Taxing Profits Through Shareholders

One of the neat ideas that caught my attention recently was the progressive case for eliminating corporate income taxation as we know it today. I had been, and in some sense still am a strong proponent of increased taxes on corporate profits, and when I had heard that one my favorite Post-Keynesian economist and his disciples were advocating the abolition of corporate income taxation, I was struck a bit dumb to be quite frank.

More recently I came by a paper published by the Levy Economic Institute in November which I took the pleasure of reading from-to-back. The paper was coauthored by L. Randall Wray, a professor and economist whose book ‘Why Minsky Matters’ I read this year. The paper (Working Paper No. 979), which is fortunately short and to-the-point, goes on to advocate the elimination of the corporate tax, referring to its potentially regressive nature (not sold on that), and more importantly the impact of corporate taxation on the behavior of firms.

What was most interesting to me was the paper’s proposition to substitute the direct taxation of corporate income with the taxation of corporate earnings through their shareholders via the individual income tax. It’s argued that not only does this remove the incentives for firms to misbehave like profit-shift, amortize expenses, and lobby for tax breaks, but it ensures that corporate earnings are in fact taxed progressively.

Aside from literally imputing corporate earnings on shareholders via the “partnership method,” or taxing earnings as capital gains, the paper referred to a ‘limited’ approach from Richard and Peggy Musgrave called dividend integration. Instead of literally abolishing corporate income taxation or implementing some messy imputation system, corporations could simply be provided a deduction for dividends paid. It’s a neat trick really, and it leaves in place an undistributed profits tax.

This last idea I find particularly attractive as it shifts corporate earnings via dividends, cash payments that shareholders can then pay their taxes out of as opposed to being forced to sell shares to pay tax on earnings they don’t actually possess. Another reason is taxing undistributed corporate earnings at a rate of say, 50 percent provides a strong incentive to make dividend payments to shareholders as opposed to accumulating idle piles of cash or pursuing share buybacks.

Finally, dividend payments may encourage investors to weigh stocks by actual profitability as opposed to ‘wow’ factor and market hype, leading to more efficient and informed capital markets.

While the much more educated thinkers over at the Levy Institute don’t seem to mind the national debt whatsoever, I’m not quite there yet. I buy into Modern Monetary Theory and the notion that the nation cannot go insolvent, I don’t quite appreciate the prospects of the Federal Government spending 10 percent of GDP on interest payments. This leads me to my crude revenue estimate:

Scenario assumes a static 36% mean effective rate of tax on newly issued dividends, the retention of some earnings, but does not take into account the affects of offshore earnings repatriation.

While my ideal reform would subject a great deal of new dividend payments to steeper rates of marginal income tax, as well as the retention of a 50 percent undistributed earnings tax, dividend integration according to my SWAG (smart wild-ass guess) alone would raise a not-unsubstantial amount of revenue, around 0.8 percent of GDP in 2030.

This is the kind of neat reform I would appreciate seeing implemented, and I’m glad it achieves so many things while having the prospect of actually increasing revenues. With some luck and cunning, maybe we can trick those pesky Republicans in Congress into supporting dividend integration!

Main photo license and source. No changes made.

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