NYU Tax Policy Colloquium, week 10: Steve Rosenthal on who owns shares of US companies' stocks, part 1

 Yesterday at the colloquium, Steve Rosenthal presented his paper (coauthored with Theo Burke), Who's Left to Tax? U.S. Taxation of Corporations and Their Shareholders. This is a follow-up to, and refinement of, his eye-opening 2016 piece with Lydia Austin, which showed that the share of U.S. corporate shares owned in immediately taxable form by US taxpayers is far lower than people have thought.

Here in part 1 I'll discuss the paper's main findings, and put them in context. In a follow-up part 2 I'll discuss some of the policy issues raised.

Rosenthal's and Burke's basic methodology is to take the excellent information compiled by the Fed regarding who owns U.S. equity, and to adjust and convert it to answer the question of who owns C corporation stock under the US federal income tax. This requires a lot of careful and well-thought-through adjustments, aided by the fact that the Fed (along with US Treasury staff who need to run revenue estimates) has capable people who are interested in the issue.

The underlying motivation is that, in the classic picture most of us have in mind, US companies (including the US affiliates of foreign companies, are subject to the classic double taxation regime. First the corporation is taxed on its income, then the shareholders are taxed on the receipt of dividends or other distributions, and on capital gains if they sell the stock. But this may be a misunderstanding insofar as the shareholders are not themselves taxable.

Understanding the US tax status of US corporate shareholders is important in a whole lot of contexts. An obvious one is how we should think about corporate integration proposals, which may be premised on preserving one layer of tax. A second is thinking about the transition effects of the 2017 U.S. corporate tax rate cut - e.g., to what extent did foreign individuals reap a short-term transition gain? The actual origin of this long-term project came from Rosenthal's taking a look at the 2016 Hillary Clinton proposal to combat short-termism among US corporate managers by giving the shareholders (via capital gains rates that would have declined over time) incentives to buy and hold for a long time. This was not a good proposal to begin with (on multiple grounds), but Rosenthal realized that it presupposed a lot of shareholders who were subject to the capital gains tax if they sold their stock.

Here is the new paper's main finding. US corporate stock appears to be owned approximately as follows:

--40 percent by foreign shareholders. This includes both foreign direct investment (FDI), as in the case where a foreign multinational has a US subsidiary through which it engages in US business activity, and foreign portfolio investment (FPI), such as in the case where a foreign company or individual owns some shares of, say, Apple, Facebook, or Google stock.

--30 percent by tax-favored US retirement accounts. These include, for example, both defined benefit (DB) and defined contribution (DC) plans, along with both traditional and Roth IRAs.

--5 percent by nonprofits, such as Harvard's $40 billion endowment, insofar as it's invested in stock.

--25 percent by taxable US individuals (leaving aside their interests held through tax-favored retirement accounts.

A few decades ago, the last group's share was 80%, as compared to 25% today. Key reasons for the drop include not only the rise of stockholding through retirement accounts, but also the rise of cross-border stock ownership. The paper shows that, just as foreign ownership of US stocks has increased, so has ownership by US individuals of foreign stocks. Home equity bias has declined sharply in recent decades, which is good news from the standpoint of individuals' diversification but very much mixed news from the standpoint of a given country's fiscal system. (Good to have outside $$ coming in, not so good to have inside $$ going out, maybe also not so good to be more subject than previously to global tax competitive pressures.)

As to their direction, these findings are entirely to be expected. We knew that there is more cross-border equity-holding than previously, and that DC plans along with other stock-funded retirement saving has been on the rise.

But the findings are very surprising in the magnitude of what they show. I gather that, before the 2016 Rosenthal-Austin paper, leading economists figured that the 80% figure for direct taxable shareholding had fallen to, say, 50%. Finding that it is already just half that is an eye-opener that can make a major difference in how we view multiple issues.

Suppose, for example, that one was interested in corporate integration specifically from the standpoint of getting rid of "double taxation." (A more sophisticated view in its favor would focus instead on specific distortions - e.g, in the choice of entity, financial instrument, or timing and form of corporate distributions.) We've already seen the entity-level tax recede substantially, due both to cross-border tax planning and the 2017 cut in the US corporate rate from 35% to 21%. We now see that the effective shareholder rate is way down, due not just to cuts in the capital gains and dividend rates, but also to the decline of directly taxable shareholding. So, just as in the international realm, where concern about "double taxation" has receded relative to that about "double non-taxation" or stateless income, so we might have such a concern in the domestic corporate realm.

As it happens, however, the lessons to be learned from the Rosenthal-Burke findings are more complex and subtle than those suggested by the above account. For one thing, one has to interrogate both viewing the 75% share as not taxed at the owner levels (which depends on further things) and viewing the 25% as taxed (e.g., given the tax-free step-up in basis at death). The one thing we can be sure of is that the findings are important and that we should interrogate them further. I'll do a bit of that in my next blog post.