In 2002, The Century Foundation convened the Working Group on Tax Expenditures to examine and propose reforms to the tax code. The resulting report, Bad Breaks All Around, identifies twelve tax breaks with little or no economic justification. These “dirty dozen” are no less ripe for the chopping block a decade later, as Congress finally takes up the task of simplifying the tax code. Follow along at Blog of the Century and on the “Dirty Dozen” expenditures homepage as we reintroduce each of the “dirty dozen” and explain why it's long past time to eliminate these costly tax breaks.

According to most economists, progressive taxation is justified by the fact that taxpayers across the income spectrum vary significantly in their “ability to pay.” A millionaire, for instance, can afford to contribute more of each additional dollar earned than a family near the poverty line. This framework, while contested by some on the right, is generally accepted as an ethical way to reduce income inequality in capitalist societies and improve the welfare of the poor.

The same cannot be said, however, of the graduated income tax for corporations, which have no such welfare to consider, and therefore no necessary limit to their “ability to pay” tax on their profits.

Corporate tax expert Jeffrey Kwall, of the Loyola University Chicago School of Law, explains why the “section 11” graduated corporate rates fail the “ability to pay” rule:

The size of a corporation bears no necessary relation to the income levels of the owners. Indeed, low-income corporations may be owned by individuals with high incomes, and high-income corporations may be owned by individuals with low incomes.

Corporations are artificial entities that do not have variable standards of living. Moreover, the income level of a corporation bears no relation to the shareholders' standards of living. The section 11 bracket system may induce privately held businesses to incorporate because it effectively provides corporations with high-income shareholders in the top individual tax bracket access to two sets of low tax brackets, one under section 1 and a second under section 11.

Unfortunately, this discrepancy has received little attention from policymakers since the creation of the graduated corporate income tax in 1936. Under current law, the first $50,000 of a corporation's profit is taxed at 15 percent, a rate that increases with higher profits until it reaches the top statutory rate of 35 percent for taxable corporate income above $18.3 million. Higher marginal rates (up to 39 percent) appear as bubbles in some income ranges, in order to phase out lower rates.

“As a result, statutory corporate rates bounce around a lot,” write the authors of Bad Breaks All Around, The Century Foundation's 2002 report on tax expenditures.

Marginal corporate income tax rates

While it is unclear what social benefit there is to privileging small businesses over large ones, the cost to the government in foregone tax revenue is substantial. According to the Office of Management and Budget's annual analysis, the graduated corporate income tax rate has cost $39.8 billion in the decade since Bad Breaks was published.

Unnecessary progressivity in the corporate tax code will cost another $17.8 billion over the next five years—an amount the OMB estimates will grow by hundreds of millions of dollars each year until this tax break is eliminated.

Graduated corporate income tax costs