The Dividends Paid Deduction Considered

Comments for the Record

United States Senate Committee on Finance

Integrating the Corporate and Individual Tax Systems:

The Dividends Paid Deduction Considered

Tuesday, May 17, 2014, 10:00 AM

215 Dirksen Senate Office Building

Chairman Hatch and Ranking Member Wyden, thank you for the opportunity to address this topic.  The Center for Fiscal Equity believes that dealing with the question of taxing dividends is a key issue in constructing tax reform legislation and ultimately in achieving comprehensive deficit reduction.  

As always, our proposals come within the context of our four-point tax reform and deficit reduction plan:

• A Value Added Tax (VAT) to fund domestic military spending and domestic discretionary spending with a rate between 10% and 13%, which makes sure very American pays something.
• Personal income surtaxes on joint and widowed filers with net annual incomes of $100,000 and single filers earning $50,000 per year to fund net interest payments, debt retirement and overseas and strategic military spending and other international spending, with graduated rates between 5% and 25% in either 5% or 10% increments.  Heirs would also pay taxes on distributions from estates, but not the assets themselves, with distributions from sales to a qualified ESOP continuing to be exempt.
• Employee contributions to Old Age and Survivors Insurance (OASI) with a lower income cap, which allows for lower payment levels to wealthier retirees without making bend points more progressive.
• A VAT-like Net Business Receipts Tax (NBRT), essentially a subtraction VAT with additional tax expenditures for family support,  health care and the private delivery of governmental services, to fund entitlement spending and replace income tax filing for most people (including people who file without paying), the corporate income tax, business tax filing through individual income taxes and the employer contribution to OASI, all payroll taxes for hospital insurance, disability insurance, unemployment insurance and survivors under age sixty.

We do not believe that providing a tax cut for dividends to corporations is appropriate at this or any other time.  Such a tax cut could not be duplicated for pass-through businesses, partnerships and sole proprietorships – the majority of business taxpayers.  It would foreclose the possibility of enacting consumption taxes, which tax labor and capital at the same rate.  Indeed, such a deduction would essentially turn consumption taxes into a payroll tax, provided that all profits were distributed as dividends (which is actually a proposal for followers of Louis Kelso and his Two Factor Theory).  This proposal is exactly the wrong way to go in this Congress, where it would be vetoed by the sitting President.

The Center for Fiscal Equity believes that lower dividend, capital gains and marginal income taxes for the wealthy actually destroy more jobs than they create.  This occurs for a very simple reason – management and owners who receive lower tax rates have more an incentive to extract productivity gains from the work force through benefit cuts, lower wages, sending jobs offshore or automating work.  As taxes on management and owners go down, the marginal incentives for cost cutting go up.  As taxes go up, the marginal benefit for such savings go down.  It is no accident that the middle class began losing ground when taxes were cut during the Reagan and recent Bush Administrations, both of which saw huge tax cuts.  Keeping these taxes low is also part of why we are experiencing a recovery performing at half speed now.

As long as management and ownership benefit personally from cutting jobs, they will continue to do so.  Tax reform must reverse these perverse incentives.

Tax cuts on capital also produce a host of bad investments that would not otherwise occur.  Every major asset bubble, including the 2008 recession, arose from dividend and capital gains taxes that were too low.  If capital is needed for business because of a demand driven expansion, the Federal Reserve is quite able to make this happen.  Fiscal policy is not, and never has been, the answer to making credit available for expansion.

Our Principal Analyst served on the Computer-Aided Manufacturing – International Cost Management System Project, part of which was the Multi-Attribute Decision Model for investment.  Cost of capital was not a major driver.  Customers who are able and willing to spend had a much greater impact on why investment should take place.  There is one word which typifies an investment manager who follows supply-side economic theory in recommending business investments: unemployed.

Double-taxation of dividends by taxing as value-added and as income to the shareholder is a myth, and a bad one at that. 

If corporate income taxes were expanded to be a subtraction VAT or net business receipts tax that all firms pay, an additional tax on shareholders is merely a surtax paid because there is no other way to fully tax profit at the business level without doing major damage to equity and privacy.

In testimony before the Senate Budget Committee, Lawrence B. Lindsey explored the possibility of including high income taxation as a component of a Net Business Receipts Tax. The tax form could have a line on it to report income to highly paid employees and investors and pay surtaxes on that income.

The Center considered and rejected a similar option in a plan submitted to President Bush’s Tax Reform Task Force, largely because you could not guarantee that the right people pay taxes. If only large dividend payments are reported, then diversified investment income might be under-taxed, as would employment income from individuals with high investment income. Under collection could, of course, be overcome by forcing high income individuals to disclose their income to their employers and investment sources – however this may make some inheritors unemployable if the employer is in charge of paying a higher tax rate. For the sake of privacy, it is preferable to leave filing responsibilities with high income individuals.

Accomplishing deficit reduction with income and inheritance surtaxes recognizes that attempting to reduce the debt through either higher taxes on or lower benefits to lower income individuals will have a contracting effect on consumer spending, but no such effect when progressive income taxes are used. Indeed, if progressive income taxes lead to debt reduction and lower interest costs, economic growth will occur as a consequence.

Using this tax to fund deficit reduction explicitly shows which economic strata owe the national debt. Only income taxes have the ability to back the national debt with any efficiency. Payroll taxes are designed to create obligation rather than being useful for discharging them. Other taxes are transaction based or obligations to fictitious individuals. Only the personal income tax burden is potentially allocable and only taxes on dividends, capital gains and inheritance are unavoidable in the long run because the income is unavoidable, unlike income from wages.

Even without progressive rate structures, using an income tax to pay the national debt firmly shows that attempts to cut income taxes on the wealthiest taxpayers do not burden the next generation at large. Instead, they burden only those children who will have the ability to pay high income taxes. In an increasingly stratified society, this means that those who demand tax cuts for the wealthy are burdening the children of the top 20% of earners, as well as their children, with the obligation to repay these cuts. That realization should have a healthy impact on the debate on raising income taxes rather than carving out even more tax breaks for the wealthy, such as making dividends deductible in the corporate income tax.

Thank you for the opportunity to address the committee.  We are, of course, available for direct testimony or to answer questions by members and staff.