NYU Tax Policy Colloquium, week 9: Len Burman & Kim Clausing, "Is U.S. Corporate Income Double-Taxed?"

Yesterday Len Burman presented the above co-authored piece, which is still an incomplete draft hence not posted online. It confirms, through distinct data, the finding in Steven Rosenthal's and Lydia Austin's widely noticed 2016 study to the effect that these days only about 30 percent of U.S. corporate equity is held in taxable accounts - as opposed to more than 80% fifty years ago.  The main reasons for this decline are the rise of (1) foreign ownership of U.S. shares - although this remains a bit low, relative to the scenario in which home equity bias had entirely disappeared, (2) the holding of corporate stock in tax-free savings accounts such as traditional and Roth IRAs and 401(k)s, along with 529s, and (3) stock ownership by nonprofits.

Should we think of stock held in a traditional IRA or 401(k), in which contributions are deducted upfront and withdrawals are taxed at the backend, as actually tax-exempt? The answer is yes, given that the present value of one's tax liability from the account is zero, if we assume both (a) that the account just earns normal returns that the taxpayer can't scale up (a la Mark Zuckerberg hypothetically deciding to create two comparably profitable Facebooks rather than just one), and (b) that the taxpayer's marginal rate is the same at the contribution and withdrawal stages.  Given the deduction limits for these types of tax-favored savings accounts, along with the fact that most people are just putting in publicly traded stock as to which they have no reason to expect special-opportunity above-normal returns, I'm fine with classifying them as tax-exempt for purposes of the studies, so long as we keep the nuances in mind.

The most obvious takeaway from the Rosenthal-Austin and Burman-Clausing bottom lines is that "double taxation" is less of an issue than many analyses of corporate income taxation tend to assume. This may reduce the appeal and urgency of treating corporate integration as a top priority, although it doesn't rebut the existence of the distortions that proponents of integration emphasize.

A further set of takeaways that I get pertain to how we should think about the existing two levels of taxation. These studies help remind us that, if one eliminated the entity-level tax and shifted corporate tax collection purely to the shareholder level (e.g., by taxing dividends and capital gains more rigorously), we would eliminate the existing indirect taxation of tax-exempts and foreigners via the entity-level tax. But the arguments for structural reform of the corporate tax, and for shifting to the owner level, are distinct from the issues around how we ought to tax (or not tax) tax-exempts and/or foreigners who or that hold U.S. equity.  So those issues ought to be addressed if one is changing the entity-level tax.  (For my money, there is no reason to extend the effective reach of tax-exempts' nominal exemption by letting them escape the tax that they are now indirectly paying; for foreigners the key question for me is incidence: to what extent are they actually bearing the tax?)

What about the owner level?  If we're relying more on taxes on this level, it's important to consider features such as interest charges for deferral plus realization at death (as in a recent Grubert-Altshuler proposal), or taxing unrealized appreciation for publicly traded stock (as in a recent Toder-Viard proposal).

But also, at the owner level we may be changing somewhat the mix of income that is being taxed.  A not very important example, just to make the basic point, is that if a corporation earns municipal bond income and then uses it to pay dividends, there is no tax at the entity level but there is a taxable dividend. Likewise, there's capital gain if the bond interest leads to stock appreciation and thus capital gain on sale.  Obviously, a more important example than this is capital gain to shareholders who sell the stock of U.S. multinationals that have appreciated by reason of their earning huge unrepatriated foreign profits.

In sum, we have these two levels of corporate tax, each frequently avoided, thereby reducing the amount of actual double taxation, and each, at present, bearing differently from the other on distinct types of persons or income. So there are extra complications to keep in mind when one is revising corporate income taxation at one level or the other.  Things would be a lot simpler if the two levels applied less distinctively from each other.

Keeping both taxes, even if their degree of integration is improved, is one possible takeaway.  Most (but perhaps not all) people in the biz favor lowering the U.S. corporate rate from 35% - say to something in the 15% to 25% range - if this can be done in a manner that is budget-neutral and distribution-neutral.  (Among the issues that would have to be addressed, however, is use of the corporate form as a lower-rate tax shelter, e.g., by owner-employees who underpay themselves from the salary standpoint because they are also benefiting from stock appreciation.)  The rationale commonly offered is that this would reduce distortions in multiple dimensions (choice of entity, debt vs. equity financing, profit-shifting within a multinational group, etc.)

Why doesn't this argument suggest lowering the corporate rate all the way to zero? After all, then these distortions disappear, rather than merely being mitigated somewhat.  Well, to proponents of replacing the existing corporate income tax with a destination-based cash flow tax, it does. But if, as a political economy or administrative matter, one needs both levels of tax in order to accomplish various distinct things that one values, then on balance one might want to retain both levels of tax, with or without express integration mechanisms - as do, for example, both the Grubert-Altshuler and Toder-Viard proposals.