06 06 2016

Hatch Holds Hearing On US Corporate Tax Integration

On May 17, further to his proposal for reform that would integrate the corporate and individual US tax codes, Senate Finance Committee Chairman Orrin Hatch (R – Utah) held a hearing on a measure that would allow US corporations to deduct dividends paid from their tax calculations.

In his opening testimony, Hatch said that, "under the current system, income earned only once by corporations – on behalf of its shareholders – is taxed twice, thanks to a fiction created in the law that treats a business and its owners as two separate, taxable entities. Specifically, [a corporation's] earnings are taxed under the corporate income tax system, generally at a rate of 35 percent. When the corporation distributes a portion of those earnings to its shareholders in the form of dividends, we tax those earnings a second time at the individual level."

In a recent paper, the Tax Foundation explained that "the combined top federal tax rate on equity-financed corporate income in the United States is 50.47 percent, compared to a top federal tax rate of 43.4 percent on other business income."

Hatch pointed out that "the current system of double taxation has resulted in a number of unintended economic distortions that wouldn't exist under a more integrated system" – including a bias in the choice of business entity against the corporate model; and the favoring of debt-financed investment over equity-financed investment, as a corporation can deduct interest paid to bond-holders, but no similar deduction exists for dividends paid to shareholders.

The two main ways to integrate the corporate and individual tax codes would either allow shareholders a credit for corporate taxes paid (credit imputation) or allow corporations to deduct dividends paid (dividends paid deduction). One of the reasons why Hatch has chosen to pursue the latter is that it "would permit businesses to cut their own effective tax rates."

It would, he said, accomplish the goal of bringing down corporate tax rates, "without many of the trade-offs associated with a reduction in the statutory tax rate." It would also "create greater parity between debt and equity, … [and] could help with some of our international tax problems by reducing the pressure on companies to invert."

While he confirmed his plan to submit a proposal to the Finance Committee "in the next several weeks," he acknowledged that "some groups – including tax-exempt entities and retirement plans – may have some concerns with a dividends paid deduction." However, he said "we can craft a system where these parties will be treated in a manner that is comparable to current law."

Such concerns were raised immediately by Ron Wyden (D – Oregon), the Committee's Ranking Member, who pointed out that a dividends paid deduction could result in the double taxation of stock holdings in retirement savings accounts, where tax is deferred until income is withdrawn. He saw that "corporate integration could often add a second tax hit up front" on the dividends the accounts receive.

In her testimony, Judy Miller, Director of Retirement Policy for the American Retirement Association, argued that corporate integration proposals would "reduce the incentives for small business owners to save for themselves through a qualified retirement plan, discourage the establishment and maintenance of these retirement plans, and so reduce the availability of workplace retirement savings."

Steven Rosenthal, Senior Fellow at the Urban-Brookings Tax Policy Center (TPC), pointed out that "the share of corporate stock issued by US corporations held in taxable accounts fell more than two-thirds over the past 50 years, from 83.6 percent in 1965 to 24.2 percent in 2015." US retirement accounts and foreign investors "have largely displaced taxable accounts as the owners of stock issued by US corporations."

As a result, according to TPC calculations, "only about a quarter of dividends are paid to taxable accounts. So, the shift [to dividends tax deduction] might generate relatively little revenue. To keep reform revenue neutral, Congress would need to substantially increase the tax rate on dividends and capital gains – perhaps both to individuals and tax-exempt accounts and institutions."