A new study showing that a shrinking fraction of shareholders of U.S. corporations pay taxes on dividends is bolstering a drive to revamp the corporate tax system.
The specter of double taxation, which animates complaints about today’s U.S. corporate tax code, is receding, according to a new study from the Tax Policy Center. Tax-exempt and tax-preferred entities—such as 401(k) plans and other retirement accounts—own more than 75% of U.S. corporate stock, nearly opposite the prevailing pattern from 50 years ago, the study said.
The study is emboldening Senate Finance Chairman Orrin Hatch (R., Utah), who says he is within weeks of releasing a proposal that would largely end the remaining double taxation of corporate dividends by shifting the burden from highly mobile corporations to less mobile shareholders.
Sen. Hatch’s plan would let companies deduct dividends, lowering their effective corporate tax rate as a backdoor way to reduce the U.S.’s world-high top statutory tax rate of 35%. Individual taxable shareholders’ dividends would be taxed as ordinary income instead of at lower capital-gains rates. Those taxes would be directly withheld by companies when they pay dividends to investors.
“It’s a huge mistake to locate the high tax at the corporate level and the low tax or the zero tax at the shareholder level,” Michael Graetz, a law professor at Columbia University, said at a congressional hearing this week. “We’ve got the tax in exactly the wrong place.”
That feature may be a major political stumbling block for Mr. Hatch, whose plan will have trouble advancing in an election year under divided government. Any big change would disrupt businesses and shareholders that enjoy tax advantages now. Beyond that, a plan that lowers corporations’ effective tax rates and places the burden elsewhere will be hard to sell publicly.
“The politics of this are just unbelievably daunting,” said Peter Merrill, a principal in the national economics and statistics group at PwC LLP.
The new Tax Policy Center study, from Steve Rosenthal and Lydia Austin, documents the growth of tax-advantaged investing. Just 24% of corporate stock is owned by taxable individuals, down from 84% in 1965. The remaining 76% includes tax-exempt investors such as endowments, mostly exempt foreign investors and retirement plans, which pay a second layer of tax at ordinary income-tax rates, but benefit from what can be decades of tax deferral.
“We can either strengthen corporate taxes by closing corporate loopholes or shift taxes more aggressively to the shareholder level,” said Mr. Rosenthal, whose organization is a project of the Urban Institute and Brookings Institution. “Shifting taxes to shareholders is much more difficult if few shareholders pay tax.”
From 2010 to 2014, public companies with positive domestic pretax book income paid 32.2% of that income as dividends and another 43.4% as share repurchases, according to Mr. Merrill. Under Mr. Hatch’s plan, companies would have greater incentives to increase dividends and substitute payouts for buybacks.
Mr. Hatch would also lessen or eliminate the tax code’s bias toward debt financing, because companies can deduct interest payments to bondholders but not dividends to shareholders. To keep the plan from increasing budget deficits, Mr. Hatch may include a tax on interest paid to foreigners and tax-exempt entities to make sure someone pays tax on that business income.
Tax-exempt investors and foreigners typically couldn’t reclaim any of the taxes withheld from their dividends because they don’t have taxable income to offset the withheld taxes. But that would be little different from now, when they get dividends after corporate taxes are paid. Dealing with tax-deferred investors—such as owners of 401(k) plans—is trickier.
Sen. Ron Wyden (D., Ore.) said he was concerned about who might pay more. “This proposal looks like it could go from double-taxing corporate income to double-taxing retirement plans,” he said.
The U.S. corporate tax has shrunk over time to 1.9% of GDP and 10.6% of revenue in 2015, from 3.6% of GDP and 21.8% of revenue in 1965. Those totals don’t include the second layer of taxation, paid when individuals sell stock and realize capital gains or receive dividends. Preferential tax rates and the ability to time transactions mitigate this second layer.
Over the past few decades, corporations have cut their tax bills, including aggressive shifting of profits into lower-tax countries.
And, as individual marginal tax rates declined below the combined tax rate on corporations and taxable investors, new firms chose to operate as partnerships even as they grow. Such companies pay just one layer of tax, because their business income passes through to owners’ individual returns. More than half of business income is now taxed this way, up from 21% in 1980, according to another recent study.
“Our tax code shouldn’t punish any particular business with double taxation simply because it was organized in a certain way,” Mr. Hatch said.
Write to Richard Rubin at [email protected]