The Tax Foundation claims to be non-partisan, but its releases and concept presentations clearly stick to the GOP anti-tax line. I tend to avoid publicizing the onslaught of press releases from the Tax Foundation for that reason. They are claiming the high ground of nonpartisanship, but pursuing a fixed objective of finding ways to present taxes in a poor light.
Their latest is just more of the same. A Tax Foundation report on the sunsetting of the Bush tax cuts for dividends: Robert Carroll, The Economic Effects of the Lower Tax Rate on Dividends, Tax Foundation Special Report No. 181, June 2010. Recall that prior to 2003, dividends out of a corporation's earnings and profits were taxed at the same "ordinary income" rate to recipient shareholders as interest and rents. The Bush legislation changed that, treating dividends from most corporations as "net capital gains" subject to the preferential rate (0% if within the first brackets, 15% otherwise) although not netted against capital losses as capital gains generally are.
This was another tax advantage provided the highest income taxpayers, since most of the financial income is owned by the upper quintile of the income distribution. The preferential rate for dividend income was originally enacted for only a five-year period, from 2003 to 2008. The rate was extended in 2008 to sunset at the same time as the other Bush tax cuts, at the end of 2010.
The tax foundation special report makes the old argument about the "double tax" on corporate profits, claiming that it discourages production of capital and ultimately reduces wages and living standards. (Funny that we have had growing wages when we have had high taxes on capital and wages actually stagnated under Bush when we instituted lower rates on capital and treated dividend as a kind of capital income subject to those lower wages, but those facts seem to have no bearing on the way groups opposing capital income taxes make arguments for removing them by claiming that low capital income taxes trickle down to benefit those whose primary or only income is from wages.) I'm still unpersuaded that these arguments are anything other than theoretical conclusions from the highly stylized economic analysis that reduces human behavior to math equations. If someone has capital, they will invest it. They will invest it where returns are good and where they think the business is a successful model. Are US taxpayers going to avoid investing to avoid taxes, and just hold their money under a mattress? Maybe they'll consume more instead of investing, which would put the money in someone else's hands to invest? It just isn't clear that there is the huge negative detriment claimed to taxing capital income.
The tax foundation also argues that the "integrated dividend tax rate"--i.e., the aggregate of the federal statutory corporate tax rate, the estimated average state corporate tax statutory rate and the federal statutory rate on dividends and the estimated average state statutory rate on divdiends--is "substantially higher than in other nations." As I have frequently commented here, this is an often misleading comparison of apples and oranges, since the statutory rates do not reflect the effective tax rates, and since "taxable income" is considerably below actual economic income. (The article also mentions the "effective marginal tax rate" but doesn't detail how it arrives at that number, which would presumably take into account some tax advantaged deductions.)
The article claims that the temporary dividend reduction made sense because it reduced the distortion and potential misallocations of income caused by the differences between corporate taxation and pass-through taxation. But you first have to accept that the dividend tax per se creates a problematic distortion, an argument made by economists based on mathematical economic thinking and ignoring the nontax issues. Investors can choose to invest in partnership or S corporations (pass throughs) or C corporations (taxable entities). There is usually a reason for the choice, and it may well be a non-tax reason.
The debt-equity issue also surfaces. Corporations are allowed to deduct interest payments, but cannot deduct payments on their equity interests. That tends to encourage overleverage, it's argued, if there are not other disincentives to overleveraging. Of course, this argument holds primarily for small closely held corporations (rather than large, publicly traded ones), where shareholder investments can be structured as either loans or equity. There are a few limitations on interest deductions, fairly easily avoided. Perhaps we should add more. Perhaps there should be more rigorous audits of thin capitalization and recharacterization of loans as equity in the closely held context in particular. Perhaps all payments on capital used in a closely held business should be treated the same, whether borrowed or "invested", and be nondeductible. Perhaps there should be very rigid and hard to satisfy standards for upholding a shareholder loan to a closely held corporation. All of these would deal with the issue. One need not instead adopt low taxation of corporate dividend payouts to shareholders.
Further, the discussion compares the post-2010 rate (assuming no extension) with the additional medicare tax on investment income to the 2003-2010 temporary rate, rather than to the pre-2003 rate. That of course makes the comparison look much worse, since dividends were taxed at a top rate of 35% prior to the 2003 change, and taxed only at a 15% rate under the temporary rate structure.
Further, the study asserts that increasing the "integrated" corporate tax rate (corporate and dividend statutory rates) may be detrimental to society.
The double tax, for example, may reduce corporate investment, encourage debt finance over equity finance, discourage the payment of dividends, and also discourage investment generally. [emphasis added]
As with many assumptions based on Chicago School economic analysis, it is not clear that this is so. Much the same arguments were made for the very low taxed repatriation benefit to US multinationals in the so-called "American Job Creation Act of 2004"--it was claimed that relief from taxation on repatriated profits would lead to larger dividend payouts, job creation, and capital investment. Yet many of the companies that took advantage of the repatriation also laid off workers, and there were increased share buybacks rather than increased dividend payouts. There was not much evidence of increased corporate investment. For all the economic arguments made about taxes, behavior is too multi-faceted for any one to be able to definitively show that taxes cause reduction in investment.
Furthermore, this claim for problems from ordinary-rate taxes on dividends fails to offset whatever negatives may result from higher taxation of corporate income with the benefits that accrue to American society by expenditure of those tax revenues by federal and state governments. To the extent those expenditures are focused on public infrastructure, human capital development (education, etc.), or benefits for ordinary Americans (such as unemployment compensation, medical care, etc.), they will tend to benefit the economy more than the savings or offshore investments of the saved taxes by the elite that tend to garner most of the financial asset income.
Finally, the study argues that allowing the reinstatement of the pre-2003 tax rates as scheduled under the Republican-based bill's sunsetting provision, together with the small additional medicare tax (3.8%) on investment income will threaten US competitiveness as a place for investment. That competitiveness argument is about as weak as the rest of the arguments. Did the enactment of the temporary rates lead to a significant new inflow of money into the US? Were the pre-2003 rates so destructive of investment that nobody wanted to invest here? Answers to both questions are surely "no".
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