From Triple Crisis:
Two changes paved the way for more and more profit to escape the corporate income tax in the United States. The federal government extended limited legal liability, which protects owners from losing their personal assets if their business fails, to some partnerships and “pass through” corporations not subject to the corporate income tax. Then the tax reform of 1986 cut the top tax bracket of the individual income tax to 28%, well below the statutory corporate income-tax rate. That opened up a large tax advantage for owners who paid individual income taxes on their profits instead of corporate income taxes.
Pass-through businesses—-S-corporations (which afford up to 100 owners limited liability), partnerships (including limited liability partnerships in which all the partners enjoy limited liability), and sole proprietorships—-have flourished over the last three decades. In 1980, corporations subject to the corporate income tax (called “C-corporations”) generated nearly four fifths (78%) of business net income, a measure of a business’s profitability. By 2007, pass-through businesses’ share of net income surpassed that of C-corporations. In fact, partnerships, S-corporations, and sole proprietorships each outnumbered C-corporations.
That was not the case in other high-income countries. In 2004, for instance, nearly two-thirds of U.S. businesses with taxable profits over $1 million were not subject to the corporate income tax. Meanwhile the next-highest share among large, high-income countries belonged to the United Kingdom, with just 26%.
The three-decade decline in the corporate share of net income, enabled by the rise in pass-through businesses with limited liability, has eroded the tax base for the U.S. corporate income tax. That explains how U.S. corporate income tax receipts as a share of GDP (2.3% in 2011) were able to drop well below OECD average (3.0% in 2011), even while the U.S. and OECD effective tax rates on corporate income were nearly identical.