While business tax revenue declined as a portion of GDP post-TCJA, revenue is likely to rebound to the historical average over the next few years as base broadeners enacted in the TCJA begin to take effect.
Using Internal Revenue Service (IRS) data on income earned from sole proprietorships, partnerships, and S corporations, and the average tax rate on individual income, we can calculate a conservative measure of pass-through business tax collections and compare it to corporate tax collections over time (see Figure 1).
Total business tax collections averaged about 2.5 percent of GDP between 1980 and 2018 when including taxes paid by pass-through firms. While the average corporate taxes paid dropped slightly from about 1.8 percent of GDP from 1980 to 2000 to 1.7 percent from 2000 to 2017, tax collections from pass-through firms rose from about 0.5 percent of GDP to 1.1 percent over that time. This reflects the growth in the number of pass-through firms and business income earned by pass-throughs over the past 40 years. Combined business tax collections rose from an average of 2.3 percent in the 1980s and 1990s to 2.7 percent from 2000 to 2017.
While the TCJA reduced business tax revenue from about 2.8 percent of GDP in 2017 to about 2.1 percent in 2018, business tax revenue remains close to the historical average of about 2.5 percent since 1980. Additionally, the first year post-TJCA is likely the largest decline in business tax revenue as firms took advantage of the law’s immediate deductions for business investment (which tend to reduce revenue more in the first few years).
The TCJA also included base broadeners, such as a tightening of the limitation for deducting interest, that will recoup business tax revenue in the coming years. This means that business tax collections will likely rise closer to the historical average of 2.5 percent of GDP in the next few years.
We calculated the share of individual income taxes paid by pass-through firms by using pass-through net income data provided from the IRS and applying the average effective income tax rate in each year on pass-through income. Our results are a conservative measure of taxes paid by pass-through firms because the average tax rate faced by these firms tends to be higher than the overall average individual income tax rate.
For example, the average individual income tax rate in 2011 was about 12.5 percent, but according to a more detailed analysis, the effective pass-through firm tax rate was 19 percent in 2011. That indicates pass-through tax collections may be substantially higher than our estimates.
When looking at the tax burden on businesses over time, it is important to provide a complete picture by accounting for the different types of businesses in the U.S and the timing effects of the 2017 tax law. Doing so provides important context on existing tax burdens and for considering the impact of raising taxes on corporations and pass-through firms.