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TREATMENT OF DIVIDENDS

Paul Ziffren

revenue.

At the outset I should like to congratulate this committee on undertaking such a comprehensive reexamination of our basic tax policy and system. No problem is more important to the economic wellbeing of this country today and, indeed, to its survival as a free society.

All students of taxes agree that a tax system must be equitable if it is to have the confidence and support of the taxpayers. This is particularly true in the case of our Federal income tax, which is the most monumental self-administered tax in the history of man.

Since 1954 one of the provisions in the Federal income tax that has been attacked consistently as inequitable is the treatment of dividends received from domestic corporations. This involves two sections of the 1954 code; Section 116 permits a $50 deduction for each individual taxpayer (or a $100 deduction for a joint return) of dividend income that is received from domestic corporations, while section 34 permits a 4-percent credit against taxes on such dividend income. In the calendar year beginning January 1, 1960, these two provisions will deprive the Treasury of more than $400 million in much needed

Now, of course, the Federal income tax permits special credits and deductions for various types of income. In every case, the test is whether there is any public policy to justify the special treatment granted as an exception to the basic rule that taxpayers with equal income should pay equal taxes.

For a number of years, until 1943, there was a special credit for earned income within certain limitations. The public policy here obviously was to permit those persons whose income consisted of wages and salaries to receive some slight advantage in comparison to those whose income resulted from dividends or interest or other socalled unearned income. This earned income credit was eliminated when the demand for revenue during World War II became so acute and has never been restored.

Instead, in 1954, the administration succeeded in getting Congress to enact the special credit and deduction for dividends outlined above. Two basic reasons were advanced for this special treatment of dividends: one was the desirability of encouraging equity investments by the American people in the capital stock of domestic corporations. Since that date, however, we have become much more concerned about inflation than about encouraging investment in stocks. Likewise, since that date, we have become more concerned about encouraging investments in Government bonds rather than in stocks. Accordingly, it seems to me that we can no longer justify the special treat

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ment for dividends on the basis of trying to encourage investments in stocks.

The second argument was that the tax on dividends represents double taxation, in view of the fact that the corporation declaring the dividend had already paid a tax on the profits represented by the dividend. In a sense, there is double taxation involved in the tax on dividends. But, for better or worse, double taxation is not uncommon in our Federal tax system. Indeed, every excise tax or sales tax involves double taxation, because the individual who spends his money on the product or service on which an excise tax or sales tax is levied has already paid income tax on his income. Likewise, a real estate owner pays both a real estate tax and an income tax out of the income the real estate ears. The courts have often observed that double taxation is no more forbidden than is the doubling of the amount of the tax, and that we should not expect to find poetic justice in our tax laws, but rather a realistic method of raising needed revenue based upon considerations of public policy.

The argument of double taxation can also be answered by the fact that the corporation pays a tax as a price for the privilege of incorporation, and not in lieu of the tax to be paid by the stockholders. There are many instances in our tax laws where a tax is imposed because of certain privileges retained by the taxpayer, and certainly there can be no doubt that Congress has a right to impose a special tax on those individuals who choose to do business in a corporate form.

In this connection we must emphasize the fact that the corporate tax, for the most part, is not a graduated tax and, therefore, to substitute the corporate tax for the tax on dividends would be a step backward from the principle of progressive taxation. Certainly it would be difficult to justify using the flat 52 percent tax on corporate income in excess of $25,000 in lieu of the personal income tax with rates up to 91 percent. On the contrary, it has been suggested that if we are to give any relief because of the double taxation argument, it should be by way of a deduction to the corporation which pays the dividend, rather than to the individuals who receive it.

Of course, the charge of double taxation assumes that the corporation tax is not shifted to consumers, because there would be no double taxation if the tax burden has been passed on.

Finally, it must be noted that the Technical Amendments Act of 1958 furnishes a method by which any double taxation on dividends for certain corporations can be completely eliminated. That is by the use of subchapter S (secs. 1371-1377 of the code) which permits individuals who have incorporated to report the corporate income as though it were a partnership and thus escape any corporate tax. Of course, not every corporation can utilize subchapters, in view of the administrative problems that are involved in the case of corporations with many stockholders, but certainly for those that qualify, subchapter S furnishes complete relief from any possible double taxation.

Basically, the question remains whether we wish to give preferential treatment to dividend income and to shift part of the tax burden from taxpayers receiving dividends to those whose income comes from wages, salaries, interest, rent, or other sources. Under the present code, a person who receives $10,000 from dividends would pay less than $1,100 after the usual deductions and credits, whereas a taxpayer receiving the same amount from wages and salaries would pay more than $1,370. In other words, the taxpayer whose income comes from dividends pays 20 percent less tax at this bracket and, of course, as the amount of income increases, the burden becomes greater. In my opinion, we cannot justify such a discount in taxes for persons whose income comes from dividends. Randolph Paul, one of the most distinguished tax authorities, in his book "Taxation for Prosperity” emphasized that: “Taxes should be fair. They should be fair because any other kind of taxes would offend a deep sense of equity most Americans possess. They should be fair because unfair taxes impair the morale of our taxpaying citizens. When windfalls are given to some, an added load is placed upon others. Resentment is bound to follow. The success of our tax system depends upon the cooperation of taxpayers more than is commonly supposed.”

47060—59—pt. 3-6

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