CBO Explains Growing Gap Between Corporate Taxes, Profits

Trends in Corporate Economic Profits and Tax Payments, 1998 to 2017

MAY | 2023

At a Glance

Over recent decades, the economic profits of corporations (that is, profits from current production) have grown in relation to the size of the economy, whereas the amounts that corporations pay in federal taxes have remained stable. That pattern, which cannot be explained by changes in federal statutory corporate tax rates, reflects a divergence between economic profits and the corporate tax base (income that is subject to the corporate tax). Because such differences affect how the Congressional Budget Office projects revenues from the corporate income tax, the agency has analyzed the relationship between the two measures. This report breaks down and explains that relationship.

Economic profits and the corporate tax base are two different concepts, and there are many reasons they might diverge. In the analysis underlying this report, CBO considered three factors that contribute to that divergence:

• Conceptual differences between the measure of economic profits and the measure of tax profits (net income as defined under tax rules);

• Differences in the types of businesses included in each measure of profits; and

• The tax treatment of losses and special deductions.

Overall, CBO finds that conceptual differences, particularly differences in the treatment of foreign profits, account for much of the growth in the gap between economic profits and the corporate tax base. Differences in the types of businesses included in each measure also help explain why there is a gap, but the effect of those differences has been relatively stable in recent years. Finally, the tax treatment of losses helps explain variations in the gap over the business cycle.

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Contents

Summary

What Causes the Gap Between Economic Profits and the Corporate Tax Base?

How Could Recent Legislation Change the Relationship Between Economic Profit and Corporate Tax Payments?

Trends in Economic Profits and Corporate Tax Payments

The Relationship Between Economic Profits and the Corporate Tax Base

Conceptual Differences Between Economic and Tax Profits

The Growing Number of Corporations That Are Not Subject to the Corporate Tax

Tax Treatment of Losses and Certain Other Types of Income

The Relationship Between Economic Profits and Corporate Tax Payments After 2017

The 2017 Tax Act

Book Minimum Tax

Possible Changes in the Future

Glossary: Key Terms Related to Corporate Economic Profits and Tax Payments

List of Tables and Figures

About This Document

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Notes

Unless otherwise indicated, all years referred to in this report are calendar years.

For additional information about terms used in this report, see the glossary.

Summary

Over recent decades, corporate economic profits — profits from current production — have grown faster than the amounts that corporations pay in federal taxes. Specifically, economic profits as a share of gross domestic product (GDP) have grown, but federal corporate tax payments as a share of GDP have shown no clear trend (see Figure 1). That divergence in trends began in the 1990s and accelerated through the 2000s.

Corporate tax payments reflect the corporate tax base — that is, income that is subject to the corporate tax — and the statutory tax rates applied to that base. Before Public Law 115-97 (referred to in this report as the 2017 tax act) made significant changes to the corporate tax system, the last major changes to federal statutory corporate tax rates occurred in 1986, when the Tax Reform Act (P.L. 99-514) was enacted. Consequently, the divergence in trends between economic profits and corporate tax payments through the 2000s was not the result of changes in federal statutory corporate tax rates; instead, it reflected changes in the relationship between economic profits and the corporate tax base.

Because such differences affect how the Congressional Budget Office projects revenues from the corporate income tax, the agency has examined the factors that explain why corporate tax payments have not grown with corporate economic profits. This report focuses on why the gap between economic profits and the corporate tax base grew in the 20 years before the 2017 tax act went into effect.

What Causes the Gap Between Economic Profits and the Corporate Tax Base?

Three factors account for the divergence between economic profits and the corporate tax base.

• Conceptual differences. The first factor involves conceptual differences in the way that profits are measured for economic and tax purposes. Whereas economic profits reflect the profits that U.S. corporations earn from current production, tax profits reflect net income as defined under federal tax rules. Those two concepts differ in a variety of important ways, including differences in the types of international income that are included in each measure.

• Types of corporations. The second factor involves differences in the set of corporations that are included in each measure. Economic profits include the profits of all corporations, but only some corporations are subject to the corporate tax.

• Losses and deductions. The third factor centers on the effects of the tax treatment of losses as well as certain special deductions that are included in the calculation of the corporate tax base.

CBO finds that both conceptual differences and the inclusion of a broader set of corporations in measures of economic profits cause economic profits to exceed the corporate tax base. The tax treatment of losses goes in the opposite direction, increasing the size of the corporate tax base relative to economic profits. Overall, each factor is important for understanding the average gap between 1998 and 2017, the period under consideration in this report (see Figure 2). The role of conceptual differences, particularly differences in the way foreign income is treated, is especially important in explaining the growth in the gap.

How Could Recent Legislation Change the Relationship Between Economic Profits and Corporate Tax Payments?

This report focuses primarily on the historical gap between economic profits and the corporate tax base through 2017, the last year before provisions of the 2017 tax act took effect. The relationship between economic profits and corporate tax payments in the years after 2017 will be affected by both the 2017 tax act and the minimum tax on corporations' book profits included as part of the 2022 reconciliation act (P.L. 117-169).

Currently, detailed data are available only through 2019. In addition, changes brought about by the 2017 tax act were significant enough to call for caution when drawing precise conclusions that are based on only a few years of data. Still, it is possible to draw some conclusions about the relationship between economic profits and corporate tax payments since 2017.

The 2017 tax act both lowered the federal statutory corporate tax rate and expanded the definition of income subject to the corporate tax.¹ In 2018, CBO estimated that the act would increase incentives for investment, resulting in higher projected corporate profits that partially offset the negative net effect of those legislative changes on corporate tax receipts.² Corporate tax receipts as a share of GDP, which averaged 1.7 percent between fiscal years 1998 and 2017, have ranged between 1.0 percent and 1.7 percent in the fiscal years since 2017.³ (Federal fiscal years run from October 1 to September 30 and are designated by the calendar year in which they end.) Consistent with the broadening of the corporate tax base, the gap between economic profits and the corporate tax base in calendar years 2018 and 2019 narrowed relative to its size in recent years.

Trends in Economic Profits and Corporate Tax Payments

The Bureau of Economic Analysis (BEA) provides measures of both corporate economic profits and corporate tax payments. One might expect that those two series would move together over time, but from 1998 to 2017, economic profits as a share of GDP increased from 8.9 percent to 10.9 percent, whereas corporate tax payments showed no clear upward trend.⁴

Two main factors determine the path of corporate tax payments over time: federal statutory corporate tax rates and the amount of income subject to tax (that is, the corporate tax base). Over the 1998-2017 period, federal statutory corporate tax rates did not change, so a reduction in rates does not account for the stability of corporate tax payments over a period when economic profits were rising. In contrast, differences between economic profits and the corporate tax base grew over that period: Specifically, the gap between the two series increased from 1.6 percent of GDP in 1998 to 5.8 percent in 2017 (see Figure 3).⁵

The path of BEA's measure of federal corporate tax payments also reflect credits allowed under the tax code — including foreign tax credits and investment tax credits — and adjustments that BEA makes for amendments and revisions.⁶ An increase in the size of those credits and adjustments could also help explain why corporate tax payments have not increased with economic profit. If those credits and adjustments were increasing over time, then the ratio of federal corporate tax payments to the corporate tax base — which can be thought of as the average tax rate — would fall over time. Th ratio is cyclical but has not exhibited a clear downward trend (see Figure 4).⁷

The rest of this report focuses on the growing gap between economic profits and the corporate tax base as the main explanation for why corporate tax payments have not grown with economic profits. To tie its budgetary projections to its economic projections, CBO uses economic profits as the starting point for its projections of corporate tax receipts.⁸ CBO's projections of the corporate tax base account for the many important differences in what economic profits and the corporate tax base measure, incorporating information on both longer-run trends and the projected effects of recent changes to the corporate tax system. Understanding what has contributed to the gap between economic profits and the corporate tax base historically and how those factors have changed over time has important implications for the methods CBO uses to project corporate tax receipts.⁹

The Relationship Between Economic Profits and the Corporate Tax Base

Three major factors cause economic profits and the corporate tax base to differ: conceptual differences in the way income and deductions are defined for economic and tax purposes; differences in the set of corporations included in each measure; and differences in how losses affect each measure. The importance of each of the three factors in explaining the gap between economic profits and the corporate tax base has changed over time and has also tended to vary over the business cycle (see Figure 5).¹⁰

Conceptual differences in the way income and expenses are measured for economic versus tax purposes have consistently contributed to the gap. Those differences are important in explaining the widening gap between economic profits and the corporate tax base that occurred over the period considered in this report.

The inclusion of corporations that are not subject to corporate taxes (also known as corporate passthroughs) in measures of corporate economic profits has consistently caused economic profits to be larger than the corporate tax base. Specifically, S corporations (businesses that meet certain qualifications to be taxed under subchapter S of the Internal Revenue Code) are included in economic profits but are not subject to corporate taxes.¹¹ Only C corporations (so called because they are taxed under subchapter C of the Internal Revenue Code) are subject to the corporate income tax. The effect of including S corporations in measures of economic profits has grown slowly over time.

Economic profits are a net income concept, so they reflect current-year losses. By contrast, the corporate tax base excludes current-year losses. That exclusion partially offsets the effects of the first two factors and narrows the gap between the two series. The difference in the treatment of current-year losses helps explain why the gap between economic profits and the corporate tax base tends to decrease during economic downturns. When losses are especially large, the exclusion of losses does more to offset the other two factors. As the economy emerges from a recession and losses shrink, the offsetting effect of excluding losses gets much smaller and the gap between economic profits and the corporate tax base grows. Two periods of relatively rapid growth in the gap — in the early 2000s and between 2008 and 2011 — occurred as the economy was emerging from recessions. The treatment of losses helps explain that growth.

Conceptual Differences Between Economic and Tax Profits

The corporate tax base and economic profits are based on different concepts of profits.¹² Whereas corporate economic profits represent profits from current production, tax profits reflect policy choices about how to define net income.¹³ As a result, there are conceptual differences in how income and expenses are defined for the purposes of measuring economic and tax profits.

Some of those conceptual differences reflect the fact that certain types of income or deductions are consistently included in one of the measures but excluded from the other. Other components reflect variations in tax policy over time, particularly how income and expenses are defined for tax purposes. Finally, tax profits reflect corporations' behavioral responses — specifically, their efforts to reduce the amount of taxes they owe. Those behaviors, which result in either understating income or overstating deductions, reduce tax profits.

Changes in the magnitude of conceptual differences closely mirror the growth in the gap between economic profits and the corporate tax base both in the early 2000s and between 2007 and 2011 (see Figure 6). The pattern of conceptual differences also mirrors what occurred after 2011, when the gap narrowed through 2015 and then widened in subsequent years.

One major driver of the growth in conceptual differences is how the two measures treat foreign income (see Figure 7). Misreporting is also an important factor, although that effect has been more stable in recent years. Differences in the treatment of depreciation did not grow over the 1998-2017 period; however, the fluctuations caused by changing bonus depreciation over time aligned with fluctuations in the gap between economic and tax profits. When the effects of bonus depreciation were especially large — for instance, in the early 2000s and then again from 2008 to 2011 — growth in the gap was especially strong.

International Profits. In measurements of economic profits and tax profits, international profits are treated differently. Because economic profits are a national income concept, they include all profits of U.S. corporations, whether earned in the United States or abroad. They do not include the profits that foreign corporations earn in the United States. Tax profits include all profits earned in the United States, whether by a foreign company or by a U.S. company, but they include only some of the foreign profits earned by U.S. corporations.

Those differences in the treatment of international profits are a significant conceptual difference between economic profits and tax profits. The exclusion of profits earned by foreign corporations in the United States reduces economic profits relative to tax profits. The U.S. profits of foreign corporations have grown over time, increasing from roughly 0.5 percent of GDP to 1.6 percent of GDP over the 1998-2017 period. That growth would push in the direction of narrowing the gap, so it is not discussed in greater detail in this report. In contrast, the treatment of the foreign profits of U.S. corporations tends to cause economic profits to exceed tax profits because the current foreign profits of U.S. corporations tend to exceed their taxable foreign income. That difference has grown over time and is one of the major drivers of conceptual
differences.

Before provisions of the 2017 tax act went into effect, the foreign profits of U.S. corporations were statutorily subject to U.S. taxes. However, for some types of foreign profits, those taxes were not assessed as the profits were earned but instead were due when foreign profits were distributed back to the United States, or repatriated.¹⁴ As a result, some companies did not repatriate foreign profits for many years, meaning that a policy that theoretically created only a timing difference essentially created a permanent difference between economic profits and tax profits as some of those foreign profits were not repatriated during the period analyzed. Consequently, the current foreign profits of U.S. corporations consistently exceeded the taxable foreign profits of U.S. corporations from 2000 onward (see Figure 8).¹⁵ That gap grew from about zero in the first few years of the 1998-2017 period to more than 2.5 percent of GDP by 2017.

The growing gap between foreign economic profits and taxable foreign profits occurred during a time when U.S. corporations were increasing their use of tax-minimization strategies to locate profits in low-tax foreign jurisdictions. That profit shifting increased for a variety of reasons, including the growing importance of assets that are hard to value, such as brand-name or intellectual property, and changes to tax rules that made it easier for foreign profits to go untaxed by the United States.¹⁶ Profit shifting increases foreign economic profits, and the incentive to leave those profits abroad rather than repatriate them to the United States meant that taxable foreign profits did not grow with foreign economic profits.

Misreporting. Another difference between economic profits and tax profits is that corporations have an incentive to understate income and overstate expenses for tax purposes to reduce their tax liability. Because BEA's measure of economic profits is based on tax information, that agency uses data on audits from the Internal Revenue Service (IRS) to make an adjustment for the effect that misreporting on tax returns has on tax profits.¹⁷ That adjustment increases economic profits relative to tax profits.

Unlike the measure of the corporate tax base, corporate tax payments do account for some underreporting. Corporate tax payments reflect postaudit tax payments, so they capture the effect of detected misreporting. That contrasts with economic profits, which include an adjustment intended to account for all underreporting.

Overall, the misreporting adjustment has grown over time, increasing from 1.3 percent of GDP in 1998 to 2.1 percent of GDP in 2017 (see Figure 9). That increase helps explain the growing gap between economic profits and the corporate tax base. Audit adjustments can capture a variety of forms of misreporting. Profit shifting is one example of how corporations may understate the amount of income subject to U.S. taxation. Some of the recent rise in misreporting could be attributable to an increase in audit adjustments that relabel foreign income as U.S. income. Consequently, the inclusion of that income in the misreporting adjustment could result in some double counting of profits in the economic-profits measure because economic profits already include the foreign profits of U.S. corporations. The data available to BEA do not identify the reason for the audit adjustment, so it is not possible to distinguish audit adjustments that arise from profit shifting from adjustments that arise from other sources.

Differences in the Patterns of Depreciation Deductions. When a corporation purchases an asset that will generate value over time, it generally calculates economic profits by deducting the cost of the purchase over the expected life of the asset. For the calculation of tax profits, the cost is also generally deducted over time, but tax rules typically allow corporations to accelerate those deductions — that is, to deduct the cost over a shorter period relative to the life of the asset used for economic depreciation. In addition to allowing that general acceleration of deductions, lawmakers have also frequently allowed companies to deduct more of the cost of certain assets in the year of purchase — that is, to take advantage of bonus depreciation.¹⁸

When the tax depreciation of a company's investments is accelerated relative to economic depreciation, that effect tends to reduce tax profits relative to economic profits in the year the investment is made. In later years of the depreciation period, the effects of that accelerated depreciation will increase the company's tax profits relative to economic profits because less of the cost remains to be deducted. Observed total deductions for depreciation in a given year reflect both initial deductions for new investments and deductions for earlier investments. On net, accelerated depreciation tends to reduce tax profits relative to economic profits, partially because, if economy-wide investment is growing over time, the effects of larger tax deductions for new investment tend to more than offset the effects of smaller tax deductions for earlier investments.

Differences in the patterns of economic depreciation and tax depreciation have frequently caused economic profits to exceed tax profits (see Figure 10).¹⁹ That effect has not consistently grown over the past two decades, so it does not help explain the general trend in the gap. However, during periods when depreciation differences had a large positive effect — for example, from 2008 to 2011 — the gap tended to widen.²⁰

Other Factors. Other conceptually important differences between economic and tax profits are not emphasized in this report because they did not grow in a way that would help explain the increasing gap between economic profits and the corporate tax base.²¹ The total effect of other differences was not large in most years of the 1998-2017 period (see Figure 7 on page 8).

However, those factors help explain why the gap between economic profits and tax profits tends to grow during economic downturns. Those factors also contributed to the decrease in the gap between economic and tax profits that was evident starting in 2012.

Among the other important differences between measures of economic profits and tax profits are the way the following types of income and expenses are treated.

• Capital gains. Tax profits include capital gains and losses from the sale of property. Because economic profits represent profits from current production, capital gains are excluded from that measure. That treatment of capital gains generally reduces economic profits relative to tax profits. Capital gains tend to be larger during economic expansions and smaller during downturns. As a result, they are one of the factors that cause the gap between economic profits and tax profits to be smaller during economic expansions and larger during economic downturns.

• Bad debt. Tax profits allow for the deduction of expenses related to bad debt (debt that is not repaid). Because those expenses are not associated the calculation of economic profits. That difference in treatment increases economic profits relative to tax profits. Bad debt — which generally tends to be larger during economic downturns and as the economy emerges from such a downturn — is another contributor to the larger gap between economic profits and tax profits during those periods.

• Dividends. Dividends received by corporations are included in tax profits. Because dividends do not represent profits from current production, they are excluded from economic profits. That treatment of dividends generally reduces economic profits relative to tax profits. Some categories of dividends are not taxed at the statutory rate. Special deductions for those dividends mean that the effect of the inclusion of dividends on the corporate tax base is smaller than the effect on tax profits. (The effect of special deductions is discussed in the section of this report titled “Tax Treatment of Losses and Certain Other Types of Income.”)

• Income from changes in the prices of retained assets and inventory. Profits that result from changes in the prices of assets or inventory are excluded from economic profits but included in tax profits. That difference in treatment generally reduces economic profits relative to tax profits.²²

• Profits of corporations that do not pay taxes. Federal Reserve banks, federally sponsored credit agencies (such as Federal Home Loan Banks), and some nonprofits are exempt from federal income taxes.²³ BEA includes the profits of those entities as part of economic profits, but those entities are not included in the measurement of tax profits because they are not subject to taxation. Those entities differ from corporate passthroughs, whose profits are not subject to corporate income taxes but are subject to individual income taxes.

The Growing Number of Corporations That Are Not Subject to the Corporate Tax

A corporation is an incorporated business that can act as a legal entity that is separate from its owners. The analysis of conceptual differences described in the previous section compared economic profits with the tax profits of C corporations and S corporations. C corporations are subject to the corporate income tax. S corporations pass their profits through to the owners of the corporation. Those profits are then subject to the individual income tax rather than the corporate income tax. (For a discussion of other types of pass-through businesses, see Box 1.)

Over time, a growing share of corporations have organized as S corporations rather than C corporations. The increasing number of S corporations contributes to the gap between economic profits, which include the profits of all corporations, and the corporate tax base, which includes only the profits of C corporations. Although that development reduces corporate tax revenues, individual taxes are paid on that income, so the net effect on federal tax collections is smaller than the effect on corporate tax collections.

The effect of S corporations on the gap between economic profits and the corporate tax base grew from 1.4 percent of GDP in 1998 to 2.5 percent of GDP in 2017 (see Figure 11). Over that same period, the gap between economic profits and the corporate tax base grew from 1.6 percent of GDP to 5.8 percent of GDP. As a result, although S corporations are an important contributor to the gap between economic profits and the corporate tax base, they account for only about a quarter of the recent growth in that gap.²⁴

One way to see the growing importance of S corporations is to look at the share of tax profits earned by C corporations. The tax profits of C corporations as a share of the tax profits of C and S corporations combined have fallen over time (see Figure 12).²⁵ That share is especially small during economic downturns because the losses of C corporations tend to be larger during downturns than the losses of S corporations.²⁶

The attractiveness of organizing as an S corporation may have increased over time for a number of reasons.²⁷ One important factor is the difference between individual and corporate tax rates. The Tax Reform Act of 1986 lowered top marginal individual rates relative to top marginal corporate rates. (The marginal tax rate is the percentage of an additional dollar of income that is paid in taxes.) Another important factor relates to the limitations placed on S corporations. Only businesses that meet certain criteria can organize as S corporations. Those limitations have been relaxed over time. The changing criteria mean that the S corporate form has become an option for a broader set of businesses, although it still is not an option for corporations with significant foreign operations. Finally, C corporations generally have greater access to capital markets than S corporations. As a result, C corporations tend to be more dominant in capital-intensive sectors, such as manufacturing. As the composition of the economy has changed over time and shifted more toward services, which are less capital intensive, that pattern may have contributed to the declining share of tax profits earned by C corporations.

Tax Treatment of Losses and Certain Other Types of Income

The final factor that affects the relationship between economic profits and the corporate tax base is how certain types of income are treated by the tax code. That factor can be broken down into three components: the exclusion of current-year losses from the corporate tax base; the inclusion of deductions for past losses in the corporate tax base; and special deductions for certain types of income that are exempted from taxation or taxed at a reduced rate. Of those differences, the tax treatment of current-year losses has the largest effects. On net, those components generally increase the corporate tax base relative to economic profits. Because of the importance of the treatment of losses, the role of those components is highly cyclical and, together, they tend to shrink the gap between economic profits and the corporate tax base by larger amounts during economic downturns (see Figure 13). Those components became less negative between 2001 and 2004 and again between 2008 and 2012, providing a partial explanation for the growth in the gap over those periods.

Tax Treatment of Current-Year Losses. Losses do not affect economic profits and the corporate tax base in the same way. Economic profits are a net concept, meaning they include corporations with both positive profits and losses. In contrast, losses are generally excluded from the corporate tax base in the year they occur, and corporations must carry the value of the loss to another year to offset positive taxable income in that year. As a result, the corporate tax base is more closely related to positive tax profits than to the net concept of tax profits. If losses were immediately realized, they would result in a negative tax liability — that is, an immediate refund — and the corporate tax base would be more closely related to a net concept of profits. Instead, over the years considered in this report, corporations could either carry losses back to a prior period and file for a refund on taxes paid in that period, or they could carry losses forward and use the losses to offset positive tax profits in that future period.²⁸ Losses that are carried back and applied to a prior year's tax liability generate refunds in the current year that reduce total corporate tax payments but do not affect the current-year corporate tax base.²⁹ Losses that are carried forward will affect the corporate tax base in the year the loss is used.

Special Deductions. There is one significant difference between positive tax profits and the corporate tax base. The tax base includes the effects of a variety of special deductions for certain types of income that are either untaxed or taxed at a reduced rate. Deductions for prior losses are by far the largest component of special deductions for C corporations.³⁰ Other special deductions are generally for certain types of dividends received and tend to be very small, although they can have a significant effect in certain years.³¹

Relative Importance of Losses and Special Deductions. The exclusion of current losses from the tax base consistently offsets the effects of the conceptual and compositional differences that cause the corporate tax base to be lower than economic profits (see Figure 14). Losses spike during economic downturns and then decrease as the economy emerges from recessions. That tendency helps explain the pattern in the gap between economic profits and the corporate tax base through the 2007-2009 recession, when the gap stabilized as losses grew and then grew rapidly as losses shrank.

Special deductions are generally small in magnitude relative to current-year losses, indicating that prior losses used in any given year are quite small relative to current losses. The spike in special deductions in 2005 was a result of the repatriation holiday, during which the reduced tax rate on repatriated foreign income was instituted by allowing a deduction for a portion of the income that was repatriated.

The Relationship Between Economic Profits and Corporate Tax Payments After 2017

Changes to the tax code can include changes to how income and deductions are defined for tax purposes. Those changes can directly affect the gap between economic profits and the corporate tax base; they can also cause behavioral responses that affect that gap. In recent years, the 2017 tax act has made significant changes to the tax code, altering tax rates and the tax base in ways that continue to affect the gap between economic profits and the corporate tax base (see Table 1). Starting in 2023, there will also be a new minimum tax on corporations that will affect the relationship between economic profits and corporate tax payments. In addition to those changes, there have been international discussions about changing the taxation of foreign income in ways that would affect the gap.

The 2017 Tax Act

The 2017 tax act made significant changes to the tax base that have narrowed conceptual differences between economic and tax profits. It also included changes that have significantly increased special deductions by creating new categories of income that are subject to taxation at reduced statutory rates. The increased special deductions have reduced the corporate tax base, partially offsetting the effects of the narrowing of conceptual differences since 2018. The change in the corporate tax rate may also affect businesses' choices about organizational form in the future.

Changes to Conceptual Differences Between Economic and Tax Profits. The 2017 tax act narrowed conceptual differences between economic and tax profits in two major ways. First, the act changed the taxation of foreign income and created a new category of foreign income — global intangible low-taxed income (GILTI) — that is subject to U.S. federal taxes, at a reduced rate, in the year it is earned. The inclusion of that type of foreign income in tax profits has reduced the gap between taxable foreign profits and current foreign profits. Second, the 2017 tax act disallowed the inclusion of some interest expenses in the calculation of tax profits. Those expenses are fully deductible for calculating economic profits, so that change has introduced a new conceptual difference that narrows the gap between economic profits and tax profits. Other, smaller changes have also narrowed the gap. For example, the elimination of the deduction for domestic production activities has reduced the gap between economic profits and tax profits.

Other changes included in the 2017 tax act have affected the timing of when expenses are realized for tax purposes. For example, bonus depreciation tends to widen the gap between economic and tax profits in the years that large tax depreciation deductions are allowed but then temporarily narrows the gap in future years when deductions remain for the calculation of economic profits. The 2017 tax act also increased the ability of some smaller corporations to deduct the full cost of certain investments in the year they are made. That similarly has caused a disconnect between the timing of tax-depreciation deductions and economic-depreciation deductions.

In addition, the amount of income excluded from tax profits because of misreporting may decline because the 2017 tax act reduced the top statutory corporate tax rate from 35 percent to 21 percent.³² A lower corporate tax rate reduces the incentive for the types of tax avoidance and evasion that are captured by BEA's misreporting adjustment. A reduction in the foreign economic profits earned by U.S. corporations could also occur because the lower statutory rate, the inclusion of GILTI in the tax base, and a new deduction for some U.S. earned income — foreign-derived investment income (FDII) — all reduce the incentives for profit shifting. That reduction would narrow the gap between the economic foreign profits and taxable foreign profits.

Changes That Could Affect Choices About Organizational Form. The reduction in the corporate tax rate has the potential to affect the share of tax profits earned by S corporations. That reduction, combined with changes to the individual tax code that reduce taxes on S corporations' income, has not significantly altered the attractiveness of structuring as a C corporation instead of as an S corporation relative to prior law. However, the changes to the individual income tax code are temporary; so, if many provisions of the 2017 tax act expire, as scheduled, at the end of 2025, the attractiveness of structuring as an S corporation will diminish. As a result, an increasing share of businesses might choose to structure as C corporations rather than as S corporations.

Changes to the Treatment of Losses and New Special Deductions. The 2017 tax act also made changes that have had a large effect on the third factor considered in the analysis underlying this report — the tax treatment of losses and other specific income sources. The new category of foreign income created by the 2017 tax act, GILTI, is subject to taxation at a reduced rate, so the act also created a new special deduction for that form of income. Similarly, the 2017 tax act created a 100 percent deduction for some foreign dividends received and a deduction that allows for a reduced tax rate on FDII. Those new deductions associated with foreign-earned income increase the magnitude of special deductions, which has widened the gap between economic profits and the tax base.

Losses will also have a different effect on the corporate tax base in the future because of changes stemming from the 2017 tax act. Those changes include the creation of a new limit on how much income can be offset by losses carried forward to that year, a factor that reduces special deductions, and the elimination of the ability to carry losses back to offset positive taxable income in past years.³³ The elimination of loss carrybacks, and the refunds associated with those carrybacks, has the potential to further smooth the average tax rate, tightening the relationship between corporate tax payments and the corporate tax base.

The Corporate Tax Base Since 2017. The 2017 tax act significantly reduced the corporate tax rate but also broadened the tax base. The fact that corporate tax receipts as a share of GDP have remained within historical bounds in the fiscal years after 2017 illustrates the offsetting effects of those changes (see Figure 15).³⁴

One way of understanding the magnitude of the base broadening included in the 2017 tax act is to examine how CBO's projections of the corporate tax base relative to economic profits in the future compare with recent history (see Figure 16). Between 1998 and 2017, the corporate tax base averaged about 70 percent of the value of economic profits. Before the 2017 tax act was enacted, CBO projected that the corporate tax base would remain at a similar percentage relative to economic profits. The agency now projects that, if current law remained unchanged, the value would average about 87 percent in the coming decade.³⁵

Book Minimum Tax

As of 2023, corporations are subject to a minimum tax that is based on book profits (profits as calculated for the purposes of financial accounting). If 15 percent of a corporation's adjusted book profits exceeds the corporation's normal tax liability, then the corporation will have to pay the difference.³⁶ Book profits differ from both economic profits and tax profits.³⁷ However, incorporating book profits in the calculation of corporate tax liability will most likely reduce the gap between economic profits and the corporate tax base in the future because the book minimum tax will increase the amount of foreign income subject to corporate taxes. Additionally, because the minimum tax on book profits will reduce or eliminate the benefits of forms of misreporting that reduce tax profits, while leaving book profits unchanged, misreporting will most likely be reduced.

Possible Changes in the Future

Recent proposals could further alter the relationship between economic profits and the corporate tax base. Proposals have been made both in the United States and internationally to implement a minimum tax on foreign earnings. Such a tax would expand the scope of earnings subject to the tax on GILTI in the United States and narrow the gap between economic profits and the corporate tax base by including a larger fraction of foreign earnings in the corporate tax base.³⁸

Glossary: Key Terms Related to Corporate Economic Profits and Tax Payments

General Definitions

corporate tax base. In this report, the corporate tax base refers to income that is subject to the corporate tax. Unlike both economic profits and tax profits, the corporate tax base is not a net concept — that is, it includes positive profits but excludes losses in the current period. The corporate tax base is equivalent to the positive tax profits of C corporations with adjustments for deductions for past losses (specifically, net-operating-loss, or NOL, deductions) and other special deductions. The measure used in this report is equal to the income of C corporations that is subject to taxation as detailed in Statistics of Income (SOI) publications. For example, see Internal Revenue Service, SOI Tax Stats — Corporation Income Tax Returns Complete Report, Publication 16, Table 2.3, https://tinyurl.com/3eezcxfw.

corporate tax payments. Corporate tax payments in this report are consistent with what is measured on tax returns for a given calendar year — that is, they measure the tax payments and refunds associated with activity during that year. Those payments and refunds can occur across several fiscal years. That measure is closely connected to the SOI's measure of tax after credits but includes the effects of audits, renegotiations, and carryback refunds. For the data series used in this report, see Bureau of Economic Analysis (BEA), “National Data: National Income and Product Accounts,” Table 3.2, row 8, https://tinyurl.com/472rushh. For a description of BEA's measure of corporate tax payments, see Bureau of Economic Analysis, NIPA Handbook: Concepts and Methods of the U.S. National Income and Product Accounts (December 2020), Chapter 13: Corporate Profits, https://tinyurl.com/2p9ajhpp.

corporate tax receipts. Corporate tax receipts as shown in the federal budget and in the Congressional Budget Office's baseline budget projections represent federal corporate tax payments collected in a given fiscal year. (Federal fiscal years run from October 1 to September 30 and are designated by the calendar year in which they end.) Those collections are heavily influenced by tax profits for that tax year, but some collections are attached to activities in earlier tax years. For example, for tax year 2016, three estimated payments would have been made in fiscal year 2016, with the fourth estimated payment and the final payment occurring in fiscal year 2017. That is, for a taxpayer whose tax year ends in December, estimated payments for tax year 2016 would have been due in April 2016, June 2016, September 2016, and January 2017, with final payments made in April 2017. Filing extensions, amended returns, and audits can further affect the degree to which fiscal year receipts reflect activity in the current tax year versus activity in past years. CBO estimates that 63 percent of the corporate tax receipts in fiscal year 2016 related to activity for tax year 2016; the remainder related to activity in prior years.

economic profits. Economic profits in this report refer to corporate profits from current production — sometimes referred to as corporate profits with IVA (the inventory valuation adjustment) and CCAdj (the capital consumption adjustment) — as reported in the U.S. national income and product accounts produced by BEA. For the data series used in this report, see Bureau of Economic analysis, “National Data: National Income and Product Accounts,” Table 1.13: National Income by Sector, Legal Form of Organization, and Type of Income, row 7, https://tinyurl.com/4ephyk66. For a discussion of BEA's concepts of economic profits and corporate taxes and how they differ from concepts based on tax data, see Bureau of Economic Analysis, NIPA Handbook: Concepts and Methods of the U.S. National Income and Product Accounts (December 2020), Chapter 13: Corporate Profits, https://tinyurl.com/2p9ajhpp.

tax profits. In this report, the term “tax profits” is used to describe corporations' net income as defined under tax rules. That measure excludes real estate investment trusts (REITs) and regulated investment companies (RICs) but includes both C and S corporations. Tax profits are a net concept — that is, they include both positive profits and losses — and they do not include deductions for net operating losses or special deductions. The measure used in this report is equal to the Internal Revenue Service's (IRS's) measure of the net income (less deficit) of C corporations plus the IRS's measure of net income (less deficit) of S corporations. See Internal Revenue Service, SOI Tax Stats — Corporation Income Tax Returns Complete Report, Publication 16, Table 2.3 and Table 2.4, https://tinyurl.com/37nccuys.

Terms Related to Conceptual Differences Between Economic and Tax Profits: Treatment of International Profits

foreign economic profits. In this report, foreign economic profits are the profits from current production that are earned overseas by U.S. corporations. Foreign profits are reported by BEA. See Bureau of Economic Analysis, “National Data: National Income and Product Accounts,” Table 6.16D, row 6, https://tinyurl.com/ yckvdd29.

international profits. International profits are the difference between the current foreign economic profits of U.S. corporations and the current U.S. profits of foreign corporations. International profits are reported by BEA. See Bureau of Economic Analysis, “National Data: National Income and Product Accounts,” Table 6.16D, row 5, https://tinyurl.com/yckvdd29.

taxable foreign profits. Taxable foreign profits are the foreign profits of U.S. corporations that are subject to U.S. corporate taxes in the current year. That measure includes some foreign profits from current production, as well as foreign profits from other sources and other years. The measure of taxable profits is equal to the sum of foreign income brought back to the United States as reported by BEA (income on equities in foreign corporations and branches) and constructive taxable foreign income reported by the IRS. See Bureau of Economic Analysis, “National Data: National Income and Product Accounts,” Table 7.16, row 17, https://tinyurl.com/37m2hemu; and Internal Revenue Service, SOI Tax Stats — Corporation Income Tax Returns Complete Report, Publication 16, Table 2.1, row 73, https://tinyurl.com/37nccuys.

Terms Related to Conceptual Differences Between Economic and Tax Profits: Treatment of Depreciation

accelerated depreciation. Depreciation is said to be accelerated when deductions for the depreciation of an asset are larger in earlier years or are allowed over a shorter period than the actual economic depreciation of the asset.

bonus depreciation. Bonus depreciation refers to a tax policy that allows an additional portion of the cost of an asset to be deducted in the year that the asset is purchased.

economic depreciation. Economic depreciation measures the decline in the actual economic value of an asset over time. It also accounts for differences in the current value of an asset in relation to its historical cost.

tax depreciation. Tax depreciation refers to how the tax code allows a business to deduct the cost of an asset over time. It is generally accelerated relative to economic depreciation and is typically based on the historical cost of acquiring an asset. (See Internal Revenue Service, “How to Depreciate Property,” Publication 946, www.irs.gov/pub/irs-pdf/p946.pdf.) Tax depreciation usually includes the effects of both the deductions allowed under the Modified Accelerated Cost Recovery System and special depreciation allowances such as bonus depreciation.

Types of Businesses

C corporation. A C corporation, so called because it is taxed under subchapter C of the Internal Revenue Code, is a corporation that is taxed separately from its owners. Profits are taxed at the entity level under the corporate tax. Profits distributed as dividends or realized as capital gains are also subject to the individual income tax.

pass-through business. A pass-through business is a business that passes its income through to its owners rather than having that income be subject to a tax at the entity level. That income is included as part of the individual income tax base rather than as part of the corporate income tax base. S corporations and partnerships are common types of pass-through businesses.

REIT. A real estate investment trust is a type of passthrough business. REITs are funds used to invest in real estate properties. Those funds allow individuals to pool resources to invest in such properties without having to directly purchase a commercial real estate property. Although REITs are considered corporations, almost all of their income is distributed to their investors and taxed under the individual income tax. REITs earn limited economic profits, so they have little to no effect on measures of economic profits; and because dividends paid out to shareholders are exempt from the corporate tax, REITs rarely pay corporate taxes.

RIC. A regulated investment company is a type of pass-through business. RICs are investment funds — for example, mutual funds — that pass their income through to shareholders. RICs are corporations, but they do not earn economic profits, so they have little to no effect on economic profits. Because income paid out as dividends to shareholders is exempt from the corporate tax, RICs rarely pay corporate taxes.

S corporation. An S corporation is a type of passthrough business that meets the requirements to be taxed under subchapter S of the Internal Revenue Code. S corporations pass their income, losses, deductions, and credits through to their shareholders, and the shareholders report that income and those losses on their individual income tax returns.

Losses and Special Deductions

losses. As used in this report, losses refer to the sum of negative profits. Current losses of C corporations as shown in this report are reported by the IRS. See Internal Revenue Service, SOI Tax Stats — Integrated Business Data, Table 1, row 27, https://tinyurl.com/yye2vjrf.

special deductions. Certain types of income are allowed a special deduction that either exempts that income from taxation or reduces the tax rate on that income. Special deductions are reported on IRS Form 1120 (in recent years, on line 29b). As shown in this report, the special deductions of C corporations with positive tax profits are calculated as the difference between the positive tax profits of C corporations as reported by the IRS and the income of C corporations that is subject to taxation as reported by IRS. See Internal Revenue Service, SOI Tax Stats — Integrated Business Data, Table 1, row 26, https://tinyurl.com/yye2vjrf; and, SOI Tax Stats — Corporation Income Tax Returns Complete Report, Publication 16, Table 2.3, https://tinyurl.com/37nccuys.

List of Tables and Figures

Table

1. How the 2017 Tax Act Has Changed the Components of the Gap Between Economic Profits and the Corporate Tax Base

Figures

1. Economic Profits and Federal Corporate Tax Payments as a Share of GDP

2. The Average Effect Over the 1998-2017 Period of Factors That Contributed to the Gap Between Economic Profits and the Corporate Tax Base

3. Economic Profits and the Corporate Tax Base as a Share of GDP

4. Average Tax Rate on the Corporate Tax Base

5. Components of the Gap Between Economic Profits and the Corporate Tax Base

6. The Role of Conceptual Differences in Explaining the Gap Between Economic Profits and the Corporate Tax Base

7. Components of Conceptual Differences Between Economic Profits and Tax Profits

8. A Comparison of Foreign Economic Profits and Taxable Foreign Profits

9. Effects of the Misreporting Adjustment on the Differences Between Economic Profits and Tax Profits

10. Effects of Tax Depreciation on the Differences Between Economic Profits and Tax Profits

11. Contribution of the Growth of S Corporations to the Gap Between Economic Profits and the Corporate Tax Base

12. The Tax Profits of C Corporations as a Share of the Tax Profits of C and S Corporations

13. Contribution of the Tax Treatment of Losses and Other Types of Income to the Gap Between Economic Profits and the Corporate Tax Base

14. The Treatment of Current-Year Losses Relative to Deductions for Net Operating Losses and Special Deductions

15. Fiscal Year Corporate Tax Receipts as a Share of GDP Before and After Enactment of the 2017 Tax Act

16. The Corporate Tax Base as a Share of Economic Profits Before and After Enactment of the 2017 Tax Act

Box

1. The Role of Other Types of Passthroughs