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Corporate tax reform: a dividends paid deduction?

October 05, 2010

I've long thought a corporation dividends-paid deduction was a logical way to approach corporate tax reform. It would enable the IRS to tax income as it is earned, but keep the same income from being taxed twice. A withheld tax on distributions to tax-exempt entities would keep the income from avoiding tax altogether. A dividends paid deduction would also eliminate the bias for debt over equity in corporate capital structures.

Yet I have never seen a "serious" tax policy wonk address the idea, until now. The TaxProf links to an abstract of a paper, "The Case for Dividend Deduction". The abstract says:

It turns out that there are two good reasons to tax some business entities under some circumstances. Specifically, we believe that publicly traded corporations should be subject to tax (a) because it is hard to tax them on a pass-though basis, and if they are not taxed they become vehicles for tax deferral, and (b) because they are economically important and taxing them is a means to regulate the behavior of the people who run them. However, if those are the reasons for taxing business entities, then we believe that the right form of achieving corporate integration is not CBIT or its progeny, or dividend exemption, or imputation (giving shareholders a credit for the corporate tax). The right form of integration, we would argue, is dividend deduction.

If there is any serious effort at tax reform in the next few years, I hope this will at least be considered.

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