It seems that each year there is a new “it” tax break for which advocates for cutting corporate tax breaks and their supporters rally. Last year the “it” tax break was a patent box and a few years back it was a repatriation holiday. This year the tax break du jour is the dividends paid deduction.
A dividends paid deduction would allow corporations to deduct from their corporate income taxes the cost of the dividends that they issue to shareholders. In other words, companies would get a tax break for paying out dividends to shareholders. Taken alone, this deduction would cripple the corporate income tax at an estimated cost of roughly $150 billion annually. At a time of growing income inequality and government austerity, enacting a massive cut in one of our country’s most progressive revenue sources would be counterproductive, to say the least.
Advocates of the dividends paid deduction argue that this policy would help end the “double tax” on corporate earnings. The biggest problem with this argument is that it wrongly assumes these earnings are being fully taxed at either the corporate and individual level. On the corporate level, a study by Citizens for Tax Justice (CTJ) found that large profitable corporations pay just over half the statutory rate in federal income taxes, meaning that almost half of corporate income escapes taxation. On the individual level, so much of dividend income is paid to tax exempt shareholders that only 35 percent of dividends are taxable, which means that nearly two-thirds of dividends are escaping taxation on individual side as well.
In addition, there is no reason that many corporations should not be subject to a tax wholly separate from a tax on the individual level. For legal purposes, corporations are treated as separate entities with legal rights and responsibilities (such as paying taxes). Corporations are also granted a series of economic advantages such as limited liability and the ability to be publicly traded.
Advocates of the dividends paid deduction have found a new champion in Senate Finance Committee Chairman Orrin Hatch, who held a hearing on the subject this week and is working on draft legislation that would enact such a deduction. While the details of the proposal have not been made public or scored, it appears that Hatch’s proposal would attempt to stem the enormous cost of the break by enacting a withholding tax that in effect eliminates the tax break for dividends paid out to tax exempt shareholders (which as discussed above constitute nearly two-thirds of shareholders). Even with this withholding tax, Hatch’s proposal would likely cost tens of billions annually.
Rather than buying into the latest corporate tax break fad, lawmakers should instead focus on closing the many outrageous loopholes that pervade our tax system, such as the inversion and deferral loopholes. Closing such loopholes would not only make our tax system fairer, but would also help raise much-needed revenue for public investments.