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Johnston: allow temporary dividend deduction

November 18, 2008

In his piece in today's electronic Tax Notes ($link) David Cay Johnston says that allowing corporations to deduct dividends for a limited period might be just the tonic for the sagging economy. The piece, reproduced by permission at the TaxProf Blog, proposes this as a way to unlock cash tied up in big companies. He would also, for the same two-year temporary period, make the dividends tax-exempt to those with incomes up to $250,000, with a 10% rate on those making more. He would also require 401(k) plans to distribute such dividends (without penalty), while charities would be required to spend their dividends or pay a 100% excise tax. Says Mr. Johnson:

Pushing dividends out the door will help align the interests of Corporate America with America and its investors by taking away the cash comfort cushions so many executives rely on to mask weak to middling performance. Yet most companies do not pay dividends, and those that do often pay only modest amounts, although the big drop in stock prices has increased yields.
So how do we align the interests of everyone with the interests of CEOs, who naturally want to hold onto cash right now, just like the bankers who now have $250 billion of our money but remain on strike, not making new business loans?

It's an interesting proposal. I dislike temporary tax provisions -- they tend not to be temporary, and they add uncertainty and complexity to the tax law -- but I like the concept of a dividends-paid deduction as a way to solve the dual problems of double taxation of corporate income and the misalignment of management and shareholder interest that Mr. Johnston (I think correctly) notes.

I think a dividends-paid deduction should be a permanent feature of the tax law. Under the Tax Update Corporate Tax Plan, dividends paid would be deductible to the paying corporation. They would be taxed to recipients at ordinary rates, except they should never be taxed at a rate higher than the top corporate rate. Dividends payable to exempt organizations should be subject to an excise tax withheld by the paying corporation, set at the top corporate rate.

The Tax Update plan would eliminate the double tax on coprorate income while removing the tax incentive to accumulate income inside corporations. As a bonus, it would eliminate the Accumulated Earnings Tax.

As far as I know, this sort of plan isn't in any of the major tax reform plans. Why not, I don't know; perhaps it would cause some intractable international problems. It does seem at least simple. Maybe that's the fatal flaw.

Tags: David Cay Johnston.tax policy.TaxProf.