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would permit dividends paid to be deducted from corporate taxable income, i.e., treating payments on ownership capital similarly to those on debt. The other, which is the British procedure, would require the stockholder to report, as part of personal taxable income, the precorporate tax equivalent of his dividend receipts, and would permit him to offset the corporate tax already paid in this connection against his personal income tax liability. On the assumption that this latter method would provide for refunds of the corporate tax traceable to the dividend receipts of nontaxable persons and organizations, there would be no essential difference between these two procedures in rem

2. As to the pressures for corporations to retain income, consider the following illustrations. Here we neglect the corporate rate (since it must be paid anyway) and focus on the personal rate differentials that exist between regular income and capital gains. But first we note simply that on a dollar of regular income the income tax rate schedule ranges from 20 to 90 percent, on a dollar of capital gains the span of the rate schedule is from 10 to 25 percent. So, clearly, it pays to convert regular income to capital gains, and saving via the corporation one of the most direct and convenient mechanisms for this type of conversion.

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More specifically, it is clear that for all stockholders except those not subject to personal income tax, the advantage of converting income to capital gains, if the foregone income shows up fully as capital gains, is large and grows in attractiveness as marginal rates rise (line (c)). A stockholder subject in lowest tax bracket would raise his net by 12 percent if, instead of receiving dividends, he obtained an equivalent capital gain; a stockholder in the highest bracket could raise his net by 650 percent. Further, of course, they could avoid the capital gains tax by holding the assets till death. (Nontaxable stockholders would, in principle, be indifferent between a dividend and a capital gain of the same amount, except, of course, the dividend is actually more certain.) While all stockholders gain from corporate saving as against distributions, the saving is greatest and the pressure strongest for the stockholders in the higher marginal rate brackets. By acquiescing to a retention that adds to their income by 12 percent for the 20-percent bracket stockholder or not at all for the nontaxable stockholder, they permit high-income stockholders to add to their net by 650 percent. Clearly there are disparities here and they show up more strongly on line (e). Here we measure the percentage disposable income loss or gain associated with retaining earnings even if the capital gains associated therewith come to only half the amount retained. In our illustrative table, not all stockholders would lose, even under these conditions. True, the 20-percent marginal rate stockholder, for example, would have only 45 cents (i.e., a capital gain tax of 50 cents minus the 5-cent tax thereon) when he might have had 80 from a dollar distributed as dividends, but at the very highest income the net would still be 275 percent greater than had the dollar been received as a dividend. Should the capital gain be as much as threefourths of the retention, the break between advantage and disadvantage would come lower down the marginal rate schedule. There are possibilities here of stockholder conflict and "exploitation" of lower income stockholders by those in the higher brackets. (The word "exploitation" and the ideas here come from W. L. Crum, “The Taxation of Stockholders," Quarterly Journal of Economics, February 1950, pp. 40–42. But his discussion is focused somewhat differently, and he uses the concept of "exploitation” in a relative rather than absolute sense. In talking about a given increase in book value, due to retained earnings, he says on p. 41, Accordingly, the $6 increase in value per share of new investment in the corporation costs the low-income stockholder more than the highincome stockholder. *** I think we may fairly say that the low-income stockholder is exploited in this situation for the benefit of the high-income stockholder.”).

While these are merely numerical examples, they illustrate the problems involved here. As Prof. Carl S. Shoup has pointed out : ** * it seems impossible to solve the problem of 'double taxation' (extra taxation) of corporate profits without solving at the same time the problems of undistributed profits and of capital gains and losses." (Carl s. Shoup, "The Dividend Exclusion and Credit in the Revenue Code of 1954," National Tax Journal, March 1955, p. 147.

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edying the overtaxation of distributed corporate earnings.30 They could, of course, have different effects in other connections, e.g., management's financial decisions. But all this lies beyond the scope of this paper. There have been a number of studies that have discussed the details of these two methods, analyzed the effects each might have on the policies of corporate management, and undertaken a general assessment of their respective merits and demerits. Outstanding among them are: Richard B. Goode, "The Postwar Corporation Income Tax," Treasury Department, Division of Tax Research (1946), and Harold M. Groves, “Preliminary Report of the Committee on the Federal Corporate Net Income Tax,” Proceedings of the 42d National Conference, National Tax Association, pages 437–470; and “Final Report of the Committee on the Federal Corporate Net Income Tax," Proceedings of the 43d National Conference, National Tax Association, pages 54–73.

However, one point already made should be reiterated here. On revenue grounds, the methods that would achieve full equality of the tax load on distributed earnings have little superiority over the "partnership" method. That is to say, it would cost the Treasury about as much to do a partial job (equalization for distributed earnings) as a complete job (equalization for all corporate earnings). Do stockholders need relief?

All that has been said up to now has assumed that, in fact, there is a problem in equity connected with the income taxation of stockholders. And this assumption is really double barreled. First, for stockholders to be disadvantaged by "double taxation” it is necessary that the corporate earnings, generated on their behalf, be lowered by the amount of the tax—that is, that the corporate tax be not shifted. Second, even if this requirement were met, current stockholders would not be overburdened if the price at which they purchased their stock reflected a discount of future expected taxpayments. That is to say, stockholders would require relief or a change in present treatment even if the corporate tax impinged to its full amount on profits only if they held the stock prior to the tax of its present high level, or, if they purchased more recently, only if the tax was not capitalized. In brief, then, we assumed, in common with all arguments, that stockholders are overtaxed (or differentially taxed), that the corporate tax is neither shifted nor capitalized.

But it is disclosing no secrets to observe that both these assumptions are closer to open questions than to established facts. Examination of the recent writings by students of public finance will show no consensus on who bears the corporate tax or whether share prices embody a full or partial discount for expected future taxes. “And, understandably, empirical data, at best not directly focused on the theoretical issue, do not permit a yes-or-no conclusion. Thus, as re

80 If dividend paid were deducted from corporate taxable income, and, assuming for simplicity a 50-percent corporate rate, on a dollar of dividends paid to someone in the 40-percent tax bracket there would be no corporate tax and 40 cents of personl tax-the same as on a dollar of interest or wages. If the "grossing up" procedure was followed, the taxpayer in the 40-percent bracket who received a 50-cent dividend would report $1 of corporate earnings and would offset against the 40 cents of personal tax thereon, the corporate tax of 50 cents. Thus he would get a net tax credit (or refund) of 10 cents which, added to his dividends, gives him 60 cents, and this is the same sum he would have left after taxes from a dollar of dividends with dividends treated as a deduction from the corporation's, taxable income.

47060—59-pt. 3

gards the incidence of the corporate income tax, the behavior of the rate of return on invested capital over time suggests, in a loose sense, that the tax has been shifted; the constancy in the percent that profits (pretax) comprise of income originating in corporations suggests that it has not been shifted.31 If (or to the extent that) corporations have succeeded in passing on the tax, or present stockholders have purchased their shares free of tax, relief of dividend overtaxation would be gratuitous. There is, then, some question as to how much relief is really needed.

If we add to this uncertainty the inappropriateness of both the exclusion and credit for alleviating overtaxation that declines in severity with rising stockholder income, it would seem as if the goal of tax equity might be just as well served by a simple reduction in corporate rates as by the present credit and exclusion. Prof. Carl S. Shoup, after analyzing the exclusion and credit, noted:

A good deal of the extra taxation, especially at the lower income levels, could be removed simply by lowering the corporate rate substantially * * *. For those who believe that some part of the corporate tax may be shifted but are not very sure about it, reduction of the corporate rate has this advantage over the credit: that it offers more direct inducement to corporate management-or creates a more direct pressure on them-for lowering product prices (or increasing wages, etc.)."

Moreover, if it is argued that dividend tax relief is desirable not only to equalize tax burdens, but as an incentive to encourage investment and growth,23 a cut in the corporate tax rate would be a reasonable alternative since it would have a similar incentive effect.

However, as Professor Shoup points out, lowering the corporate tax "like adoption of the credit device, is open to the windfall objection (capitalized tax) ; 34 and it makes more urgent than ever some method of reaching undistributed profits accuring to high-income stockholders.” 36

31 For the evidence pointing to shifting, see Eugene M. Lerner and Eldon S. Hendriksen, "Federal Taxes on Corporate Income and the Rate of Return on Investment in Manufacturing, 1927 to 1952,” National Tax Journal, September 1956. For evidence consistent with the hypothesis that the tax has not in general been shifted, see M, A. Adelman, "The Corporate Income Tax in the Long Run," Journal of Political Economy, April 1957, and Edward T. Thompson and Charles E. Silberman, “Can Anything Be Done About Corporate Taxes," Fortune, May 1959.

39 Carl S. Shoup, "The Dividend Exclusion and Credit in the Revenue Code of 1954," National Tax Journal, March 1954, p. 145.

33 As President Eisenhower did when he initially proposed the exclusion and credit. See “The Budget of the U.S. Government for the Fiscal Year Ending June 30, 1955," Bureau of the Budget, 1954, p. M18.

34 Those who bought stock at a price that took into account an expectation of tax rates continuing at a given level would enjoy an appreciation in price if rates were lowered.

86 Ibid.


Paul G. Darling, associate professor of economics, Bowdoin College In discussing the treatment of dividend income under the Internal Revenue Code I shall address myself to the questions of (1) equity and fairness, and (2) the effects of taxation of dividend income on economic growth and stability: Other panelists, I feel sure, are more qualified than I to analyze dividend taxation in the light of the other three criteria suggested by the committee as guides for the current review of the code: progression in the distribution of tax burdens, ease of taxpayer compliance and administration of the law, and effects on market allocation of resources.

Because a major aspect of the current review of the code concerns the possibility of broadening the base of taxation, I shall try to make my comments relate to the question : Should sections 34 and 116 of the present code, providing for certain exclusions and credits for dividends received, be deleted from future tax legislation?


I will be concerned here only with the fairness of tax treatment to stockholders as a group as compared with the tax treatment of groups of recipients of other forms of income. The fairness of the relative burdens imposed by dividend income taxation within the stockholder group

will not be at issue here. Both the House Ways and Means Committee and the Senate Finance Committee submitted reports in 1954 to accompany H.R. 8300, the bill which after amendments gave effect to the 1954 Internal Revenue Code. Both reports urged the passage of the dividend exclusion and credit provisions of sections 34 and 116 on the grounds that“under present law the earnings of a corporation are taxed twice, once as corporate income and again as individual income when paid out as dividends to stockholders.” Since other forms of income, such as wages and interest, are not subject to this sort of "double taxation," an unfair burden, it is alleged, is placed on dividend income and those who receive it.

Clearly this view rests on the conviction that the corporate income tax is not shifted. For if the tax is shifted, for example by raising prices to consumers or lowering prices to suppliers or by denying to either group benefits they otherwise would have enjoyed, no extra burden is placed on corporate income by such taxation, and full individual taxation of dividends received out of these earnings would amount to a single, not a double, tax burden. It is impossible, therefore, to reach a conclusion regarding tax equity in the case of dividend income until it is known whether the corporate income tax is shifted to others.



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A review of professional opinion over the last few decades on this question of corporate income tax incidence is revealing. Earlier economists were sure that the tax would be substantially borne by the corporation but their conclusions were based on a static and incomplete theory of corporate enterprise. More recently economists have become divided in their thinking about tax shifting by corporations. In a 1957 survey of opinion, for example, Ratchford and Han 1 found three economists concluding that little or none of the corporate income tax is shifted, and five who believe that only in the short run is the tax borne almost entirely by the corporation; also three economists who hold that the amount of tax shifting depends on such factors as the degree of competition and rate of turnover, with five others agreeing with this only with respect to what economists call the "long run"; and, finally, they draw attention to still another five who have reached the conclusion that most, if not all, of the tax is successfully shifted by corporations to others.

However I do not wish in citing this division of opinion to leave the impression that the whole matter is up in the air. There has been, I think, a perceptible trend over time in professional analysis of income tax shifting, a trend from the view that the tax is borne by the corporation and its stockholders toward the conclusion that most, if not all, of the tax is shifted. Earlier analyses of the incidence problem leaned heavily on a form of economic theory that failed adequately to recognize the importance of the dynamic elements of technological change and economic growth, the constraints and other conditions imposed on a single enterprise or industry by the totality of aggregative economic activity, the pricing practices in industries dominated by a few very large firms. And they could not have anticipated the extent to which Government has increased the scope of its commitment to maintain an adequate degree of aggregate demand to insure high employment, a development which bears on the ability of functional groups to "pass the buck” to others when society levies a new burden on their shoulders, whether its form is a new tax or a reduction in living standards brought about by rising prices.

In more recent years what seems to me a more realistic approach to the problem of corporate income tax incidence has led an increasing number of economists to conclude that in a growing economy of rapid technological change, where prices in wide areas of the economy are set under conditions of competition among the few rather than the many, and where pressures are forcing the Federal Government to accept a responsibility for high employment, that in this setting increases in corporate income tax burdens are rapidly shifted to others.

Thus although in earlier years Congress, on the basis of professional opinion, may have been quite justified in assuming that the corporate income tax was borne by corporations, the weight of more recent professional opinion would now seem to justify a shift to the assumption that the corporate income tax places no substantial extra burden on corporations considered as a group.

1 B. U. Ratchford and P. B. Han, “The Burden of the Corporate Income Tax," National Tax Journal, vol. X, December 1957.

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