From Real Clear Markets
Senator Orrin Hatch, chairman of the Senate Finance Committee, is focusing on an important aspect of the agenda for corporate tax reform — — allowing U.S. corporations to receive a deduction for dividends paid to their shareholders. That deduction would eliminate double taxation of corporate profits distributed as dividends; instead, these profits would be taxed only to shareholders, not at both the shareholder and corporate levels.
Although Senator Hatch has not disclosed the details of his proposal, a corporate deduction for dividends paid has several advantages. But such a proposal would raise financial and political challenges that would have to be addressed.
Here is a simple example. Under current law, if a firm organized as a corporation had $100 in net income, it would pay 35 percent in federal taxes– leaving it $65 in corporate income. Then, if the corporation distributed this $65 as dividends to its shareholders, they would pay roughly 20 percent in taxes on these dividends — leaving it with $52.
By contrast, if such a corporation received a dividends-paid deduction, it could distribute all $100 of its net income as dividends to its shareholders directly and pay no corporate tax on such distributed income. Then its shareholders would pay the taxes on these dividends at the applicable rate — currently about 20 percent of the $100, leaving them with $80 of income.
However, if Congress passed the dividends deduction for corporations and kept the 20 percent tax rate on dividends for shareholders, the combination would result in a big revenue loss for Treasury. In response, some politicians would push for revenue neutrality — offsetting those revenue losses with tax increases and/or spending cuts. Both would run into stiff political resistance.
Read the full post at Real Clear Markets.
Robert Pozen is a Senior Lecturer at the MIT Sloan School of Management.