A Corporate Rate Hike Is Still Unwise

Recently, a couple of analysts (here and here) have called for a higher corporate tax rate. In both cases, they argue that such a tax increase would be economically efficient, in part, because the One Big Beautiful Bill Act (OBBBA) expanded expensing. Expensing allows businesses to fully deduct the cost of new investments immediately. Although expensing does improve the corporate tax base, the corporate tax code is far from the ideal that these analysts suggest. Raising the rate would still distort investment decisions, encourage profit shifting, and discourage incorporation.

It is true that expensing reduces the economic harm of raising the corporate tax rate. Expensing moves the corporate tax closer to what is called a “cash flow tax.” Under such a tax, corporations would face no tax burden on new investments regardless of the tax rate. There are two important differences between the corporate tax and a cash flow tax. First, all capital assets are fully deducted when purchased instead of being depreciated over several years or decades. This would apply to all fixed assets: machinery, equipment, structures, inventories, land, and intellectual property products. Second, net interest expense would no longer be deductible, creating parity with the tax treatment of equity.

The corporate tax has moved in the direction of a cash flow tax over the past decade. The 2017 Tax Cuts and Jobs Act (TCJA) temporarily enacted 100 percent bonus depreciation (expensing) for short-lived assets and introduced a limitation on net interest expense deductions. The 2025 OBBBA made 100 percent bonus depreciation permanent and reinstated research and development expensing, which was repealed in 2022 under the TCJA. The law also introduced temporary expensing for qualifying production structures.

Even with these reforms, the corporate tax is far from being a cash flow tax.

First, interest expense is still mostly deductible. Under current law, businesses’ interest expense deductions are limited to the sum of interest income plus 30 percent of adjusted taxable income. Adjusted taxable income is equal to taxable income plus interest expense, taxes paid, depreciation, and amortization (EBITDA). Most corporations find themselves below this threshold. In a previous paper, I estimated that roughly 87 percent of corporate interest expense is still deductible. A higher statutory corporate income tax rate would mean a greater bias in favor of debt-financed investment.

Second, only a portion of the business capital stock is expensed. 100 percent bonus depreciation only applies to assets with lives under 20 years; the new structure expensing only applies to qualifying production facilities; and R&D expensing only applies to a subset of intellectual property products. Land, inventory, some intellectual property, and most structures are not expensed. On net, corporations can only expense roughly 36 percent of their capital stock, or about 50 percent of their stock excluding land and inventories. Raising the corporate income tax would still burden equity-financed investment in most assets.

Third, international profit shifting remains an issue despite reforms. Even under a pure cash flow tax, a higher corporate income tax rate still poses a problem in an open economy. Multinational enterprises (MNEs) have an incentive to locate both profits and mobile assets in low-tax jurisdictions. As the corporate tax rate increases, that incentive climbs. The existing minimum tax on foreign profits, Net CFC Tested Income (NCTI), places a rough floor of 16 percent on foreign profits, but it does not always apply.

Fourth, raising the corporate tax will discourage incorporation. Ideally, a tax code would be neutral with respect to a business’s legal form of organization. Under current law, the tax code creates a distinct incentive to organize as a pass-through business such as a sole proprietorship, S corporation, or partnership. The average effective tax rate on pass-through business investment is about 6.6 percentage points lower than that on C corporate investment. Raising the corporate tax rate to 28 percent, for example, would nearly double the advantage to 11 percentage points.

The federal government faces growing budget deficits. Lawmakers will undoubtedly look to tax increases to either reduce the deficit or pay for new priorities. They would be wise to avoid tax increases that have relatively high economic costs, such as a corporate rate increase.

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