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S. HRG. 114–654 

INTEGRATING THE CORPORATE AND 

INDIVIDUAL TAX SYSTEMS: THE DIVIDENDS 

PAID DEDUCTION CONSIDERED 

HEARING 

BEFORE THE

COMMITTEE ON FINANCE 

UNITED STATES SENATE 

ONE HUNDRED FOURTEENTH CONGRESS 

SECOND SESSION 

MAY 17, 2016 

( 

Printed for the use of the Committee on Finance 

COMMITTEE ON FINANCE 

ORRIN G. HATCH, Utah, Chairman 

CHUCK GRASSLEY, Iowa 

MIKE CRAPO, Idaho 

PAT ROBERTS, Kansas 

MICHAEL B. ENZI, Wyoming 

JOHN CORNYN, Texas 

JOHN THUNE, South Dakota 

RICHARD BURR, North Carolina 

JOHNNY ISAKSON, Georgia 

ROB PORTMAN, Ohio 

PATRICK J. TOOMEY, Pennsylvania 

DANIEL COATS, Indiana 

DEAN HELLER, Nevada 

TIM SCOTT, South Carolina 

RON WYDEN, Oregon 

CHARLES E. SCHUMER, New York 

DEBBIE STABENOW, Michigan 

MARIA CANTWELL, Washington 

BILL NELSON, Florida 

ROBERT MENENDEZ, New Jersey 

THOMAS R. CARPER, Delaware 

BENJAMIN L. CARDIN, Maryland 

SHERROD BROWN, Ohio 

MICHAEL F. BENNET, Colorado 

ROBERT P. CASEY, Jr., Pennsylvania 

MARK R. WARNER, Virginia 

CHRIS CAMPBELL, Staff Director 

JOSHUA SHEINKMAN, Democratic Staff Director 

(II) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

Hatch, Hon. Orrin G., a U.S. Senator from Utah, chairman, Committee on 

Finance .................................................................................................................. 1 

Wyden, Hon. Ron, a U.S. Senator from Oregon .................................................... 4 

WITNESSES 

Graetz, Michael J., Wilbur H. Friedman professor of tax law and Columbia 

alumni professor of tax law, Columbia University, New York, NY ................. 6 

Miller, Judy A., director of retirement policy for the American Retirement 

Association and executive director of the American Society of Pension Professionals and Actuaries, College of Pension Actuaries, Arlington, VA .......... 9 

Rosenthal, Steven M., senior fellow, Urban-Brookings Tax Policy Center, 

Urban Institute, Washington, DC ....................................................................... 11 

Wells, Bret, associate professor of law, Law Center, University of Houston, 

Houston, TX .......................................................................................................... 12 

ALPHABETICAL LISTING AND APPENDIX MATERIAL 

Graetz, Michael J.: 

Testimony .......................................................................................................... 6 

Prepared statement .......................................................................................... 33 

Hatch, Hon. Orrin G.: 

Opening statement ........................................................................................... 1 

Prepared statement .......................................................................................... 46 

Miller, Judy A.: 

Testimony .......................................................................................................... 9 

Prepared statement .......................................................................................... 48 

Rosenthal, Steven M.: 

Testimony .......................................................................................................... 11 

Prepared statement with attachment ............................................................. 53 

Wells, Bret: 

Testimony .......................................................................................................... 12 

Prepared statement .......................................................................................... 71 

Wyden, Hon. Ron: 

Opening statement ........................................................................................... 4 

Prepared statement .......................................................................................... 73 

COMMUNICATION

Center for Fiscal Equity .......................................................................................... 75 

(III) 

(1) 

INTEGRATING THE CORPORATE AND 

INDIVIDUAL TAX SYSTEMS: THE DIVIDENDS 

PAID DEDUCTION CONSIDERED 

TUESDAY, MAY 17, 2016 

U.S. SENATE, 

COMMITTEE ON FINANCE, 

Washington, DC. 

The hearing was convened, pursuant to notice, at 10:10 a.m., in 

room SD–215, Dirksen Senate Office Building, Hon. Orrin G. Hatch 

(chairman of the committee) presiding. 

Present: Senators Crapo, Thune, Isakson, Portman, Heller, Scott, 

Wyden, Stabenow, Cantwell, Carper, Cardin, Bennet, and Casey. 

Also present: Republican Staff: Chris Campbell, Staff Director; 

Mark Prater, Deputy Staff Director and Chief Tax Counsel; Tony 

Coughlan, Tax Counsel; Chris Hanna, Senior Tax Policy Advisor; 

and Nicholas Wyatt, Tax and Nominations Professional Staff Member. Democratic Staff: Joshua Sheinkman, Staff Director; Ryan 

Abraham, Senior Tax Counsel; and Tiffany Smith, Senior Tax 

Counsel. 

OPENING STATEMENT OF HON. ORRIN G. HATCH, A U.S. 

SENATOR FROM UTAH, CHAIRMAN, COMMITTEE ON FINANCE 

The CHAIRMAN. The hearing will come to order. I would like to 

welcome everyone here this morning. 

Even a cursory examination of the business tax system demonstrates clearly the problems that arise from the out-of-step corporate tax, which contributes significantly to our anti-competitive 

business climate and leads sophisticated tax planners to engage in 

costly efforts—which some would call gamesmanship or tax avoidance—to either minimize their taxes or manage competitive tax 

pressures from abroad. Without significant reforms to the corporate 

tax system, we will continue to see an erosion in our overall tax 

base along with diminished growth and diminished investment. 

Among the most significant and inexplicable inefficiencies in our 

business tax system is the fact that a significant portion of U.S. 

business income is taxed more than once. Under the current system, income earned only once by corporations—on behalf of its 

shareholders—is taxed twice, thanks to a fiction created in the law 

that treats a business and its owners as two separate, taxable entities. 

Specifically, when a corporation turns a profit, those earnings are 

taxed under the corporate income tax system, generally at a rate 

of 35 percent. When the corporation distributes a portion of those 

2 

earnings to its shareholders in the form of dividends, we tax those 

earnings a second time at the individual level, with a maximum 

dividend tax rate approaching 25 percent. 

This, put simply, is a problem. We have this problem, in large 

part, due to the fact that rules for taxing corporations were written 

without taking into account the rules for taxing individuals, and 

vice versa. A better, more efficient system would be one that integrates the taxation of corporate and individual income. That is 

what we are here to discuss today. 

The current system of double taxation has resulted in a number 

of unintended economic distortions that would not exist under a 

more integrated system. I will discuss just a few of those distortions here this morning. For example, the current system creates 

a bias in the choice of business entity, disfavoring the corporate 

model versus others. Of course, businesses—small and start-up 

businesses in particular—should have the flexibility to determine 

how to organize themselves. But our tax code should not punish 

any particular business with double taxation simply because it was 

organized a certain way. 

Double taxation also discourages savings and investment and is 

a major factor in our current domestic savings and investment 

shortage. Savings and investment are essential to capital formation, increased job productivity, wage growth, and adequate retirement savings. Yet, we have created a system that essentially punishes those who save and invest. In addition, the current system 

explicitly favors debt-financed investment over equity-financed investment. 

In the U.S., corporations can deduct interest paid to bond holders, but no similar deduction exists for dividends paid to stockholders. Now, in some situations, there may be strong reasons for 

a company to opt for debt financing, but there is no real reason 

why the tax code should favor debt over equity. 

Double taxation also contributes to the problem of lock-out; that 

is, it discourages businesses from bringing income earned overseas 

back into the U.S. As many have already noted, with the highest 

corporate tax rate in the developed world, American multinational 

companies are often loath to repatriate their foreign earnings and 

subject them to U.S. taxes on top of the taxes they have already 

paid in foreign jurisdictions. Their shareholders rarely demand 

that they do so, because those earnings would be taxed again if and 

when they are ever paid out as dividends. As a result, experts estimate that U.S. corporations have over $2 trillion in earnings that 

are locked out of the U.S. due, in large part, to our stupid tax system. 

These problems—and there are many others—have been observed for years. As a result, many have argued for the elimination 

of double taxation and in favor of integrating the individual and 

corporate tax system. We are going to continue that discussion here 

today. 

In any discussion of an integrated system, the fundamental design choice that has to be made is whether the single instance of 

taxation should fall on the corporation or the shareholders. Given 

the substantial burdens our corporate tax system already imposes 

on U.S. businesses, coupled with the relatively high mobility of corVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 R:\DOCS\25795.000 TIMD
3 

* For more information, see also, ‘‘Overview of Approaches to Corporate Integration,’’ Joint 

Committee on Taxation staff report, May 13, 2016 (JCX–44–16), https://www.jct.gov/publications.html?func=startdown&id=4913. 

porate residence in the age of globalization, as illustrated by the 

recent wave of inversions and foreign takeovers, some have questioned the wisdom of collecting the tax on the corporation side. 

Another method of integrating the two systems would be to impose a single layer of tax at the shareholder level by allowing companies to deduct any dividends they pay out. As I see it, there are 

a number of benefits to this approach. I will mention just a few. 

First, a deduction for dividends paid would allow businesses to 

cut their own effective tax rates. There is bipartisan agreement on 

the need to bring down corporate tax rates. A dividends paid deduction could accomplish the same goal without many of the tradeoffs associated with a reduction in the statutory tax rate. 

Second, this type of deduction would create greater parity between debt and equity. As I noted earlier, current law generally allows corporations to deduct earnings paid out as interest on debt 

obligations. A dividends paid deduction would provide similar tax 

treatment for earnings paid out as dividends to investors, allowing 

the companies to make debt-versus-equity decisions after considering market conditions instead of simply referencing biases in the 

tax code. 

Third, a dividends paid deduction could help with some of our 

international tax problems by reducing the pressure on companies 

to invert and greatly reducing the lock-out effect. 

To hopefully take advantage of these and other benefits, I have 

been working for over a year now on a tax reform proposal that 

would eliminate double taxation of corporate income by providing 

this type of deduction. While I plan to unveil that proposal here in 

the next several weeks, I am hoping we can inform this ongoing effort by having a more detailed discussion of these concepts and others during the course of today’s hearing. 

Before I conclude, I want to acknowledge that some groups—including tax-exempt entities and retirement plans—may have some 

concerns with a dividends paid deduction. However, at the end of 

the day, I believe we can craft a system where these parties will 

be treated in a manner that is comparable to current law or, in 

fact, in many cases, be better off. At the same time, our overall tax 

system will, in the opinion of many, be very much improved. 

Still, I want everyone to know that I am preparing our integration proposal, and I am aware of the concerns that these and other 

groups might raise, and I am studying them very closely. Today, 

and going forward, we seek your comments and suggestions. 

With that, I just want to say that I appreciate the fine panel of 

witnesses being here today, sharing their knowledge and expertise 

with the committee. I think this is going to be a very informative 

hearing.* 

[The prepared statement of Chairman Hatch appears in the appendix.] 

The CHAIRMAN. With that, I will turn the time over to the distinguished ranking member, Senator Wyden, for his opening statement as well. 

4 

OPENING STATEMENT OF HON. RON WYDEN, 

A U.S. SENATOR FROM OREGON 

Senator WYDEN. Thank you very much, Mr. Chairman. I share 

your view that we have an excellent panel of witnesses and this is 

going to be a valuable morning. 

Mr. Chairman and colleagues, we are going to discuss the concept today of corporate integration, which is not exactly a topic that 

comes up at summer picnics. But this issue is important to the tax 

reform debate, and I want to thank Chairman Hatch and his staff 

who have put an enormous amount of sweat equity into this topic. 

I am glad the committee is going to have the opportunity to dig 

into the specifics about this issue. This morning I am going to focus 

primarily on questions about what corporate integration could 

mean for hardworking middle-class families and small businesses 

that are looking for opportunities to get ahead. 

Now, by way of making sure everybody understands what it is 

we are talking about, corporate integration is about eliminating 

what some people call double taxation, where income is taxed once 

at the corporate level and again at the individual level. Once in 

place, this kind of tax change would allow companies to write off 

payments they make to shareholders in the form of dividends. 

The theory goes, the profit corporations bring in would go out as 

dividends, and corporate tax bills would shrink. But to finance the 

big corporate tax cut, 35 percent of the money paid out in dividends 

and bond interest would be withheld automatically by the Treasury. 

Now this raises, in my view, a number of questions. For example, 

I am particularly interested—as I indicated—in what this would 

mean for middle-class people, their retirement savings, and what 

it means for small businesses. Small businesses dominate the economic landscape of our country. 

In my State, when you are done with a handful of big businesses, 

that is it for big business. We are overwhelmingly a small business 

State. 

So I want to make sure that we drill deeply, and the chairman 

has talked to me about this. When his proposal is formally unveiled, he knows that our staff is going to look into it in great detail. So it is important to dig into these issues, and I am especially 

interested this morning in looking at retirement savings and small 

business. 

Now it looks, on its face, like this proposal could go from doubletaxing corporate income to double-taxing retirement plans. Let me 

be specific about it. Today, most middle-class savers put their 

money into retirement plans that are tax-deferred. It is a good deal 

for working families, and this country’s savings crisis would probably be a lot worse without it. 

Retirement plans invest in lots of stocks and bonds, but under 

a corporate integration plan, when you withhold a chunk of the 

dividends and interest payments that go to retirement plans, suddenly they could get hit with a big, new tax bill for the first time. 

Their special tax-deferred status—which today is the key that 

unlocks opportunities to save for millions of Americans—could go 

away. 

5 

Right now, most savers already face a tax bill when they take 

money out of their accounts. Corporate integration could often add 

a second tax hit up front. So if you are an electrician in Medford, 

OR or a teacher in Salem and you have an IRA or a 401(k), you 

are going to wonder if this system says that the dollar you socked 

away is worth less than it used to be. 

If the math on retirement plans suddenly looks worse to small 

business owners, there is a possibility they might think twice about 

offering a plan to their employees. 

Now, on the question of the impact on businesses, and particularly small businesses that, as I indicated, are the foundation of so 

much of the American economy, I think there are real questions 

about whether corporate integration, in effect, gets America into 

the business, once again, of picking winners and losers with respect 

to businesses. 

Companies that run airlines and wind farms, which need capital 

to invest and operate, could face higher costs if interest rates jump. 

Start-ups may not necessarily want to pay dividends to shareholders because they need to turn their earnings into growth instead of dividends. 

A corporate integration plan might look great to established companies with lots of cash on hand, but not so hot to the small businesses that I have indicated dominate the economic landscape in 

my State and hundreds of communities across the country. 

So we have big issues to discuss today. I thank our witnesses. 

Before I conclude, I want to recognize that we have one of our 

witnesses, Ms. Judy Miller, who is retiring at the end of the summer. She served as a senior pension advisor to this committee 

under Senator Baucus for 41⁄2 years. She has testified before us a 

number of times. I think all of the members congratulate and 

thank Ms. Miller for her service and her valuable advice over the 

years, and wish her well. 

So, Mr. Chairman, thank you, and I look forward to digging into 

these issues. 

The CHAIRMAN. Well, thank you, Senator. 

[The prepared statement of Senator Wyden appears in the appendix.] 

The CHAIRMAN. We have a very impressive group of individuals 

here today. I would like to thank each of you for coming. 

First we will hear from Mr. Michael Graetz, Wilbur H. Friedman 

professor and Columbia alumni professor of law at Columbia University. Prior to coming to Columbia Law School in 2009, Mr. 

Graetz served as the Justus S. Hotchkiss professor of law at Yale 

University, where he started teaching in 1983. 

Prior to Yale, Mr. Graetz was a professor of law at the University of Virginia and the University of Southern California law 

schools. Before that, he served as professor of law in social sciences 

at the California Institute of Technology. 

He is a prominent researcher in the tax field and has written far 

too many books and articles to list here today. Mr. Graetz also dabbled in government service when he served as Assistant to the Secretary and Special Counsel at the Treasury Department in 1992 

and as the Treasury Deputy Assistant Secretary for Tax Policy 

from 1990 to 1991. 

6 

Next we would hear from Ms. Judy Miller, the director of retirement policy for the American Retirement Association and the executive director of the ASPPA College of Pension Actuaries. Prior to 

joining ARA, Ms. Miller served as the Senior Benefits Advisor on 

the staff of the Senate Finance committee from 2003 through 2007. 

We welcome you back. 

Ms. MILLER. Thank you. 

The CHAIRMAN. Before joining the Finance Committee staff, Ms. 

Miller provided consulting and actuarial services to employersponsored retirement programs for nearly 30 years. She is a member of ACOPA, a member of the Society of Actuaries, a member of 

the American Academy of Actuaries, and an enrolled actuary. 

She received her bachelor of science degree in mathematics from 

Carnegie Mellon University. 

Third, we will hear from Mr. Steve Rosenthal, senior fellow in 

the Urban-Brookings Tax Policy Center at the Urban Institute. Mr. 

Rosenthal’s week primarily revolves around Federal income tax 

issues with a particular focus on business taxes. 

In 2013, Mr. Rosenthal served as the staff director of the DC Tax 

Revision Commission. Before joining the Urban Institute, Mr. 

Rosenthal practiced tax law in the private sector for over 25 years, 

most recently as a partner at Ropes and Gray. 

He also deserves a warm welcome back, because he previously 

served as legislative counsel with the Joint Committee on Taxation. 

Mr. Rosenthal is also the former chair of the taxation section of the 

District of Columbia Bar Association. He holds an A.B. and a J.D. 

from the University of California at Berkeley, and an M.P.P. from 

Harvard University. 

Finally, we will hear from Mr. Bret Wells, associate professor of 

law at the University of Houston. Mr. Wells currently teaches at 

the University of Houston Law Center, where he specializes in the 

fields of tax and oil and gas law. 

Prior to his current position, Mr. Wells served as the vice president, treasurer, and chief tax officer for BJ Services Company and 

as head of tax for Cargill Corporation. He received his bachelor’s 

degree from Southwestern University and earned his law degree at 

the University of Texas School of Law. 

I want to thank all of you for taking time out of your busy schedules to be in attendance today. We will hear from the witnesses in 

the order they were introduced. 

So, Mr. Graetz, please proceed with your opening statement. 

STATEMENT OF MICHAEL J. GRAETZ, WILBUR H. FRIEDMAN 

PROFESSOR OF TAX LAW AND COLUMBIA ALUMNI PROFESSOR OF TAX LAW, COLUMBIA UNIVERSITY, NEW YORK, 

NY 

Mr. GRAETZ. Thank you, Mr. Chairman, Senator Wyden, and 

members of the committee. I thank you for inviting me to participate in today’s hearing. I have been involved with the subject of 

corporate integration for 25 years now, in particular working on 

the Treasury report on this topic in 1992 and the ALI report in 

1993. 

In the 1990s, when integration was the topic du jour, domestic 

tax policy issues were the principal concern. They included things 

7 

like the chairman mentioned, including the relative treatment of 

income earned through corporations and pass-throughs, the comparative taxation of debt and equity, the relationship of entity taxation to investor taxation, the relative treatment of distributed and 

retained earnings, and the relative treatment of dividend and nondividend transactions such as share purchases. 

Today, international income issues have come to be also prominent. These include the relative treatment of domestic and foreign 

income, differences in the treatment of domestic and foreign corporations, the coordination of domestic and foreign taxes, and the 

problem of repatriation of foreign earnings to the United States. 

Needless to say, these domestic and international policy issues, in 

combination, make business tax reform a daunting task. 

I strongly support corporate integration through a dividend deduction with withholding, but I want to make clear that while this 

would improve the system by shifting taxation from companies that 

are highly mobile to shareholders who are not, we should not regard this as a cure-all for all of the ills that ail the tax system. 

As members of this committee know, I have long proposed a 

much lower corporate tax rate, as low as 15 percent. That kind of 

solution would eliminate incentives for investing abroad, for shifting income abroad, and for foreign takeovers. But I do not believe 

we can really fix our Nation’s tax system without another revenue 

source. 

I have been a supporter of the progressive consumption tax proposal of Senator Cardin, but that does not seem to be imminent. 

So the question is, ‘‘What should we do in the meantime?’’ I should 

also add that, in order to combat income shifting by U.S. corporations, I have argued that we ought to locate more profit in the 

country where the goods are sold, rather than where the IP is 

owned or used. 

But these are not on today’s agenda. So the key question is 

whether we move to these kinds of reforms or not—whether corporate integration could solve some of these questions that I began 

my testimony with, and that the chairman began with. 

My written statement goes through all of the main issues of corporate integration, so I will just make a few limited remarks. 

The first is that, when the Treasury and the ALI considered integration in detail in the 1990s, they both rejected a dividend deduction because it automatically extended to foreign shareholders and 

tax-exempt entities, at considerable revenue costs, the benefits of 

integration. 

The staff of this committee and Senator Hatch deserve credit for 

recognizing that this problem can be solved through a nonrefundable withholding tax that retains the advantages of the dividend 

deduction, shifting the tax burden from corporations to shareholders, and lowering the effective tax rate for companies, while 

avoiding that revenue loss and the tax reductions that would otherwise occur for foreigners and tax-exempts. 

This proposal has all of the benefits of shareholder or imputation 

credit integration, which is a system that has been proven to work 

well in European countries and in Australia and is a far better system than our current law, which imposes a low shareholder tax 

and a high corporate rate. Shifting the tax from corporations to 

8 

shareholders would be more advantageous and more progressive 

than the current system. 

Let me just, with my limited amount of time, make one comment 

about one of the major design issues. Others, I am sure, will come 

up during the questions and answers, but I want to say something 

about the treatment of interest in this proposal. 

Retaining a withholding tax on dividends of 35 percent is a way 

of avoiding a tax reduction for those tax-exempt and foreign shareholders who are now paying the corporate tax through nondeductible dividends. So it is not an increase in tax on those shareholders. 

On the other hand, a similar withholding tax on interest is an increase in tax on those shareholders, because that interest is now 

deductible and not taxed if you are tax-exempt or a foreign shareholder. 

This raises some important questions. It is worth saying that you 

cannot equate debt and equity without making some changes in the 

way that tax-exempt and foreign shareholders are now treated. It 

is impossible to do so in the absence of that. 

Let me just say that I am concerned about the fact that, if you 

have withholding on corporate interest but not withholding on 

other forms of interest, such as Treasury bills and bank accounts 

and so forth, this may induce portfolio effects by tax-exempt and 

foreign shareholders who will look for the interest in the form that 

has no withholding. 

It seems to me that one thing we ought to think about is the option of limiting the deduction for interest as an alternative. It turns 

out, Senator Wyden, you have proposed eliminating the deduction 

for interest. Eliminating the deduction for interest and a 35- 

percent withholding tax on interest are, essentially, the same. 

They have some differences for higher-income taxpayers, but 

they are very close. The biggest difference is that by eliminating 

the deduction, you do not reduce the effective rate at the corporate 

level, which you do with a dividend deduction. But it might avoid 

the kinds of portfolio realignments that would occur with withholding on interest, and it seems to me something that ought to be 

considered. Even though at first blush a full deduction for dividends with withholding and a partial or limited deduction for interest seems odd, it would actually better align the tax system. 

I am sure this is an issue we will come back to. It is an important issue. It is one we struggled with at the Treasury Department, 

along with many other issues that Senator Wyden and others have 

raised. I am sure we will have a chance to talk about these other 

issues. 

Thank you very much. 

The CHAIRMAN. Thank you, Mr. Graetz. 

Senator WYDEN. Mr. Chairman, just before we go on, on the 

point that you touched on with respect to eliminating the deduction 

for interest, Mr. Graetz, the bill that Senator Coats and I have 

would just take a tiny part of it, not the entire thing. Thank you. 

[The prepared statement of Mr. Graetz appears in the appendix.] 

The CHAIRMAN. Ms. Miller, we will turn to you. 

9 

STATEMENT OF JUDY A. MILLER, DIRECTOR OF RETIREMENT 

POLICY FOR THE AMERICAN RETIREMENT ASSOCIATION 

AND EXECUTIVE DIRECTOR OF THE AMERICAN SOCIETY OF 

PENSION PROFESSIONALS AND ACTUARIES, COLLEGE OF 

PENSION ACTUARIES, ARLINGTON, VA 

Ms. MILLER. Thank you, Chairman Hatch, Ranking Member 

Wyden, and members of the committee, for the opportunity to talk 

with you about the impact of corporate integration on qualified retirement plans with an emphasis on retirement plans for small 

business. 

Data clearly shows that workplace savings are critical to retire- ment security. In fact, workers earning between $30,000 and 

$50,000 are 15 times more likely to save if they have a plan at 

work than if they have to set up an IRA and save on their own. 

This means the impact of corporate integration on the establishment and maintenance of workplace retirement plans has to be 

considered when assessing the proposal’s impact on the retirement 

security of American workers. 

Two key features distinguish retirement savings tax incentives 

from other incentives in the Internal Revenue Code: the deferral 

nature of the incentive and the nondiscrimination rules that make 

employer-sponsored retirement plans efficient at delivering benefits 

across the income spectrum. 

These incentives play an especially critical role in encouraging a 

small business owner to establish and maintain a retirement plan. 

When that small business owner decides to set up a 401(k) plan, 

they agree to take on administrative costs and responsibilities, including fiduciary liability for operating that plan, but that is not 

all. To comply with the nondiscrimination rules, they usually have 

to also make contributions for their employees. So they are not just 

putting money aside for themselves, they are putting money aside 

for their workers. 

A corporate integration proposal that treats retirement plan assets the same as investments made outside of a plan would be a 

broadside hit on the tax incentives for establishing, maintaining, 

and participating in a retirement plan. The impact can be illustrated by considering a couple of examples. 

For illustration purposes, I am assuming the proposal requires 

mandatory 35-percent withholding on dividends and interest paid 

on all domestic stocks and bonds, including those held in a retirement plan, with no ability to recover withholding. Also, I am assuming investment income is from dividends and interests, funds 

are initially invested 50–50 in equities and bonds, the annual rate 

is 5 percent, which is not terribly relevant, and the taxpayers marginal rate is 28 percent. So first, let us look at somebody who has $10,000 to invest, and 

they are considering, should I put it in the 401(k) plan or should 

I invest it outside of the plan? With corporate integration, both accounts are going to net the same amount after 20 years, so there 

would be no tax incentive for investing in the 401(k) plan instead 

of just putting it in your personal account. 

Since money held in a 401(k) plan and other qualified retirement 

plans has a lot of withdrawal restrictions, you are actually tying 

up the money, giving yourself less flexibility, and possibly incurring 

10 

a 10-percent penalty if you need it before retirement by putting it 

in the plan. So there is actually a disincentive to save through a 

401(k) plan if there is no tax incentive to do it. 

Corporate integration looks even worse if you look at a small 

business owner deciding whether or not to set up a 401(k) plan. 

The business has been in operation for 5 years and is now turning 

a profit. There are five non-owner employees with total payroll of 

$300,000. The owner takes $10,000 a month during the year, so 

they have $120,000 in compensation. At the end of the year, they 

take a bonus which is equal to profits. They ‘‘clean it out’’ so to 

speak. In the current year, it is $65,000. 

Without a retirement plan, the owner is going to pay individual 

income taxes on the bonus, at a marginal rate of 28 percent. So 

they would have $46,800 left after tax that they could invest outside of the plan. 

The retirement plan consultant recommends setting up a safe 

harbor 401(k) plan with an additional cross-tested contribution instead of taking the bonus. With this type of plan, the owner can 

contribute $50,000 of the profits to the plan on her own behalf, and 

thanks to the nondiscrimination rules, the owner will also contribute $15,000, 5 percent of pay, for the staff. 

So instead of taking home $46,800 and sending the IRS a check 

for $18,200, the owner would contribute $50,000 to the plan on her 

own behalf and $15,000 on behalf of the employees. 

With corporate integration, the deduction for the contribution is 

still going to cover the cost of the contribution for the other staff, 

or largely cover it. If the owner just paid on the $65,000 now and 

invested the difference, though, she would end up with significantly 

more savings 20 years from now than if she put in the 401(k) plan. 

That is even if she were to drop to a 15-percent marginal rate in 

retirement. 

In this case, with the 28-percent rate in retirement, she can actually increase her savings by 30 percent by not putting in a 401(k) 

plan. Given all of the strings attached to withdrawing money from 

a 401(k) plan, she would also have more flexibility holding those 

savings outside of the plan. 

In other words, with corporate integration, the owner would not 

only have less expense, less liability, and more flexibility, she 

would actually have more long-term savings by just saying ‘‘no’’ to 

putting in that 401(k) plan. 

In summary, corporate integration may be good tax policy in theory, but it would be horrible retirement policy in practice if there 

is no incentive for a small business owner to set up and maintain 

a workplace retirement plan. Without a plan at work, most workers 

with modest income just are not going to save for retirement. 

We would be pleased to work with the committee on how the proposal can be fashioned to preserve the tax incentives for retirement 

savings. Again, I want to thank you for inviting me, and I would 

be pleased to discuss this issue or answer any questions you may 

have. Thank you. 

[The prepared statement of Ms. Miller appears in the appendix.] 

The CHAIRMAN. Well, thank you. 

Mr. Rosenthal? 

11 

STATEMENT OF STEVEN M. ROSENTHAL, SENIOR FELLOW, 

URBAN-BROOKINGS TAX POLICY CENTER, URBAN INSTITUTE, WASHINGTON, DC 

Mr. ROSENTHAL. Chairman Hatch, Ranking Member Wyden, and 

other members of the committee, I am Steve Rosenthal, senior fellow at the Urban-Brookings Tax Policy Center. Thank you for inviting me to testify today. 

I would like to highlight some new research which we published 

yesterday, and the implications of that new research on the effort 

to further integrate the corporate and individual tax systems. 

Let me draw your attention to Figure 1 of my written testimony, 

which is displayed on the monitors to my left. My co-author, Lydia 

Austin, and I found a seismic shift of stock ownership from taxable 

accounts to nontaxable accounts over the last 50 years. We estimate that the share of U.S. corporate stock that is held in taxable 

accounts of individuals fell from 80 percent in 1965 to less than 25 

percent in 2015, which is the gray shaded area at the bottom of the 

figure. 

What happened? Nontaxable retirement accounts, the blue 

shaded area, and foreigners, the white at the top, displaced much 

of the stock holdings of taxable accounts. As a result of the downward trend in taxable stock ownership and the reduction in tax 

rates on individuals for qualified dividend income and long-term 

capital gain, corporate earnings now face a very low effective tax 

rate at the shareholder level. The base is small, and the tax rates 

are low. 

I would like to highlight three important implications to further 

integrating taxes on corporate earnings. Corporate earnings are ostensibly taxed twice, but in practice rarely are. 

By our calculations, more than three-quarters of the shelter base 

is untaxed, and those remaining face reduced tax rates. Second, 

taxing corporate earnings only at the corporate level is challenging 

in today’s environment, as Chairman Hatch has noted. Corporations are mobile, and they can easily shift their earnings abroad. 

To further integrate our tax system, we can either strengthen 

corporate taxes by closing corporate loopholes or shift taxes more 

aggressively to the shareholder level, as is being explored by staff 

today. But shifting taxes to shareholders is much more difficult if 

few shareholders pay tax. 

The best policy answer is creating more taxable shareholders, 

which will be challenging politically. A nonrefundable withholding 

tax on dividends paid to shareholders would help. 

Thank you for allowing me to speak at today’s hearing. I am 

happy to answer any of your questions. 

The CHAIRMAN. Well, thank you very much. We appreciate your 

work. 

[The prepared statement of Mr. Rosenthal appears in the appendix.] 

The CHAIRMAN. Mr. Wells, we will turn to you now for your 

statement. 

12 

STATEMENT OF BRET WELLS, ASSOCIATE PROFESSOR OF 

LAW, LAW CENTER, UNIVERSITY OF HOUSTON, HOUSTON, TX 

Mr. WELLS. My name is Bret Wells, and I am an associate professor of law at the University of Houston Law Center. I too would 

like to thank Chairman Hatch, Senator Wyden, and the other 

members of the committee for inviting me to testify. I am testifying 

in my individual capacity, so my views do not necessarily represent 

the views of the University of Houston Law Center. 

As both Chairman Hatch and Senator Wyden have said, our tax 

system is in need of fundamental reform. Finding a path to rationalizing the taxation of active business income in the United States 

is an important goal—a monumental goal, in fact—and the integration of shareholder and corporate taxation can achieve that goal. 

Corporate integration has been extensively studied for decades by 

prior administrations, the American Law Institute, and numerous 

highly respected academics, one of whom joins me on this panel. 

As this committee staff has recently written, a broad consensus 

exists that significant efficiencies can be achieved through corporate integration. Thus, before one gets enmeshed in the important details of how to create an appropriately functioning corporate 

integration regime, it is important to say that reform along these 

lines can significantly improve our tax system. 

Focusing specifically on the dividends paid regime, this particular method of achieving corporate integration would, as to distributed earnings, harmonize the tax treatment between debt and 

equity and would level the playing field between pass-through entities and C corporations. There is much to commend this proposal. 

But, notwithstanding the potential benefits of corporate integration, the reality is that business tax reform must carefully consider 

the international tax implications of any new paradigm, and to that 

end, the United States must ensure that its tax regime withstands 

at least three systemic international tax challenges. 

First, a critical international tax challenge is the inbound earnings stripping challenge, and this earnings stripping challenge can 

be further categorized along the following types of tax base erosion 

strategies: related party interest stripping transactions, related 

party royalty stripping transactions, related party lease stripping 

transactions, supply chain restructuring exercises, and related 

party service stripping transactions. 

The second key international tax challenge relates to corporate 

inversions. Corporate inversions are often categorized as a discrete 

stand-alone policy problem, but in my view, the corporate inversion 

phenomenon provides unmistakable evidence of the enormity of the 

inbound earnings stripping advantage that exists for all foreignbased multinational corporations. 

A foreign-based multinational corporation can engage in an inbound related party interest stripping transaction, royalty stripping transaction, and an inbound related party lease stripping 

transaction without any concern for the U.S. subpart F rules, 

whereas these very same transactions would create subpart F inclusions if conducted by a U.S. multinational corporation. 

Corporate inversions, rightly understood, represent an effort by 

U.S. multinational corporations to place their U.S. businesses into 

an overall corporate structure that affords them the full range of 

13 

inbound earnings stripping techniques without being impeded by 

the backstop provisions of the subpart F rules. 

Third, fundamental tax reform must deal with the so-called lockout effect. 

As to the earnings stripping challenge and its alter ego, the corporate inversion phenomenon, the dividends paid deduction regime, 

by itself, does not equalize the tax position of the U.S. multinational corporation with that of a foreign-based multinational corporation. Even though the dividends paid deduction regime provides a corporate-level tax deduction for dividend payments, the 

dividend payment is subject to a corresponding withholding tax. 

In comparison, a foreign-based multinational corporation can engage in all five of the enumerated earnings stripping strategies to 

create a comparable U.S. tax deduction without incurring a corresponding withholding tax. Thus, the dividends paid deduction regime does not eliminate the financial advantage that motivates 

earnings stripping or that fuels the inversion phenomenon. 

In order to address those two key international issues, the 

United States must impose an equivalent withholding tax or a surtax or—building on the idea advanced by Professor Graetz in his 

earlier written testimony—disallow a deduction on all related party 

base erosion strategies. An expansive approach—and not just one 

that is focused on interest stripping transactions or royalty stripping transactions—is needed. 

Let me conclude my oral statement by stating that an appropriately structured corporate integration regime has much to offer. 

The committee is to be commended for considering fundamental 

business tax reform, but at the same time, this committee must ensure that the dividends paid deduction regime is structured to 

withstand the systemic international tax challenges that face the 

United States. 

Thank you for allowing me to speak at today’s hearing. I would 

be happy to answer any of your questions. 

[The prepared statement of Mr. Wells appears in the appendix.] 

The CHAIRMAN. Thank you. All four of you have been very interesting to me, and I am sure to other members of the committee. 

Mr. Graetz, this question is for you, but the other witnesses are 

certainly welcome if they want to weigh in with their thoughts as 

well. This relates to the international tax rules. 

Specifically, we hear a lot about the $2 trillion locked out from 

the United States because of our worldwide deferral tax system. 

There are over $2 trillion that the foreign subsidiaries of U.S. corporations have that no U.S. tax has been paid on and that the companies are loath to bring back to the U.S. because of the high 35- 

percent U.S. corporate tax rate that awaits them. 

Now, I have heard that the dividends paid deduction would lessen this lock-out effect, but not necessarily eliminate it. Do you 

agree or disagree? 

Mr. GRAETZ. I agree with that. I think it would lessen the lockout effect, especially for companies that are distributing their earnings to shareholders. They get the deduction and would not pay the 

35-percent tax at the corporate level, so it would definitely help. 

It is worth saying that integration systems of this sort can work 

well with either the foreign tax credit system that we now have or 

14 

with a territorial system which provides an exemption for foreign 

earnings. That is the system in Australia. They have a shareholder 

credit system and a territorial system, for example. 

The CHAIRMAN. Mr. Rosenthal, in your written testimony, you 

note that ‘‘having two levels of tax distorts business decisionmaking in several important ways: whether to establish as a corporation, partnership, or other business form; whether to finance 

with debt or equity; and whether to retain or distribute earnings.’’ 

Now, I would like to focus on the second distortion that you note: 

whether to finance with debt or equity. Could you elaborate on the 

distortion created by the debt financing versus equity financing? 

And how would you eliminate that distortion? 

Mr. ROSENTHAL. Yes. Under present law, corporations can take 

a deduction on the interest they pay to bondholders. By contrast, 

corporations cannot deduct the dividends they pay to shareholders. 

As a result, under present law, there is an incentive to issue more 

debt to reduce corporate taxes instead of issuing equity. 

As I described in my testimony, effectively today, we collect most 

taxes at the corporate level and few at the shareholder level, which 

particularly exacerbates that incentive to issue debt over equity. If 

we were to shift to collecting taxes at the shareholder level through 

allowing a dividends paid deduction, that also would accomplish integration, collecting at the shareholder level rather than as we do 

today, principally at the corporate level. 

That form of collection would eliminate the debt-equity bias that 

you have highlighted, Chairman Hatch. 

The CHAIRMAN. Thank you. Mr. Wells, in your written testimony 

you write that ‘‘it is important to say that reform along the lines 

of corporate integration can significantly improve our tax system.’’ 

Now, you were formerly vice president of tax at a large publicly 

traded company. Now, how do the two levels of taxes of corporate 

earnings distort business decision-making, and would a dividends 

paid deduction eliminate some or all of those distortions, and how 

would it improve our tax system? 

Mr. WELLS. For a company to distribute earnings, it would create 

a shareholder tax, a double tax on the distributed earnings that is 

avoided if the company simply reinvests the earnings back in the 

business. By having a corporate integration regime, the company 

would get a deduction currently, and there would be an offsetting 

withholding tax, and that would ensure that the company makes 

the most efficient decision as to what to do with that income. 

There would not be a double tax cost. The decision of what to distribute to shareholders or to invest in the business would be solely 

one based upon the right economics for that company. 

Today, companies suffer a double tax issue if they want to distribute earnings to their shareholders. That is a distortion that 

need not be there. 

What is a better answer is to ensure that there is one level of 

tax and that it is taxed at the shareholder level at the high shareholder effective tax rate, whatever rate this committee wants to put 

in for individuals. That would be the most efficient system and the 

way to ensure a progressive tax system, in my view. 

The CHAIRMAN. Well, thank you. 

Senator Wyden? 

15 

Senator WYDEN. Thank you very much, Mr. Chairman. 

Ms. Miller, let us start with this question of the retirement 

plans, and particularly small employers, because I know you have 

done a lot of work with them over the years. 

Hypothetically, let us say that you are the owner of ABC Plumbing in Coos Bay, OR, which has five employees. And you are beginning to have some success with your business. You are interested 

in putting some money aside. 

How would these corporate integration ideas, 35-percent withholding proposals, impact my business in Coos Bay, OR and my decision on whether or not to set up a 401(k) plan? 

Ms. MILLER. That is a great question. Thank you. 

Right now, when that business gets to that point, they have their 

payroll, they feel like employees are fairly compensated, so when 

you are approaching that employer about putting in a plan, you are 

really talking, largely, about their personal tax situation. If they 

have profits, you can show on the current year’s tax basis that they 

are going to make a contribution for employees, but the overall deduction is going to pretty much cover that cost. 

But then you get into, okay, is this plan the right place for you 

to invest your money, or would you be better off just not setting 

up the plan and going elsewhere? That is where an example in my 

testimony comes into play, because under current law, if you put 

in the 401(k) plan, you get the current-year deduction, you feel 

very good about putting money in your employees’ accounts as 

well—it is little net cost. 

Then you project your retirement, and depending on what your 

effective tax rate is when you retire, you might have a little less 

than if you just invested outside the plan, but you might have 

more. It is pretty much a wash, so it is a good situation. You say, 

I would rather give the money to my employees than Uncle Sam, 

and you can put in the plan. 

But with corporate integration—because you lose that inside taxdeferred buildup—you will actually find that the owner would be 

better off, by a substantial amount, to not put in the 401(k) plan 

at all. So if you are advising that employer—— 

Senator WYDEN. That is why the five employees ought to be concerned about this. 

Ms. MILLER. Right. Exactly. The five employees should be concerned, because the employer probably is not going to put that plan 

in, and they are not going to get that contribution from the employer that they would be getting now. 

Senator WYDEN. Let me ask you about another challenge that 

the chairman and I have talked about, all the members are talking 

about, and that is the ramifications for the multiemployer pension 

situation. As you know, there are many of these multiemployer 

pensions that are in financial peril, a number of them running out 

of money. The Pension Benefit Guaranty Corporation estimates 

that it would cost $100 billion to provide full plan benefits for participants and multiemployer plans that are currently insolvent or 

expected to be insolvent over the next 20 years. 

Describe what these proposals could mean in terms of the funding levels for these kinds of plans. 

16 

Ms. MILLER. That is a really critical point, in that if bond interest that is currently not taxable becomes taxable and dividends, to 

the extent that there is not an increase in the dividend amount to 

absorb the withholding—there is an argument that there would be, 

but possibly not. Basically, the investments you are now holding in 

the plan are worth less, so when you look at the underfunding in 

that plan, your assets will have shrunk. This proposal that has 35- 

percent withholding on dividends and interest without the ability 

to recapture it if you are in a qualified retirement plan trust, if it 

goes into effect today, tomorrow your bonds are worth less than 

they are today, and your underfunding has grown. 

Senator WYDEN. Thank you. 

One question for you, Mr. Rosenthal. You say that, ‘‘Ostensibly, 

corporate earnings are taxed twice.’’ The committee was told during 

our last tax reform hearing that less than a quarter of corporate 

equities are now subject to the so-called double tax. 

Can you describe current situations in which corporate earnings 

may be taxed only once or not at all? 

Mr. ROSENTHAL. Well, there is the theory, and then the practice. 

In theory, if a corporation issued a bond, and the bond was held 

by a tax-exempt, there would be no level of tax on the corporate 

earnings. If the corporation had issued equity to a tax-exempt 

shareholder, it would be taxed once at the corporate level. 

In practice, as a result of carefully looking at the data, I believe 

that today we principally or overwhelmingly collect our tax on corporate earnings at the corporate level, and very little tax at the 

shareholder level. So I use the words ‘‘ostensibly taxed twice.’’ I 

think the important issue is not how many times we tax corporate 

earnings, but how much we tax corporate earnings. 

Senator WYDEN. Mr. Chairman, my time is up. I have indicated 

to the chairman that I am going to work closely with him to explore any of the ideas he has. I just want to come back to the proposition that, to get tax reform passed, it is going to have to be bipartisan. That is how we are going to get to tax reform. To me, 

that means giving everybody in America a chance to get ahead, not 

just the fortunate few, but everybody. Small businesses and the 

middle class, especially, have to be part of that effort to give everybody a chance to get ahead. That will be the key, in my view, to 

getting a bipartisan bill. 

Thank you, Mr. Chairman. 

The CHAIRMAN. All right. 

Senator Thune? 

Senator THUNE. Thank you, Mr. Chairman. I think all of us 

would like to see comprehensive tax reform: business and individual done at the same time. I think moving to a territorial system—in a perfect world, that is what we would like to see happen 

here. In the more realistic world, it may be that we get some rifleshot opportunities. 

I guess my question kind of gets at the point you were making 

earlier, Mr. Wells; that is, is it possible to do corporate integration 

without creating a lot of unintended consequences—earnings stripping, the sorts of things that you described—where you would actually, perhaps, do more harm than good? Can this be done in a vacuVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 R:\DOCS\25795.000 TIMD
17 

um? Can we rifle-shot this, or does this have to be done in that 

broader context? 

Mr. WELLS. It has to be done in a broader context. And the 

thought you need to have in your mind—I would urge, Senator— 

is that when you have a deduction at the corporate level under the 

dividends paid deduction regime that creates a 35-percent withholding tax, you have to compare that to the other earnings stripping opportunities. 

And, if an inbound company has the opportunity to create a tax 

deduction in their U.S. affiliate at the same benefit but through interest stripping, royalties, and the rest, and those are not subject 

to a withholding tax, then there is a structural competitive advantage for that foreign-based multinational in the United States, even 

though they both get a corporate tax deduction. 

So if we want to have horizontal equity between domestic corporations and foreign corporations, we need to ensure that the tax 

base will not be reduced through a deduction that avoids the withholding tax through intercompany arrangements for the inbound 

foreign company that does not exist for the U.S. multinational. As 

I said in my testimony, many of those earnings stripping techniques, if tried by a U.S. multinational, would be subject to the 

U.S. subpart F regime and would be currently taxed. 

So today, there are earnings stripping opportunities to the inbound foreign-based multinational that give them a deduction with 

no withholding. If we want to have a level playing field, we need 

to make those not exist for one group of companies when they are 

not available for the other group of companies. 

Senator THUNE. Mr. Graetz, you mentioned in your testimony 

that the form of corporate integration that was advanced by the 

Bush administration in 2003, which is taxing business income once 

at the entity level—you state that approach is no longer apt today. 

So my question is, can you discuss why those corporate integration proposals from the 1990s and the early 2000s are no longer 

apt? What has changed since then? 

Mr. GRAETZ. Yes, I can. I was responsible, in large part, for the 

1992 proposal which would have located the single tax at the corporate level, which then was proposed again by President George 

W. Bush and became the blueprint for the 2003 legislation. 

It is hard for me to admit I am wrong, so I am fond of saying, 

if I was right then, I am wrong now because the world has 

changed. The competition globally was not as much on our radar 

screen as it should have been at the time. Foreign takeovers were 

not nearly as important as they are now. There were not the nonrepatriated profits sitting offshore that we are now looking at, and 

we did not have significant inversions of U.S. companies to speak 

of. They were very minor, and all they did was send paper to Bermuda instead of sending jobs to Europe. So, it was a very different 

world than we are in now. 

Now I think it is a huge mistake to locate the high tax at the 

corporate level and the low tax or the zero tax at the shareholder 

level. We are much better off taxing the shareholders who are 

going to stay in the United States, who are going to be residents 

of the United States, than the corporations who will change their 

18 

residence through paper transactions and will also shift a tremendous amount of income abroad, as we have seen. 

So we now have the tax at exactly the wrong place. We have a 

low tax on the shareholders and a high tax on the corporations. 

Senator THUNE. Do you believe—and this is for any of you—that 

a dividends paid deduction coupled with withholding at the shareholder level can be done in a manner that is consistent with our 

existing tax treaties? 

Mr. GRAETZ. If you withhold at 35 percent on foreign shareholders, you have treaty issues. If you do not withhold at 35 percent on foreign shareholders, you will have given a tax cut to those 

foreign shareholders and increased the revenue cost of the proposal. So it is a difficult issue. 

I will say one thing, and that is that the United Kingdom in 

adopting its so-called ‘‘diverted profits tax,’’ and Australia in doing 

something similar, have claimed, oh well, that is just a different 

tax. That is not the same tax that we are talking about in the treaties. So maybe if you call this something other than withholding 

tax, you could make similar claims and then let everybody fight 

about the treaties subsequently and put us in a stronger negotiating position vis-a`-vis our treaty partners, but you could not call 

it a withholding tax and not get into treaty issues. 

Senator THUNE. All right. Thank you, Mr. Chairman. 

The CHAIRMAN. Okay. Senator Scott? 

Senator SCOTT. Thank you, Mr. Chairman. Thank you to the 

panelists for being here this morning to discuss this very important 

issue. 

Without any question, when you think about the fact that we 

have the highest corporate tax rate in the world at 35 percent, we 

have the second-highest integrated tax rate on corporate income at 

56.6 percent, it is no wonder that we find ourselves in the situation 

that we do today. Investment levels are not where they should be. 

Debt financing is preferred, and inversions will continue. 

I applaud the chairman for his efforts to make any progress on 

this antiquated, outdated, should-be-obsolete tax code without any 

question. I am concerned, however, that absent a total overhaul of 

our tax code, the United States is going to become more and more 

uncompetitive in our global economy. Further, as the United States 

becomes less competitive and fewer domestic profits and revenue 

are realized, there will be a greater negative impact on middleincome Americans and poor and economically disadvantaged communities. 

To me, one of the major focuses of tax reform must center on 

helping middle-income Americans and the poor. We know that so 

many families are just trying to find a way to the American dream. 

Too often, our policies at the Federal level are preventing that from 

happening. Actually, the inability for us to come together in a bipartisan fashion to eliminate the highest corporate tax rate, to 

allow for repatriation, and to eliminate this global form of taxation—as opposed to territorial taxation—is crippling job creators 

in this Nation. 

One of the reasons why I have introduced new legislation, called 

the Investing in Opportunities Act, is to help more than 50 million 

Americans living paycheck to paycheck, and to look for ways to enVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 R:\DOCS\25795.000 TIMD
19 

courage and to incent trillions of dollars into these distressed communities. My legislation does not create new government programs 

but rather focuses on private-sector investment. 

My home State of South Carolina has done a really good job attracting enormous growth and opportunities in the industrial, manufacturing, and high-tech economies that has helped those folks living in distressed communities consistently. 

We still have a very long way to go, but I believe that my legislation and other tax proposals for lower rates on the over-burdened 

middle class will have a positive impact in improving regional economic conditions across the country. And while I certainly appreciate the hearing today, my thoughts are still the same, that ultimately, until we have a panoramic view of our tax code and drill 

into ways for us to reduce the overall corporate tax rate and then 

deal, as well, with our business organization—LLCs, other forms 

and entities in our business structure—we will still find ourselves 

struggling for a real solution. 

Thank you, Mr. Chairman. No questions. 

The CHAIRMAN. Thank you, Senator. 

Senator Casey? 

Senator CASEY. Thank you, Mr. Chairman. We appreciate the opportunity to talk about this subject. 

Ms. Miller, I will start with you—not only because you went to 

Carnegie Mellon in Pittsburgh, but that always helps. 

I was noting in your testimony, the first page of your testimony, 

that you said in pertinent part, ‘‘workers earning between $30,000 

and $50,000 per year are 15 times’’—and you emphasize those two 

words—‘‘15 times more likely to save at work than to go out and 

set up an IRA to save on their own.’’ Your source for that was the 

Employee Benefits Research Institute. 

So based upon that statement in your testimony—and I share a 

lot of your concerns, especially as it relates to nonprofits and retirement vehicles—can you walk through how corporate integration 

would reduce incentives for small business owners to set up, establish retirement plans for them and for their employees? How do 

you summarize that? I know you walked through some of it already. 

Ms. MILLER. It really relates to the growth of the investment 

during the deferral period, what is now a deferral period, to the extent that the investment income is interest and dividends. Corporate integration is going to modify it. In fact, that is going to be 

reduced somewhat. 

But in addition, to the extent that there is now double taxation, 

and there would not be outside of the program, there will be kind 

of a bump-up in how their savings would grow if they were outside 

of the program as opposed to inside the program. 

So if you were only looking at an individual, it is going to pretty 

much equalize things inside and outside of the plan. But when you 

are looking at a small business owner—because they have to make 

that contribution for other employees as well—you are really, 

under current law, kind of counting on the tax-deferred inside 

buildup to kind of make up what they have spent by making those 

contributions for other people. 

20 

So it really just shifts what looks like a good place to put your 

money to, ‘‘Do not put it in that plan. Let us take the money and 

just invest it outside of the plan.’’ 

Senator CASEY. In terms of a broader, more particular concern 

about access to retirement vehicles and savings rates, what would 

you conclude about those two issues? 

Ms. MILLER. Well, I think there are a certain number of people 

who save no matter what, but they tend not to be people that we 

are most concerned about. For people in the more modest income 

level, there is lots of evidence, not just that data, about the need 

to have automatic savings to enroll them at work, and to the extent 

that you do not have those programs at work, the savings rate will 

fall. I do not have an estimate of how much, but it is clear that 

there would be a dramatic drop for people who are in those more 

modest income levels. 

Senator CASEY. Mr. Rosenthal, I was noting in your testimony on 

page 3 that, in reference to the work that you and your colleague 

did, you say, ‘‘The share of corporate stock issued by U.S. corporations that is held in taxable accounts fell by more than two-thirds 

over a period of 50 years from 83.6 percent in 1965 to 24.2 percent 

in 2015.’’ 

Is it fair to conclude from those numbers that—and this is an 

opinion—but, based upon those numbers, is it fair to say that relatively few shareholders pay at that second level of taxation? 

Mr. ROSENTHAL. Yes, Senator. That is the inference that I draw 

from the data. You can see the decline on the monitor to your right. 

The taxable ownership dropped quite considerably from 1965 to 

2015. 

I think the decline changes the way we look at a lot of the different tax issues that this committee and the Congress address. 

Senator CASEY. And in particular, can you walk through for us— 

and I know you have been through this a little bit already—the 

type of taxpayers who might be subject to withholding tax under 

corporate integration? 

Mr. ROSENTHAL. Well, as our research illustrates, only about 25 

percent of shareholders are taxable, and the balance are taxexempt. They fall in different categories; most principally, retirement plans and then foreigners. 

If we shift to a dividends paid deduction with a withholding tax, 

the issue arises as to whether that withholding tax would be refundable or nonrefundable. I think most expect it would be nonrefundable for a variety of revenue and policy reasons, but the consequence of that—as Ms. Miller has observed—would be to collect 

a withholding tax at the corporate level that would not be of any 

value to the retirement plans or presumably to foreigners, and that 

is going to put a lot of stress on shifting the tax on corporate earnings from the corporate level to the shareholder level, how we can 

address that issue. 

Senator CASEY. Thank you. I know I am over time. Thank you, 

Mr. Chairman. 

The CHAIRMAN. Thank you, Senator. 

Senator Portman? 

Senator PORTMAN. Thank you, Mr. Chairman. 

21 

Thank you all for being here. This is a terrific group of witnesses. 

We are talking about an issue that is incredibly important to 

America’s economy right now. We have a tax code that is not competitive, and we need to do a number of things to change it, and 

quickly; otherwise, we will continue to lose jobs and investment. 

We also have a retirement system, as Ms. Miller has talked 

about, that is in need of restoring. Senator Cardin and I worked 

a lot on this over the years, together. You are absolutely right. We 

do not want to create disincentives for people to save for their retirement at a time when we need more and more people to be saving—10,000 baby boomers retiring every day and a Social Security 

system that is incredibly important, but also in trouble based on 

the fiscal outlook. 

My biggest concern right now, frankly, is what is going on with 

our companies taking their jobs and investment overseas. Professor 

Graetz, you have been terrific on this issue over the years. I am 

going to take you back in time here to an article that you wrote 

that I pulled up. It was in December, at the end of year. It was 

about what is going on right now. Right now, as we sit here, the 

European Commission is taking state aid cases against U.S. companies that are overseas in European countries, although this is 

happening more broadly with the BEPS project with all OECD and 

G20 countries. 

But with regard to these state aid cases, we are looking at the 

possibility of U.S. companies being told that whatever arrangement 

they have worked out with another country is no longer valid on 

a retroactive basis, to the tune of millions if not billions of dollars. 

This is money that, frankly, comes out of the U.S. Treasury, because that is where it, otherwise, should go. So, because we have 

a worldwide tax system—that is true—but also because of the reform efforts that Senator Schumer and I and others have been 

talking about—now Speaker Ryan, former Chairman Ryan, and 

others—you have a toll charge on your earnings overseas, and that 

is how you pay for going to a territorial system, which I think we 

all should agree is the way to go. I will just presume that is the 

way you all feel. 

That will not be there if these state aid cases continue, and they 

will. There are another 300 cases, we are told, that are on the 

docket. 

I guess my concern is, what is happening now is not working. I 

think, frankly, both governments are looking at the symptoms of 

the problem rather than the problem. Our own Treasury Department has just issued these new regulations under section 385 for 

earning strippings that I think are an overreach. I am against inversions. I want to stop them, but I want to stop them by dealing 

with the underlying problem, and, frankly, it has some unintended 

consequences, what is going on right now. 

So I am bringing you right up to the present. This is what is 

happening. Both the EU and the United States government are reacting to the problem in ways that I think are counterproductive 

to our interests as Americans to create more jobs and opportunity 

here. So I would ask you to comment on that, and in the area of 

corporate integration, how does that work with what we know we 

have to do on the international side? 

22 

I think this is urgent. The house is on fire. We need to get the 

fire truck up there to start putting it out quickly. Some of you have 

probably read the Wall Street Journal story—I think it appeared 

yesterday—where Ernie Christian, who has worked with Mr. 

Graetz over the years on tax policy and other issues, just laid out 

what is happening with these foreign transactions. So it is not just 

about inversions. That is almost the tip of the iceberg. 

There are companies in the United States that, because of our 

tax code, are targets for takeover because these foreign companies 

can pay a premium, and it is escalating every year—again this 

year. 

So I guess I would start with you, Mr. Graetz. And you have 

commented on this briefly, but do you not think we have a crisis 

here that you have written about, and how does this corporate integration idea help or hurt in terms of dealing with this underlying 

problem we have, which is a corporate international tax code that 

is not competitive and leads to job loss here in this country? 

Mr. GRAETZ. Thank you, Senator. As you know, I agree entirely 

we have a crisis. We have a terrible tax system. Its distortions and 

complexities and inefficiencies would take us more time to list than 

we have. The state aid cases are troubling, both for their retroactivity and for, I think, their potential discrimination against U.S. 

corporations. There are some European corporations that are also 

under investigation, but they seem to be small potatoes compared 

to what the European Commission is going after with U.S. companies. 

Senator PORTMAN. Five big ones right now, and four are U.S. 

companies, and the fifth is Fiat with huge U.S. holdings. 

Mr. GRAETZ. Yes, exactly. The foreign tax credit means that any 

additional taxes that are paid will be borne not by the companies, 

but by the U.S. taxpayer. So it is a reason for concern. 

All of the things that you mentioned, I think, are reasons for concern. Yes, there is a crisis. 

I was thinking, as Senator Wyden was talking, about a variety 

of issues. Integration is not penicillin. It is not a cure-all. It is not 

a new antibiotic. It is a step—I think an important step—in the 

right direction in terms of improving the U.S. tax system. 

I regard it, as I said in my testimony, as a useful step and an 

important step, but not a cure-all. I have said this many times— 

I think the only solution for the U.S. is a very low corporate rate. 

I think in order to do that, we probably have to tax consumption 

more than we are taxing it. 

Senator PORTMAN. But you have also said we need to go to a territorial system. 

Mr. GRAETZ. I have. I have, because I think that this current system, which creates a disincentive for bringing money home to invest in America, is foolish at the current time. 

Senator PORTMAN. My time has expired. I appreciate it. Mr. 

Chairman, I hope we will have a hearing also on the international 

tax issues and, specifically, what Treasury is doing with these new 

regulations and the unintended consequences of the section 385 

changes, and hopefully we can deal with this immediate problem 

that we have. If we do not, I think we will see our corporate comVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 R:\DOCS\25795.000 TIMD
23 

munity and our businesses and jobs continue to go overseas. Thank 

you, Mr. Chairman. 

The CHAIRMAN. I intend to do that, Senator. I agree with you on 

that and have been one of the pushers for that. 

Mr. Wells, let me ask you this question. There have been several 

questions regarding corporate integration and retirement plans and 

small businesses. Would you like to comment on anything like 

that? 

Mr. WELLS. Okay. From my perspective, this is not a disadvantage to anyone, is the way you ought to think about it. When you 

take a distortion away from a group of taxable shareholders and 

you make them not suffer a double tax, then those who are benefitted under current law because they don’t suffer from that double 

tax distortion are not disadvantaged. The reform is simply removing a double tax distortion that makes taxable shareholders less efficient. It is only in that sense that tax-exempts can say that the 

reform proposal is a relative disadvantage to them. 

I think what this committee ought to understand—and I think 

the corporate inversion phenomenon is getting us to understand— 

is the following: if we allow one group the opportunity to erode the 

corporate tax base as a subsidy, whether that is an inbound earnings stripping advantage, whether that is this particular technique, 

then the result will be a source of market inefficiency going forward. 

I think what is a better system—a thoughtful system that this 

committee ought to adopt—is to collect one level of tax on active 

business income. When the dividends paid deduction regime imposes the 35-percent withholding tax, it is only because the tax system has given a dividend deduction that eliminated the corporate 

tax. There is not a net increase. With the 35-percent withholding 

tax, all we are saying is that we want to preserve the corporate tax 

base to be taxed once at the shareholder level. 

Senator Hatch, I will conclude by saying this: if you tell me the 

one person who can get a dividend under the dividend reduction regime without a corresponding withholding tax, I will tell you to 

whom everyone in the market will sell their stock the day before 

the deductible dividend is paid, and then from whom everyone will 

buy the stock back from that preferred person the day after the deductible dividend has been paid. That person will be the source of 

eroding the corporate tax base. 

From a tax policy perspective, I think this committee needs to 

say that we need to preserve one level of efficient tax on active 

business income. Having that active business income taxed at the 

shareholder level assures individual progressivity. That is a wonderful goal. 

If we take the distortions out of who the owner is, whether that 

is a foreign-based multinational or a pension or the others, that 

creates the tax symmetry that I think the system needs. 

The CHAIRMAN. It seems to me corporate integration helps us to 

get there. 

Mr. WELLS. It absolutely is the vehicle to get there, whether it 

is the dividends paid deduction regime or other forms of integration, but I think it is absolutely a wonderful first step. The committee is to be commended for thinking through it. 

24 

The CHAIRMAN. Thank you. 

Mr. Graetz, in your written testimony you note that, with respect 

to tax-exempt shareholders and debtholders, ‘‘The approach of the 

ALI report was to subject these entities to a tax on investment income. This would maintain a single level of tax on corporate income received by such investors at whatever rate Congress deems 

appropriate and could serve to eliminate tax-induced distortions between debt and equity.’’ 

Now the Treasury report estimated that in 1992, a uniform tax 

of 6 to 8 percent would have approximated the tax burden on investment income received by tax-exempt shareholders. Now, some 

have suggested that under a corporate integration proposal, taxexempts would bear the same tax burden on corporate earnings as 

taxable shareholders and bondholders. Would a modest tax on the 

investment income of tax-exempts alleviate such concerns? 

Mr. GRAETZ. Mr. Chairman, I actually think it would. Just to be 

clear about this, at least as I understand Ms. Miller’s testimony, 

the way in which dividends would be treated under integration 

would be the same for these retirement funds and tax-exempts as 

under current law. They are paying the corporate level tax, and the 

same would be true of retained earnings. 

I think what is pressing the numbers that she has given us—if 

I understand them—is interest withholding, where you are putting 

in a new tax that is now not paid by tax-exempt organizations or 

retirement funds, and that is the additional tax burden. 

So the question that we asked at the Treasury and that the ALI 

asked was, at what rate are tax-exempts now taxed because they 

are paying tax at the corporate level on their ownership of corporate equity? We ran some estimates when I was at the Treasury—it was the early 1990s—and we concluded it was about 6 to 

8 percent. That is as you said, what is their investment income? 

It is about a 6- to 8-percent tax. 

It is now completely imposed on corporate equity. There is a zero 

tax on debt. If you put in a 6- or 7- or 8-percent tax—I do not know 

what the number would be today; you would have to ask the Joint 

Committee or the Treasury, but it is probably about the same. If 

you put in that kind of tax, you could then make the withholding 

refundable to tax-exempts and to lower-bracket taxpayers and not 

have the revenue costs. Now it would be an explicit tax on taxexempts, so it may raise some political problems. We certainly 

thought there were some political problems at the Treasury. 

But the goal was to equate debt and equity, treat them the same, 

without increasing the tax burden on tax-exempts. That was the 

goal. In order to do that, you either have to raise the tax on interest or lower the tax on dividends, or both. We concluded that doing 

it on an evenhanded basis, a 7- to 8-percent tax, and then allowing 

a refund of the credits would get you to about the same place as 

you are today for those taxpayers. 

I think if you are really considering providing withholding on the 

interest side, this is certainly something that is worthy of consideration. 

The CHAIRMAN. Thank you. This question is for Mr. Graetz and 

Mr. Rosenthal. But the other witnesses, if you care to, feel free to 

weigh in. 

25 

Would the dividends paid deduction coupled with a withholding 

tax simply make more transparent to tax-exempt entities the current corporate tax that they are bearing? 

Mr. ROSENTHAL. I would say, yes, that if we had a dividends paid 

deduction with a nonrefundable withholding tax, that would make 

quite clear the tax that a tax-exempt such as a retirement fund or 

foreigner is paying. 

I would just add that I agree with Professor Wells and Professor 

Graetz that if we collect one tax from taxable entities, we will inevitably disadvantage tax-exempts if we also tax them once, whereas today, we tax taxable entities twice and tax-exempts once. That 

is inevitable. 

But I cannot see us move to a system in which business profits 

are not taxed at all. Our tax code is framed around collecting one 

level of tax on profits from a trade or business, and we make sure 

of collecting with our UBIT on the profits of a trade or the business 

of tax-exempts. We also tax the effectively connected income of a 

U.S. trade or business of foreigners. We make sure of that, by and 

large, with the way we tax capital gains. 

So the notion of trying to exempt completely wide classes of taxpayers from any tax on a trade or business, I think would be a 

huge revenue loss and a mistake. 

The CHAIRMAN. Mr. Graetz? 

Mr. GRAETZ. I basically agree with what Mr. Rosenthal has said. 

I think that the question is—as I said earlier—at what rate are we 

now taxing tax-exempts? We are taxing them on the retained earnings and the dividends that are paid by corporations when they invest in equity. 

I do think there are some questions about what would happen to 

dividend payments. Ms. Miller has raised them, and we talk about 

them in our testimonies. I talk about them in my testimony—what 

would happen to interest rates, especially corporate interest rates 

which are subject to withholding, and whether those rates would 

have to go up. Ms. Miller, I think, assumes in her examples that 

interest rates are the same as they now are for corporations and 

that they would not go up. 

But I think if there is going to be this kind of withholding, in 

order to sell bonds, interest rates are going to have to go up in 

some manner. So I think that there are issues here. But I basically 

agree with Mr. Rosenthal. 

The CHAIRMAN. Thank you. 

Senator Cardin, I will turn to you. 

Senator CARDIN. Well, thank you, Mr. Chairman. Thank you for 

continuing the questions so I could get back into the committee 

room. I appreciate it. 

Let me thank the entire panel. I did hear your testimony. I am 

ranking member on Senate Foreign Relations, which is meeting at 

the same time. So I apologize for not being here for the entire hearing. I appreciate all of your testimony. 

Ms. Miller, you raised some very important points on retirement 

issues. We have been working a long time to make sure our tax 

code, at a minimum, does not hurt the current incentives that we 

have for retirement savings, considering we still do not have 

enough retirement security in this country. 

26 

We would certainly like to do better, but we do not want to do 

worse. I think your point about corporate integration and how it 

impacts the incentives for retirement savings is a point that needs 

to be taken into consideration. 

The easiest way to deal with that is to follow Professor Graetz’s 

point of changing the reliance on our revenues from income to consumption, at least doing that in a more balanced way. I guess my 

first question, Professor Graetz, would be that, if we get corporate 

tax rates to a level that you are suggesting, which is, I think, 10 

percent or somewhere on that level, or legislation that I filed which 

gets it down to 17 percent, and you get the individual rates down 

by at least 10, 11, 12 points, we really do not run into the same 

problems of discriminating how business sets up its tax structure, 

because the tax rates become much less significant. 

Mr. GRAETZ. Senator Cardin, as you know, I agree entirely with 

your proposal and with the direction that you are going. Frankly, 

I do not think there is any other solution to the problem we now 

have. The British have now announced that they are moving their 

corporate rate down to 17 percent. I have suggested 15 percent. 

We are now taxing earnings domestically at the 35-percent rate 

in many cases, and we are taxing, at least, equity-financed investment in the U.S., and we are now taxing foreign earnings at a very 

low rate. This makes absolutely no sense, because we have created 

an incentive for U.S. companies to invest abroad rather than domestically, and we have inhibited our ability to attract foreign investment with a high corporate tax rate. The evidence is increasing 

that a greater and greater share of the corporate tax is being borne 

by labor because capital is so mobile in the current economy. So it 

is not as progressive as taxing the shareholders directly on their 

earnings, on their dividends, on their interest, on their capital 

gains, and so forth. 

So, I think this is the only solution that is a solution to fix our 

current system. I think it is worth saying, just given the nature of 

this hearing, that integration of the sort that is being discussed 

here is compatible with a lower-rate corporate tax. In the same 

way, you would have a lower-rate withholding tax if you lowered 

the corporate rates. 

So there is nothing that is incompatible with doing integration 

and moving to a lower tax rate, but as I said—I think while you 

were in the Foreign Relations Committee—integration is not penicillin and it is not going go solve our problems. 

Senator CARDIN. I agree. I think you are absolutely correct in 

that the only way you are going to deal with this is through some 

type of proposal that we are suggesting. You are not going to solve 

it otherwise. We will move the chairs around the deck a little bit, 

but we are not going to really deal with the fundamental problems. 

Ms. Miller, did you want to comment more on the retirement aspect of this? 

Ms. MILLER. Thank you. I mentioned earlier that the issue is 

really with interest and not with dividends, and it is actually with 

dividends to the extent that there is double taxation of dividends 

now because we are talking about a relative advantage to investing 

in a qualified retirement plan over investing outside the plan. So 

to the extent that somebody outside the plan is paying that second 

27 

level of tax and now they will only be paying one, they have 

bumped up. You have given an advantage to investing outside the 

plan. So the issue is both dividends and interest. So it is really on 

both sides. 

Senator CARDIN. I just really want to throw one thing out, Mr. 

Chairman, that I do not think has been mentioned yet, and that 

is, as we look at these proposals, we also have to look at the impact 

they have on tax credits that we currently have in law. I have been 

a strong proponent of the New Market Tax Credits. Their value 

will change under this proposal. What impact does it have on 

those, and historic tax credits? 

I think those issues need to be understood, the impact they 

would have. In trying to reform our current tax structure in an important way, but a modest way on the overall structure, and in a 

way that has an impact on incentives that may be unintended, I 

think we need to understand those issues. 

Mr. Wells, I see you are very anxious to reply. 

Mr. WELLS. I am. I just want to—what I would urge you to also 

consider is that, if you drop the tax rate to 15 percent, you should 

consider that high net wealth individuals are not going to earn active business income outside of the C corporation at substantially 

higher individual tax rates. So we will have laborers paying individual taxes at a high rate, and corporations paying taxes at a 15- 

percent rate. 

The wonder of this proposal, this integration regime, is it gets us 

a zero corporate rate as to distributed corporate earnings, and it 

gets that income at the shareholder level to pay tax at a progressive individual rate schedule. So if you really want to get to a zero 

corporate tax result, I think corporate integration does that. 

Senator CARDIN. If you use the model that we are using, there 

will be an individual tax as the money is taken out of the C corporations. 

Mr. WELLS. But I will not do that until I die, and my stock 

goes—— 

Senator CARDIN. Not necessarily. It depends on the type of structure that you have, and that is why most people in that circumstance have used pass-through entities rather than using the 

C corporation. So I think it really argues against your point. The 

point is that, if you are a large company, you are organized as a 

C, and you are not the one holding the wealth in the company because your impact is much smaller. If you are a small company, 

you are more likely to be holding wealth, but you are using it 

through pass-through entities, by and large. So you are already 

paying the individual rate. 

So I do not see the lower corporate rate—and again, the difference between the C rate and the pass-through individual rates 

in the models that we are using is about the same as it is today. 

So we really are not changing the equation of an individual deciding whether to use a pass-through entity or using C rates. 

I do not quite follow your point, but I appreciate that exchange. 

The CHAIRMAN. Thank you, Senator. 

Let me just ask you—this is a question for each of you, and it 

can be answered ‘‘yes’’ or ‘‘no,’’ I believe. Do you agree that there 

28 

would be a behavioral response to a dividends paid deduction? I 

will start with you, Mr. Graetz. 

Mr. GRAETZ. All right. Yes, if you want a ‘‘yes’’ or ‘‘no’’ answer. 

The CHAIRMAN. Well, if you want to add more, that is fine with 

me. 

Mr. GRAETZ. Well, I think it does reduce the burden for repatriations, which is an important point, because you get to deduct the 

dividends at the corporate level. I think it would, perhaps, increase 

the distribution of earnings as dividends. It would certainly increase the distribution of earnings as dividends versus share repurchases, which are now favored. So it would certainly change that 

balance, and one would hope that it would change the debt-equity 

balance, which of course, is one of the important reasons to go forward. 

So I think it would reduce all of the distortions that you began 

this hearing with and also have some international advantages. It 

would not eliminate all of these problems, but it would certainly 

make them less important. 

The CHAIRMAN. Well, I am not bringing up corporate integration 

as a cure-all of all problems, but I bring it up as something that 

would put us in the right direction and solve a number of problems, 

and then we could work on the rest of them as we go along. Ms. 

Miller, what do you think about that? 

Ms. MILLER. I think there definitely would be problems. As I 

have said, my concern is that it be structured such that it is not 

a negative behavioral change. 

The CHAIRMAN. Sure. Okay. 

Mr. ROSENTHAL. Yes, Mr. Chairman, there would be a big change 

to our tax system, and we could expect behavioral consequences. I 

would worry about unintended consequences. For instance, if the 

committee goes down the path of having a nonrefundable withholding tax so that tax-exempts, in effect, bear a U.S. tax on corporate income but perhaps avoid a foreign tax on corporate income 

or a U.S. tax by moving the corporation abroad to a tax haven, you 

might see more inversions depending on the structures that are 

pursued. 

So we have to be careful in the way we change our rules, because 

there are various issues that could pop up. 

The CHAIRMAN. Okay. Mr. Wells? 

Mr. WELLS. Yes, I think there would be a definite response. I 

think that the parity this committee is attempting to achieve is 

wonderful and would be a good avenue for corporate tax reform. 

I think where the real difficulty will be, Chairman Hatch, will be 

the earnings stripping, the deductions we can get at the corporate 

level, where the income goes to someone who is not taxable on that 

income, and if we need to protect the corporate tax base to one 

level of tax, that is where the complexity is going to be. 

What I would urge you to consider is that, as soon as you let one 

avenue of those profits be deducted and paid to someone without 

a comparable withholding or surtax, then you have created a market distortion. But I agree, this is a step towards correcting systemic distortions that the current system has. 

The CHAIRMAN. Am I correct in believing that there would be appreciatively more dividends under a DPD system with withholding? 

29 

Mr. GRAETZ. I would assume that the companies would increase 

their dividends, to some extent at least, to gross up the benefit of 

the dividend deduction. I think there you would certainly see a 

substitution of dividend payments for share repurchases, which I 

think is a very important beneficial step given the current advantages for nondividend distributions over dividend distributions. 

The CHAIRMAN. It seems to me that every company would want 

to get their shareholders to reinvest those dividends in the company, which would help the company to expand or, at least, do 

much better than it, perhaps, had been doing. At least, that is one 

of the goals that we would have, I would think, with this program. 

Mr. GRAETZ. Both the Treasury Department and the ALI proposals had a reinvestment option in them, which both Professor 

Warren and I thought was a useful and important piece of the proposal. 

The CHAIRMAN. Let me ask you just another question, Mr. 

Graetz. In your written testimony you note that, ‘‘A deduction for 

dividends and domestic earnings could serve as a full or partial 

substitute for rules directly limiting erosion of the U.S. corporate 

income tax base, and for rules explicitly directed at curtailing or 

prohibiting corporate inversions.’’ 

Now as you know, erosion of the U.S. tax base is a significant 

concern, as are corporate inversions. Could you elaborate on your 

statement that a dividends paid deduction could address both base 

erosion and inversions? 

Mr. GRAETZ. Well, Mr. Chairman, with regard to base erosion, I 

would cite the experience in Australia, where Australia has had 

very good success in its integration system because, in order to be 

eligible for the integration system, you have to pay domestic taxes. 

It sort of puts a floor on the domestic tax that has been paid. 

There is also an empirical study by Dan Amiram and some colleagues at the Columbia Business School in which he investigates 

both the European experience and the Australian experience, and 

he found that base erosion increased after the repeal of integration 

systems in Europe, which was due to a series of decisions by the 

European Court of Justice at the time. He found that the Australian system does protect against base erosion. 

When I was in Australia last winter, I spoke to people at the 

Treasury and in the business community who all agreed that the 

Australian companies, at least, were much less likely to look to 

shifting their taxes and income abroad because of the integration 

system. In Australia, this is referred to as an integrity benefit. I 

think it is real. 

It would also, I think, help with the inversion problem. Although 

again, I do not think it is a complete solution to either of these 

problems, but it would help with the inversion problem, because 

U.S. companies paying U.S. dividends to U.S. shareholders would 

be able to pay considerably more dividends under more advantageous circumstances than foreign companies. And by eliminating 

the barrier on repatriating for those companies that distribute 

their earnings, that also takes some of the pressure off of inversions. 

As long as foreign rates are dramatically lower than U.S. rates 

and as long as other countries have a territorial system and looser 

30 

Controlled Foreign Company or subpart F rules than we do, there 

are going to continue to be advantages for foreign parents over domestic parents, however. 

The CHAIRMAN. Well, thank you. I want to thank our fantastic 

panel of witnesses for appearing here today. 

Professors Graetz and Wells, I think you made compelling cases 

for taking the next steps on exploring corporate integration. 

Ms. Miller, thank you for pointing out some important design 

issues with respect to the impact of corporate integration on retirement plans. 

Mr. Rosenthal, I want to thank you and the Tax Policy Center 

for all of your research on domestic corporate stock ownership 

trends. That has been very important. Your research is very informative. 

My take is, it shows that investors and management are voting 

with their feet. The double tax burden is driving taxable shareholders away from corporate shares. It is driving management towards debt financing. Once more, it shows the premium put on 

transactions to minimize exposure to U.S. corporate tax, like corporate inversions. 

I take it TPC would agree with the Treasury Department, the 

Joint Committee on Taxation, and the Congressional Budget Office 

that driving economic activity towards debt financing and other 

techniques to minimize the corporate tax would lead to more distortions. More distortions mean less growth, fewer jobs, and loss of 

the U.S. tax base. 

I also want to thank my colleagues for their participation as well. 

I think we can all agree here today that the system needs to be 

changed. 

I hope that my colleagues on both sides of the aisle will work 

with me to ensure that my proposed changes take as many perspectives into account as possible. The more I get to hear from each 

of you, the better my proposal will likely be. Now, it is up to each 

of us to try to get the system right for the first time since World 

War II. 

Now, let me just say that this may be a small step, but it is a 

step that would be pretty impressive over the long run if we could 

actually get both sides to agree to work together to get this done. 

If anything, this committee has shown that we can do a lot of bipartisan work together. 

Last year, we passed 37 bipartisan bills out of this committee. 

Most of them are law today. Some are being made law this year. 

This year we have had a pretty impressive year as well. 

I just hope we can all work together in the best interest of our 

country. Clearly, we are not going to be able to do comprehensive 

tax reform this year. I would love to do it, but there is no way that 

I think with the current makeup of Congress we are going to be 

able to do that, as complex as that would be. It took 3 years last 

time. I do not think it needs to take 3 years, but I think if we could 

do something like corporate integration, that would let people know 

that we are making headway, that we are moving forward, that 

true tax reform is something that is not only a possibility, but a 

probability. 

31 

To that extent, I think your testimonies here today have really 

been helpful to the committee, and certainly to me. So I want to 

thank you for being here and tell you I appreciate each one of you 

making the effort to be here. I hope you will continue to enlighten 

the committee as much as you can, because I think we can do some 

really great work together if we can just get rid of all of the partisan crap around here and work together as people who love to do 

bipartisan work. 

Thank you so much. With that, let me just say that we will recess this committee until further notice, but we will ask that any 

questions for the record be submitted by Tuesday, May 31, 2016. 

With that, the hearing is adjourned. Thanks so much. 

[Whereupon, at 11:55 p.m., the hearing was concluded.] 

(33) 

1This testimony represents only the views of Michael J. Graetz and not any organization with 

which I am or have been affiliated. 

A P P E N D I X 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

PREPARED STATEMENT OF MICHAEL J. GRAETZ, WILBUR H. FRIEDMAN PROFESSOR OF

TAX LAW AND COLUMBIA ALUMNI PROFESSOR OF TAX LAW, COLUMBIA UNIVERSITY

Mr. Chairman, Senator Wyden, and members of the committee, thank you for inviting me to participate in today’s hearing on integrating the corporateand individual tax systems.1 I have been involved with the issue of corporate-shareholder 

integration for 25 years. I was intensely involved in the Treasury Department’s 

1992 Report on integration, Taxing Business Income Once, while serving as Deputy 

Assistant Secretary (Tax Policy); I served as a consultant on what became a reporter’s study of integration by Harvard Law Professor Alvin Warren for the American 

Law Institute, published in 1993; and I have published several articles on the subject, co-authored with Professor Warren. 

In the 1990s, when integration came to the fore, domestic tax policy issues were 

of principal concern. These include: (1) the relative treatment of income earned 

through corporations and pass-through entities, (2) the comparative taxation of debt 

and equity finance, (3) the relationship of entity taxation to investor taxation, (4) 

the relative treatment of distributed and retained corporate earnings, and (5) the 

relative treatment of dividend and non-dividend distributions, such as share repurchases. Today, international issues are also important. These include: (1) the relative treatment of domestic and foreign income, (2) differences in the treatment of 

domestic and foreign corporations, and (3) the coordination of domestic and foreign 

taxes. In combination, these domestic and international policy concerns make business tax reform a daunting task. 

As this committee knows, I have long advocated a major restructuring of our Nation’s tax system. The ‘‘Competitive Tax Plan,’’ described in my book 100 Million 

Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United 

States, has five key elements: 

• First, enact a VAT, a broad-based tax on sales of goods and services, now used 

by more than 160 countries worldwide. Many English-speaking countries call 

this a goods and services tax (GST). 

• Second, use the revenue produced by this consumption tax to finance an income 

tax exemption of $100,000 of family income—freeing more than 120 million 

American families from income taxation—and lower the income tax rates on income above that amount. 

• Third, lower the corporate income tax rate to 15 percent. 

• Fourth, protect low-and-moderate-income workers from a tax increase through 

payroll tax cuts. 

• Fifth, protect low- and moderate-income families from a tax increase by substantially expanding refundable tax credits for children, delivered through debit 

cards to be used at the cash register. 

Such a plan has major advantages for the United States, including the following: 

• It would take advantage of our status as a low-tax country, making the U.S. 

a low income-tax country. 

• Most Americans would owe no tax on their savings and all Americans would 

face lower taxes on savings and investments. 

34 

2 Internal Revenue Code section 1(h)(11). 

• Over the longer term, such a tax reform would make the United States a much 

more favorable place for savings, investment, and economic growth, without 

shifting the tax burden down the income scale. 

• The vast majority of Americans would never have to deal with the IRS. 

• By returning the income tax to its pre-World War II role as a relatively small 

tax on a thin slice of high-income Americans, there would be no temptation for 

Congress to use tax breaks as if they are solutions to America’s social and economic problems. We have tried that, and it doesn’t work. 

• Unlike other unique consumption tax proposals (e.g., the Flat Tax; David Bradford’s X-Tax; George W. Bush’s panel’s Growth and Investment Tax), this proposal fits well with existing international tax and trade agreements. 

• A 15% corporate tax rate would solve the problems caused by international tax 

planning by multinational corporations, corporate inversions, and competition 

for corporate investments among nations. 

• By taxing imports and exempting exports, this plan would yield hundreds of billions of dollars for the U.S. Treasury from sales of products made abroad in the 

decade ahead—$600 to $700 billion at current trade levels. 

• During the interval of up to 2 years between enactment and commencement of 

the VAT, Americans would accelerate their purchase of durables, such as cars 

and large appliances, providing a short-term boost to our economy. 

Senator Benjamin Cardin has introduced a progressive consumption tax proposal 

that has much in common with my plan, and I heartily endorse his efforts and his 

Progressive Consumption Tax Act of 2014. 

But such a major restructuring of our Nation’s tax system may not be imminent 

and such a goal need not stand in the way of incremental reforms that could significantly improve our broken tax system. In my view, integration of the corporate and 

shareholder taxes presents an important opportunity for such improvement. Importantly, integration, done right, would move us in the right direction. Indeed a dividend deduction with withholding system of integration could improve our Nation’s 

tax system either as a stand-alone measure or as a part of a more comprehensive 

business tax reform. 

When the Treasury and the ALI considered corporate-shareholder integration 

nearly 25 years ago, their emphasis was on domestic policy concerns—in particular, 

narrowing the income tax advantages for debt over new equity and for retained over 

distributed earnings, while creating greater parity between corporate and partnership taxation. Although reducing or even eliminating these distortions remains important, additional advantages of integration now include its potential to reduce incentives for U.S. multinationals to shift income abroad or to retain earnings abroad. 

Integration could also reduce incentives for U.S. businesses to change their domicile 

to a foreign jurisdiction in an ‘‘inversion’’ transaction and for foreign takeovers of 

U.S. businesses. 

In the 1990s, principally because of its administrative advantages, the Treasury 

Department recommended taxing business income once—at the business level. This 

form of integration was advanced by President George W. Bush in 2003, but Congress instead simply lowered shareholders’ income tax rates on dividends.2 That approach is no longer apt today. Locating the income tax at the shareholder level 

would be more progressive and, given the mobility of business capital and operations, makes much more sense in today’s global economy. 

Simultaneously with the Treasury Report, a reporter’s study by Alvin Warren for 

the American Law Institute (ALI) recommended integrating corporate and shareholder taxes by converting the corporate tax into a withholding levy on income ultimately distributed to shareholders, who would receive a credit for the corporate tax. 

This option was also discussed in the Treasury report. Shareholder-credit integration—also known as imputation-credit integration because corporate taxes are imputed to shareholders as credits—is not a new or untried idea, as there have been 

many years of experience with this form of taxation in developed economies. 

In 2015, a working group of the Senate Finance Committee discussed integration 

of corporate and shareholder taxes by combining a corporate dividend deduction 

with withholding on dividends (U.S. Senate 2015), based on an earlier in-depth staff 

study (U.S. Senate 2014). As emphasized in the various documents released by this 

committee, this combination could retain the advantages of shareholder-credit integration while also reducing effective corporate tax rates. 

35 

3For the Treasury report’s discussion, see U.S. Treasury (1992a), in Graetz amd Warren 

(2014b) at Amazon Location 1771. 

The remainder of my written testimony here is taken from an article on corporateshareholder integration, co-authored with Professor Alvin Warren, to be published 

in the National Tax Journal this fall. We begin with a bit of history; next we describe how a shareholder credit or a dividend deduction with withholding would 

work; then we review some of the major design issues to be considered (including 

extension of withholding to interest) and discuss how integration would address 

those issues. 

A BIT OF HISTORY

If integration offers such promise, why has it not already been enacted? The answer involves a bit of history regarding corporate taxation in Europe, the United 

States, and Australia. 

Shareholder-credit (or imputation) integration was originally developed after 

World War II in Western Europe (Ault 1978, 1992). France, Germany, and the 

United Kingdom, for example, all adopted some variant of the system. 

By 2003, these European countries had all repealed (in form or substance) their 

shareholder-credit systems after decisions by the Court of Justice of the European 

Union (CJEU) suggested that those systems violated European Union treaties 

(Graetz and Warren 2006). Tax policy changes concerning income taxes at the EU 

level require unanimity of the member states, so such changes are extremely rare 

and are typically quite limited in scope. Given that void, the CJEU has become a 

major arbiter of national income tax policies by applying to member state income 

tax laws the fundamental treaty principles that prohibit discrimination against 

cross-border investments and ensure the free movement of capital within the EU. 

Consider a French investor in a German company in an integrated shareholdercredit system. Should Germany refund the credit to a French investor who is not 

otherwise subject to German taxation? Should France give a credit for German corporate taxes that France did not receive? Notwithstanding years of analysis and debate, EU member states were unable to reach unanimous agreement on those questions. That failure left shareholder-credit systems vulnerable to attack under the 

CJEU’s treaty jurisprudence. Several adverse CJEU decisions—unrelated to any underlying tax policy—eventually led to the repeal of shareholder-credit integration 

systems by the national legislatures (Graetz and Warren 2006, 2007). 

Two conclusions emerge from this history. First, shareholder-credit systems have 

been successfully implemented in numerous major economies. Second, the reason for 

their demise in the EU has no relevance for the United States, which obviously is 

not a party to the European treaties and is not subject to the constraints imposed 

by European courts. 

As we have said, integration of corporate and investor taxes was intensively studied in the United States in the 1990s. In January 1992, Treasury published a comprehensive study of integration that discussed several alternative methods of corporate-shareholder integration. (U.S. Treasury 1992a). It analyzed and described, 

but did not recommend, shareholder credits. Instead, Treasury supported an exclusion for dividends as the way to reduce double taxation of corporate income. In 1993, 

the American Law Institute published a comprehensive analysis and proposal for 

shareholder-credit integration in the United States (Warren 1993). 

Neither study proposed extending to corporations a partnership system of directly 

allocating earnings to investors. The complex capital structures of many public companies, along with the frequency and volume of changes in share ownership, make 

such allocation impractical.3

Congress eventually acted in 2003 and reduced shareholder tax rates, rather than 

accepting the exclusion of dividends then recommended by Treasury. This approach 

left in place the separate corporate tax at the rate of 35 percent. 

Remarkably (and contrary to the original 1992 Treasury study), the 2003 legislation reduced shareholder tax rates even on dividends that have not been subject to 

taxation at the corporate level. Reducing the shareholder tax on dividends that have 

not borne corporate tax is not a coherent approach to rationalizing the tax burden 

on corporate income. That approach provides a tax benefit for high-income shareholders on income that may not have borne any corporate-level tax. 

36 

4See, for example, Liu and Altshuler (2013), Cronin et al. (2013), and Altshuler, Harris, and 

Toder (2010). 5Thirty-five percent plus 23% tax on $65 dividend equals 54.47%. 

6Thirty-five percent plus 30% withholding on $65 dividend equals 54.5%. 

Whatever the merits of the 2003 legislation at the time, it is no longer a sensible 

component of a system of business and investment taxation in the world of international competition now faced by American companies. Given the ability of multinational corporations to create new entities in low-tax jurisdictions, to shift items 

of income and deduction among countries to obtain tax advantages, and even to 

change the residence of the parent company, it is the corporate, not the shareholder, 

rate that needs to be reduced today. Shareholder residence is far less mobile than 

corporate income. In addition, because economists now agree that some portion of 

the corporate tax is borne by labor (although they disagree over how much), shifting 

income tax from the corporate to the shareholder level could increase the progressivity of the tax system.4 Locating the ultimate business tax at the shareholder level 

could therefore be both more efficacious and more progressive than the current system (Altshuler, Harris, and Toder 2010). 

In the 1990s, most U.S. corporate managers did not favor shareholder-credit integration. They generally preferred a tax reduction for retained rather than distributed earnings and were particularly interested in preserving certain tax preferences, 

which might have been eliminated on payment of dividends under shareholdercredit integration (Arlen and Weiss 1995). Today, most of these preferences seem 

certain to be eliminated or reduced in any business tax reform, and it is the high 

U.S. corporate tax rate that most concerns corporate management. 

The potential of shareholder-credit integration for business tax reform in the 

United States is demonstrated by considering briefly the experience in Australia, 

which for many years has combined territorial taxation for its companies with a 

shareholder credit for dividends (Vann 2013). The credit is generally refundable to 

Australian resident individuals and to pension funds (which are usually taxable at 

lower rates than individuals in Australia). Individuals and pension funds are significant holders of shares in Australian companies, so Australian corporations distribute a large proportion of their profits as dividends with shareholder credits attached. Because Australia allows no shareholder credits for foreign corporate taxes, 

Australian companies have considerably less incentive to shift corporate taxable income abroad than under the current U.S. system. The result is a corporate tax that 

operates both as a final tax on foreign investors and as a withholding tax on Australian investors. A recent study of European and Australian shareholder-credit systems found that erosion of the domestic corporate tax base increased in European 

countries after repeal of imputation, while such erosion has decreased under the 

Australian integration system (Amiram, Bauer, and Frank, 2014). While the American and Australian economies are obviously different, the Australian experience offers important evidence that shareholder credits can be both practical and beneficial. 

HOW INTEGRATION BY A SHAREHOLDER CREDIT OR A DIVIDEND DEDUCTION

WITH WITHHOLDING WOULD WORK

Present Law 

Let us briefly describe present Federal law. If a U.S. corporation earns $100 of 

domestic taxable income and distributes its after-tax income as a dividend to its 

shareholders, the corporation will owe corporate tax of 35%. A taxable individual 

shareholder in the top bracket will owe 23.8% tax on the dividend, and a foreign 

shareholder would owe from zero to 30%, depending on its circumstances and any 

relevant tax treaties. A tax-exempt domestic shareholder, of course, would owe no 

tax on the dividend. In combination, the current tax burden is 35% for the tax-exempt shareholder, 50.5% for the taxable U.S. individual,5 and from 35% to 54.5% 

for foreign shareholders.6 By comparison, partnerships will owe no entity-level tax 

on business income, and taxable individual partners who materially participate in 

the business will be taxed at a top rate of 39.6% on the partnership’s income. Tax 

exempt organizations will not be taxed (unless the income is subject to the unrelated business income tax of 35% which often can be avoided). Foreign partners will 

pay tax at the U.S. rate (up to 39.6%), perhaps with a credit against their domestic 

taxes. In 2011, 54.2% of U.S. business income was earned by partnerships (or other 

pass-through entities) compared to 20.7% in 1980 (Cooper et al., 2015). Today, only 

37 

7The 1992 Treasury Report and the ALI proposal included recommendations for dividend reinvestment plans that, in effect, would have extended the benefits of integration to retained 

earnings. See U.S. Treasury Department (1992a), in Graetz and Warren (2014b) at Amazon Location 3273 and Warren(1993), in Graetz and Warren (2014b) at Amazon Location 10451. President Bush’s 2003 dividend exclusion recommendation also included such a feature but it was 

widely criticized for its complexity and not adopted by Congress. A discussion of the recommendation can be found in Joint Committee on Taxation (2003). For analysis of the opposition see Sullivan (2005). 

about 25% of U.S. corporate stock is held in individuals’ taxable accounts. (Austin, 

Berman, and Rosenthal, 2014). 

Shareholder-Credit Integration 

Under shareholder-credit integration, the corporate tax is essentially converted 

into a withholding tax that is creditable against the shareholder tax due on dividends. By way of example, assume that the corporate tax rate is 35 percent and 

dividends are taxed as ordinary income. A company that earns $100 of income 

would pay $35 in corporate tax, leaving $65 for distribution as a dividend. Assume 

now that a $65 cash dividend is paid to a domestic shareholder whose individual 

tax rate is, alternatively, 20 percent, 25 percent, or 40 percent. Individual shareholders would include $100 in their taxable income (just as employees include prewithholding wages in income), apply their normal tax rate, and, assuming that the 

credit is refundable, offset the resulting tax by a credit for the $35 corporate tax 

(just as employees receive a credit for taxes withheld by their employers). 

As shown in Table 1 below, the result would be that the ultimate tax burden 

would be the same as if the shareholders had earned the business income directly: 

Table 1. $65 Cash Dividend Out of $100 Corporate Income After $35 Corporate Tax Payment 

Shareholder tax rate 20% 25% 40% 

1. Shareholders’ taxable income 100 100 100 

2. Initial tax 20 25 40 

3. Tax credit (35% x line 1) 35 35 35 

4. Final tax or refund (line 2Øline 3) Ø15 Ø10 5 

5. Net shareholder cash ($65Øline 4) 80 75 60 

As this example illustrates, a refundable shareholder credit would incorporate the 

entity-level business tax into the graduated individual income tax. The resulting integration of the two taxes would advance the goal of ultimately taxing income, from 

whatever source derived, at an individual’s personal tax rate, thereby reducing the 

differences in partnership and corporate taxation described above. 

If no refunds of imputation credits were allowed, corporate income would be taxed 

at the 35% corporate rate (as under present law), unless the individual shareholder’s rate is higher, in which case the higher rate would apply. As Table 2 shows, 

an integrated tax at the highest current individual rate would be lower than the 

combined corporate and shareholder taxes of present law, even given the current 

low rate applied to dividends. 

Dividend Deduction Integration With Withholding 

When integration has been proposed for the United States in the past, corporate 

managers have been unenthusiastic—in part because integration proposals have 

largely benefited only distributed earnings.7 Some corporate managers have preferred a dividend deduction, which would permit corporations to deduct dividends 

when paid. By directly reducing corporate taxes and thus a company’s tax expense 

for financial reporting purposes, a dividend deduction could have the effect of reducing effective corporate tax rates and thereby increasing a company’s earnings per 

share. 

The Treasury and the ALI Reports rejected dividend-deduction integration because it would automatically extend the tax reductions of integration to foreign and 

exempt shareholders. However, by coupling a deduction for dividends with withholding on dividends, results can be achieved that combine the benefits of shareVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00041 Fmt 6601 Sfmt 6621 R:\DOCS\25795.000 TIMD
38 

holder-credit integration with reduction of effective corporate tax rates. (U.S. Senate 

2014, 2015). The withholding credits in this case would fulfill the same function as 

imputation credits and, if nonrefundable, would eliminate the automatic tax reduction for foreign and exempt shareholders that would occur with a deduction for dividends without withholding. This, of course, would also reduce the revenue cost of 

integration. 

In addition, a deduction for dividends of domestic earnings could serve as a full 

or partial substitute for rules directly limiting erosion of the U.S. corporate income 

tax base and for rules explicitly directed at curtailing or prohibiting corporate inversions (Sullivan 2016a, 2016b). A dividend deduction would also permit U.S. multinationals to repatriate foreign earnings to the United States free of any residual 

U.S. corporate tax when those earnings were distributed as dividends to shareholders. 

To demonstrate how a dividend deduction with withholding might achieve results 

similar to shareholder-credit integration, we consider a corporation that earns $100 

and distributes $30 of cash as a dividend to its shareholders. Table 2 shows the results under present law, shareholder-credit integration, and a dividend deduction 

with withholding for a top bracket individual U.S. shareholder. 

Table 2. Comparison of Present Law, Shareholder Credit, and Dividend Deduction 

With Withholding Cash Dividend of $30 

Assumptions: Corporate and withholding tax rates are 35%. Shareholder tax rate is 20% under current law and 40% with a 

shareholder credit or dividend deduction. The corporation receives $100 in taxable income and pays a cash dividend of 

$30 (i.e., a dividend that reduces corporate cash by $30 and increases shareholder cash by $30). 

Taxpayer Present Law Imputation 

credit 

Dividend 

deduction and 

withholding tax 

CORPORATION 

1. Taxable income before dividend $100.00 $100.00 $100.00 

2. Corporate tax before dividend $35.00 $35.00 $35.00 

3. Corporate cash before dividend $65.00 $65.00 $65.00 

4. Declared dividend $30.00 $30.00 $46.15 

5. Corporate tax to be imputed to shareholder (35/65 x line 4) NA $16.15 NA 

6. Dividend withholding (35% x line 4) NA NA $16.15 

7. Tax reduction due to dividend deduction (35% x line 4) NA NA $16.15 

8. Total corporate tax (line 2Øline 7) $35.00 $35.00 $18.85 

9. Remaining corporate cash (line 3Øline 4 + line 7) $35.00 $35.00 $35.00 

10. Reduction in corporate cash (line 3Øline 9) $30.00 $30.00 $30.00 

11. Effective corporate tax rate * (line 8/line 1) 35% 35% 18.85% 

U.S. SHAREHOLDER 

12. Cash dividend (line 4Øline 6) $30.00 $30.00 $30.00 

13. Taxable dividend (line 4 + line 5) $30.00 $46.15 $46.15 

14. Shareholder tax before imputation or withholding credit $6.00 $18.46 $18.46 

15. Imputation or withholding credit (line 5 or 6) 0 $16.15 $16.15 

16. Net shareholder tax (line 14Øline 15) $6.00 $2.31 $2.31 

17. Net shareholder cash (line 12Øline 16) $24.00 $27.69 $27.69 

COMBINED CORPORATE AND SHAREHOLDER TAXES 

18. Total tax (line 6 + line 8 + line 16) $41.00 $37.31 $37.31 

19. Corporate tax on distributed income [(35/65 x line 10)Øline 7] $16.15 $16.15 0 

20. Shareholder tax on distributed income (line 16 + line 6) $6.00 $2.31 $18.46 

21. Total tax on distributed income (line 19 + line 20) $22.15 $18.46 $18.46 

22. Pre-tax distributed income (line 10/.65) $46.15 $46.15 $46.15 

23. Total effective tax rate on distributed income * (line 21/line 22) 48% 40% 40% 

* Assumes book and taxable income are the same. 

As Table 2 illustrates, identical results can be reached under a shareholder credit 

and a dividend deduction with withholding. There are, however, several important 

differences in the characterization of those results even when they are identical. Notice first that the declared dividend under the deduction in Table 2 is higher, because it includes the withholding tax of $16.15. As compared to the shareholder 

credit, the dividend deduction reduces the ‘‘corporate’’ tax to $18.85. The company’s 

effective tax rate would therefore be 18.85% (assuming that book income also equals 

$100), rather than 35% under the imputation credit. In both cases, the government 

39 

receives total payments from the corporation of $35 and a total 40% tax on the distributed earnings, but, as shown in lines 6, 16 and 19, those amounts are classified 

differently, as among corporate, withholding, and shareholder taxes. 

Table 2 illustrates the proposal for the dividend deduction with withholding under 

discussion in the Senate Finance Committee, given a corporate and withholding tax 

rate of 35%. The proposal is, of course, fully compatible with other rates. Table 2 

displays the results for a declared dividend of $46.15. To explore further how such 

a system would work, Table 3 displays the results for a similar analysis for a declared dividend of $30. Once again, identical results could be obtained under a 

shareholder credit, but some of the elements of those results would be characterized 

differently. 

Table 3. Comparison of Present Law, Shareholder Credit, and Dividend Deduction 

With Withholding Deductible Dividend of $30 

Assumptions: Corporate and withholding tax rates are 35%. Shareholder tax rate is 20% under current law and 40% with a 

shareholder credit or dividend deduction. The corporation receives $100 in taxable income and pays a cash dividend of 

$19.50 (i.e., a dividend that reduces corporate cash by $19.50 and increases shareholder cash by $19.50). 

Taxpayer Present Law Imputation 

credit 

Dividend deduction and 

withholding tax 

CORPORATION 

1. Taxable income before dividend $100.00 $100.00 $100.00 

2. Corporate tax before dividend $35.00 $35.00 $35.00 

3. Corporate cash before dividend $65.00 $65.00 $65.00 

4. Declared dividend $19.50 $19.50 $30.00 

5. Corporate tax to be imputed to shareholder (35/65 x line 4) NA $10.50 NA 

6. Dividend withholding (35% x line 4) NA NA $10.50 

7. Tax reduction due to dividend deduction (35% x line 4) NA NA $10.50 

8. Total corporate tax (line 2Øline 7) $35.00 $35.00 $24.50 

9. Remaining corporate cash (line 3Øline 4 + line 7) $45.50 $45.50 $45.50 

10. Reduction in corporate cash (line 3Øline 9) $19.50 $19.50 $19.50 

11. Effective corporate tax rate* (line 8/line 1) 35% 35% 24.5% 

U.S. SHAREHOLDER 

12. Cash dividend (line 4Øline 6) $19.50 $19.50 $19.50 

13. Taxable dividend (line 4 + line 5) $19.50 $30.00 $30.00 

14. Shareholder tax before imputation or withholding credit $3.90 $12.00 $12.00 

15. Imputation or withholding credit (line 5 or 6) 0 $10.50 $10.50 

16. Net shareholder tax (line 14Øline 15) $3.90 $1.50 $1.50 

17. Net shareholder cash (line 12Øline 16) $15.60 $18.00 $18.00 

COMBINED CORPORATE AND SHAREHOLDER TAXES 

18. Total tax (line 6 + line 8 + line 16) $38.90 $36.50 36.50 

19. Corporate tax on distributed income [(35/65 x line 10)Øline 7] $10.50 $10.50 $0 

20. Shareholder tax on distributed income (line 16 + line 6) $3.90 $1.50 $12.00 

21. Total tax on distributed income (line 19 + line 20) $14.40 $12.00 $12.00 

22. Pre-tax distributed income (line 10/.65) $30.00 $30.00 $30.00 

23. Total effective tax rate on distributed income * (line 21/line 22) 48% 40% 40% 

* Assumes book and taxable income are the same. 

In this example, with a smaller dividend deduction of $30, the corporation’s effective tax rate would be 24.5%. The amount withheld would be 35% of the dividend 

or $10.50. An individual shareholder in the 40% bracket would include $30 in income, owe $12 of tax and receive credit for the $10.50 withheld, paying a total of 

40% on the pre-tax dividend of $30. Again, the total corporate and withholding taxes 

equal 35% of the company’s income. 

Notice that in both of the dividend deduction examples of Tables 2 and 3, the total 

taxes collected from the corporation on its $100 of earnings are the same: in the 

first case, $18.85 as corporate tax and $16.15 of withholding tax for a total of $35, 

and in the second case a corporate tax of $24.50 and $10.50 of withholding, again 

for a total of $35. The individual shareholder’s taxes are different: the shareholder 

owes a residual tax of $2.31 in the first case and $1.50 in the second. The individual 

shareholder’s after-tax cash is also different in the two cases: $27.69 in the first case 

and $18.00 in the second. This reflects the fact that the corporation pays a pre-tax 

dividend of $46.15 in the first case and of $30.00 in the second, a difference that 

also shows up in greater retained earnings by the corporation in the second case. 

40 

8 A subsequent version of a dividend exclusion proposed by Treasury includes some passthrough of corporate preferences (U.S. Treasury, 1992b). 9 A corollary to this treatment would be that unused deductions for dividends out of untaxed 

income should not be added to corporate net operating loss carryovers. 

Together these two examples show that a corporation may achieve results equivalent to a shareholder credit if it increases its declared dividend by the amount of 

withheld taxes. If it does not increase the declared dividend by that amount, both 

its retained earnings and its corporate tax rate will be higher. The key point for 

our purpose here is to demonstrate the close relationship between a shareholder 

credit and a dividend deduction with withholding. 

Either of these two integration methods offers a promising approach for mitigating the distortions of present law described in our introduction. As illustrated in 

these examples, the tax burden on income received by individual investors would 

become less dependent on the form of business organization. The discontinuities between debt and equity finance, between retention and distribution of earnings, and 

between different forms of distributions would also be mitigated. Moreover, as in the 

Australian system, the incentives for corporations to shift their income or their 

domicile abroad could be reduced. 

The real world is considerably more complicated than these introductory examples, so a number of important design issues would have to be addressed, including 

the treatment of corporate income that has not borne U.S. corporate tax, retained 

earnings, tax-exempt shareholders, foreign income, foreign shareholders, distributions other than dividends (such as share repurchases), and interest payments. As 

described below, substantial work has already been done on addressing these issues. 

SOME MAJOR DESIGN ISSUES

Adoption of a shareholder credit or a dividend deduction with withholding has the 

potential for rationalizing and simplifying the taxation of business income. Like any 

significant reform of corporate taxation, such a change raises a series of design 

issues. The most important of these issues have been extensively analyzed in the 

ALI and Treasury studies, which were recently republished in electronic form 

(Graetz and Warren 2014b), as well as in the recent Senate Finance Committee 

studies (Senate Finance Committee 2014, 2015). Here we are able only to sketch the 

major design issues and describe some potential resolutions. The key point is that 

integration provides a very flexible framework for addressing the major tax policy 

issues regarding domestic and international corporate taxation. 

Untaxed Corporate Income 

How would integration take account of the fact that some corporate income is distributed to shareholders without bearing a full corporate tax? There are two basic 

approaches. The first would apply at the corporation level, so that shareholder treatment would not depend on whether the dividend had borne corporate tax. For example, the ALI report follows the approach of some previous European systems in requiring a compensatory corporate tax if untaxed income is distributed to shareholders. Similarly, a dividend deduction could be limited to undistributed corporate 

taxable income (Senate Finance Committee, 2014). 

A different approach, which would apply at the shareholder level, was recommended in the 1992 Treasury report (U.S. Treasury 1992a). Instead of requiring 

a withholding tax on any dividends paid by the corporation, individual taxpayers 

would be allowed to treat dividends as taxable or nontaxable, based on a statement 

from each corporation regarding the amount of its dividends that had borne corporate tax. This is similar to the law in Australia and New Zealand. Such a system 

would require a corporate-level account to keep track of what income has borne corporate taxes. 

Both of the foregoing approaches would prevent pass-through of corporate tax 

preferences to shareholders, If, on the other hand, Congress wanted to pass certain 

tax preferences through to shareholders, it would be possible to allow certain dividends to be free of corporate tax. The ALI report describes a method to accomplish 

this result, although neither the ALI report nor the Treasury report recommended 

doing so. The Treasury report explicitly rejected passing through corporate tax preferences to shareholders, which current law avoids, principally on the ground that 

allowing individuals to take advantage of corporate tax preferences would produce 

a large revenue loss that would have to be offset by raising other taxes.8 By requiring that withholding applies to every dividend distribution, the proposal under discussion in the Senate Finance Committee reaches a similar result.9 The major disVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00044 Fmt 6601 Sfmt 6621 R:\DOCS\25795.000 TIMD
41 

10Whether or not there was multiple taxation would depend in part on the availability of offsetting capital losses in the future. See the discussion in Part 3 of Warren (1993), in Graetz 

and Warren (2014b) at Amazon Location 10309. 11For an overview of the proposal including the DRIP option, see Burman and Rohaly (2003). 12For more, see the discussion in Part 6, Proposal 9 in Warren (1993), and in Graetz and Warren (2014b) at Amazon Location 10906. 

advantage of not allowing individual shareholders the benefit of corporate tax preferences would be a continued difference in the treatment of corporate and noncorporate businesses in this regard. 

Retained Earnings 

Under a shareholder credit or a dividend deduction with withholding, retained 

corporate earnings raise two problems. First, even if withholding credits are refundable, shareholders whose marginal tax rates are below the corporate tax rate would 

be disadvantaged by such retentions. Corporate earnings would compound at the 

lower after-corporate-tax rate of return, potentially creating an incentive to distribute earnings. Making credits nonrefundable would increase the disadvantage to 

lower-bracket shareholders. 

Second, taxation of shareholder capital gains due to retained corporate earnings 

could, as under current law, in some cases constitute multiple taxation of the same 

gain.10 It is sometimes suggested that the second problem could be addressed by retaining preferential taxation of gains on corporate stock, but such a preference 

would be overbroad, because not all gains on corporate stock are due to taxable retained corporate earnings. 

The ALI and Treasury addressed both problems by providing for constructive dividend and reinvestment plans, which are sometimes identified by the acronym DRIP. 

Under such an option, corporations could make tax credits available to shareholders 

without the necessity of a cash distribution. The corporation could elect to treat retained earnings as if they had been paid to shareholders as dividends and immediately recontributed as equity to the corporation. The increase in shareholder basis 

resulting from the constructive reinvestment would eliminate the possibility of double taxation on sale of the stock. The Treasury recommended a DRIP option in its 

2003 dividend exclusion proposal, but Congress rejected the idea.11

Exempt Shareholders and Creditors 

Current law taxes corporate income without regard to the tax status of shareholders, so tax-exempt suppliers of corporate capital, such as charitable endowments 

and pension funds, do not now necessarily receive their share of corporate income 

free of tax. The portion of corporate income distributed to such investors is sometimes taxed (due to the corporate tax on income distributed as dividends) and sometimes is not (due to the corporate deduction for interest payments and to corporate 

preferences for some dividends). Since one of the goals of integration is to reduce 

such discontinuities, any system of integration will necessarily affect tax-exempt 

shareholders. Neither the ALI report (Warren 1993), the Treasury report (1992a), 

nor the dividend deduction proposal under discussion in the Senate Finance Committee recommends elimination of taxation of corporate-source income attributable 

to tax-exempt investors. Indeed, none of these proposals recommends refunding 

withholding taxes to such investors unless an explicit tax is imposed on their income. 

The approach of the ALI report is to subject entities that are nominally exempt 

under current law to a tax on investment income, subject to shareholder (and debtholder) withholding and credits, with any excess credits potentially refundable. This 

would maintain a single level of tax on corporate income received by such investors, 

at whatever rate Congress deems appropriate, and could serve to eliminate taxinduced distortions between debt and equity. The rationale for this proposal is that 

the rate of tax on income from corporate investment received by exempt entities 

should be uniform and explicitly determined as a matter of tax policy. (Warren 

1993).12 The tax rate on tax-exempt investors might be set to maintain a similar 

amount of revenue as is currently collected on corporate income attributable to exempt shareholders, to increase that amount, or to decrease it. 

The Treasury report (1992a) also discusses a uniform tax on tax-exempt investors’ 

investment income along similar lines, but does not propose such a tax, probably 

because the Treasury did not regard that tax as politically viable. The Treasury report estimated that in 1992 a uniform tax of 6 to 8 percent would have approximated the tax burden on investment income received by tax-exempt shareholders 

($29 billion in 1992, or about a third of corporate tax revenue). 

42 

13See Part 7 in Warren (1993), available in Graetz and Warren (2014b) at Amazon Location 

10959. 14See the discussion in Chapter 7 in U.S. Treasury (1992a), in Graetz and Warren (2014b) 

at Amazon Location 2853. 15 A subsequent Treasury recommendation proposed unilateral pass-through of some foreign 

tax credits to U.S. shareholders, presumably in an effort to make the proposal more attractive 

to U.S. multinational corporations (U.S. Treasury 1992b). 

International Income 

Under the current classical tax system and longstanding treaty practice, taxes on 

corporate income are collected primarily by the source country, while taxes on interest and dividends are collected primarily by the investor’s country of residence (Ault 

1992). Integration of the corporate and individual taxes generally shifts taxes from 

corporations to shareholders and in some cases might undermine this historical division completely by collapsing the two levels of tax into one. The trend in Europe, 

after the collapse of integration systems due to decisions of the CJEU has been to 

reduce corporate tax rates and make up for the revenue lost through higher income 

or consumption taxes on individuals. 

Two important international questions must be considered in designing an integration system for the United States. First, what should be the extent of U.S. taxation of U.S. corporate income paid to foreign investors and parent companies? Second, how should foreign taxes paid by U.S. companies or their subsidiaries on foreign income affect the U.S. taxation of U.S. shareholders on distribution of those 

earnings? Resolution of these issues is complicated by the existence under current 

law of nonrefundable ‘‘withholding’’ taxes on U.S. dividends and interest paid to certain foreign recipients. These taxes theoretically substitute for the income tax applicable to domestic recipients of such income, but are generally eliminated or reduced 

to low levels by bilateral income tax treaties or by statute. 

The approach of the ALI report with respect to foreign parent companies and investors is similar to that for domestic exempt investors. Foreign parents and investors would be subject to a new withholding tax on their U.S. investment income and 

would receive potentially refundable integration credits. This tax would replace the 

current nonrefundable withholding tax, which applies to some, but not all, U.S. corporate income distributed abroad. The rationale for this proposal is again to make 

the rate of tax on U.S. income uniform and explicitly determined as a matter of U.S. 

tax policy, first by legislation and then through treaty negotiation.13 The uniform 

tax developed in the ALI report would be an innovation in international taxation 

and would therefore require discussion and perhaps coordination with our trading 

partners. The Treasury report considered the possibility of a uniform tax on foreign 

parent companies and investors along these lines, but ultimately concluded that 

such changes should not be made legislatively by the United States. The Treasury 

recommended instead that withholding be imposed on dividends paid to foreign 

shareholders but not refunded to them except by treaty, thereby preserving our bargaining power in treaty negotiations with our trading partners.14 The dividend deduction under discussion in the Senate Finance Committee also imposes withholding 

taxes on dividends paid to foreign shareholders and does not provide for refunds. 

With respect to foreign income of U.S. companies, shareholder-credit integration 

is compatible with either the traditional U.S. foreign tax credit or replacement of 

the credit with an exemption for dividends paid to U.S. parents out of their subsidiaries’ foreign business income. The Senate Finance Committee proposal for a dividend deduction with withholding is also designed to be compatible with either a tax 

credit or exemption for foreign income. 

If the U.S. were to adopt integration and retain a foreign tax credit, conversion 

of the U.S. corporate tax into a withholding tax would pose the question whether 

credits for foreign taxes paid by U.S. companies should be passed through to U.S. 

shareholders on distribution of dividends out of the foreign income. Passing through 

foreign taxes would be approximated under the ALI report with considerably less 

complexity by treating an appropriate amount of corporate foreign income as tax exempt when distributed as dividends. As with the recommendation regarding foreign 

investors, this proposal could be limited to income from countries that agreed to reciprocal treatment for U.S. shareholders. The Treasury report discusses the possible 

pass-through of foreign tax credits, but concludes that the U.S. should not after such 

a change unilaterally. The Treasury estimated that allowing foreign tax credits to 

offset the single level of tax in an integrated system would in 1992 have entailed 

a revenue loss of $17 billion a year, or 19 percent of corporate tax revenues.15

43 

16See Part 4, Proposal 7 in Warren (1993), in Graetz and Warren (2014b) at Amazon Location 

10667. 17We are indebted to Peter Merrill for this point. 

Limiting shareholder credits to the amount of U.S. corporate taxes paid on income 

distributed as dividends has the advantage of reducing incentives of dividend-paying 

U.S. corporations to shift their income from the United States to lower tax foreign 

jurisdictions. In Australia, this ‘‘integrity’’ benefit of integration is important (Australian Government, 2015). As described above, this limitation can be achieved either by maintaining a taxes-paid account or by imposing withholding on all dividend 

distributions. Limiting the allowance of dividend deductions to U.S. taxable income 

would decrease the incentive for U.S. corporations to re-domicile to a foreign jurisdiction, although such a limitation might raise issues under the nondiscrimination 

provisions of our income tax treaties (Verlarde and Basu 2016), (Herzfeld 2016), 

(Sullivan 2016b). 

Nondividend Distributions 

There are a variety of transactions other than dividends by which corporate income may be distributed to shareholders, including repurchases by a corporation of 

its stock, purchases by one corporation of the stock of another corporation from noncorporate shareholders, and payments in liquidation. Under current law, the tax 

treatment of such nondividend distributions to individuals can be less onerous than 

that of dividends, because selling shareholders benefit from basis recovery. Since 

2003, qualified dividends have been taxed at capital gains rates, but under either 

an imputation credit or a dividend deduction with withholding, the rationale for this 

preferential treatment of dividends (reduction of double taxation) would disappear, 

so the regular individual income tax rates should apply to dividends. 

The principal tax policy issue presented by nondividend distributions in the design of an integration system is whether any of the benefits of integration should 

be available for such distributions in order to achieve neutrality with dividends. The 

ALI report recommended that nondividend distributions should carry out some 

shareholder credits to approximate parity with dividends.16 To the contrary, the 

Treasury report concluded that no change in the current law treatment of nondividend distributions would be necessary, because the incentive to engage in such distributions would be reduced under integration (U.S. Treasury, 1992a). 

Under the proposal under discussion in the Senate Finance Committee illustrated 

in Tables 2 and 3, the dividend deduction could increase reported earnings per 

share, if the accounting authorities classified withholding as shareholder, rather 

than corporate, taxes. Companies that used share repurchases under current law to 

increase earnings per share might therefore find the current law advantage of share 

repurchases over dividends reversed, even with dividends taxed at ordinary income 

rates and the capital gains preference retained for repurchases.17

Debt 

An important goal of integration is to reduce the differential income tax treatment 

of corporate equity and debt. Equivalent treatment would be achieved under the 

ALI report (Warren, 1993) by imposing a withholding tax on corporate interest payments. The proposal under discussion in the Senate Finance Committee might also 

include a withholding tax on certain interest payments. The withholding credit for 

interest would then function in the same manner as a shareholder or withholding 

credit for dividends. However, as discussed above (and recommended in the ALI report), achieving equivalence for debt and equity for tax-exempt and foreign investors 

under such a system requires imposing a separate tax on their U.S. investment income. 

In the absence of a tax on U.S. investment income of tax-exempt organizations 

and foreign shareholders (coupled with refundability of the withholding tax on interest), extending withholding to corporate suppliers of debt financing could raise serious economic concerns. If, for example, nonrefundable withholding on interest applied only to corporate debt, portfolio shifts by foreigners and tax-exempt investors 

might occur. Corporate interest payments would be subject to a nonrefundable withholding tax, but interest paid by the Treasury bonds, by banks or other financial 

institutions, or by foreign corporations would not bear such a tax. In such a case, 

foreigners and tax exempt investors would likely prefer debt not subject to withholding since they would receive no benefit from credits for withheld taxes. 

A less disruptive option might be to deny deductions for all or part of interest payments at the corporate level. This could avoid the kinds of portfolio realignments 

44 

18See Internal Revenue Code sections 163(j) and 385, as well as U.S. Treasury (2015, 2016). 

See also the discussion in the OECD’s early BEPS discussion draft for a similar proposal 

(OECD, 2014). 

that might accompany nonrefundable withholding on interest and could be achieved 

in a number of ways, including by tightening the provisions of current law regarding 

interest deductibility.18 A full deduction for dividends with withholding, coupled 

with limited deductions for interest without withholding, might seem an odd combination, but it might achieve a better balance of incentives for debt and equity finance than current law while avoiding potential disruptions in the debt markets. 

Noncorporate Taxpayers 

By relieving the double corporate tax, integration would reduce the current law 

advantages of operating in partnership or other noncorporate form. As we have emphasized, however, in the absence of a new tax applicable to tax exempt or foreign 

shareholders, integration with nonrefundable withholding would preserve an advantage for investments in noncorporate entities by tax exempt and foreign investors. 

The growth in businesses organized outside of corporate form in the quarter century 

since the Treasury and ALI reports suggests eliminating the distinction between 

corporate and noncorporate business entities, at least for businesses of a certain 

size. Absent such a change, an alternative would be to extend nonrefundable withholding to noncorporate income, but none of the proposals have yet advanced such 

a recommendation. Thus, integration seems likely to reduce, but not eliminate, differences in the taxation of corporate and noncorporate entities. 

We have discussed integration here in the context of present law, with its 35- 

percent rate and foreign tax credit, rather than assuming a lower rate and an exclusion for dividends paid to a U.S. parent from a foreign subsidiary. But, as previously 

discussed, either a shareholder credit or a dividend deduction with withholding is 

fully compatible with a territorial system of taxing foreign source income or a lower 

corporate rate. The magnitude of the distortions of current law would of course be 

reduced as the corporate rate is lowered. 

CONCLUSIONS

In the absence of another revenue source that would permit a drastic reduction 

in the corporate tax rate (see, e.g., Graetz, 2010), we continue to believe that a 

shareholder credit or a dividend deduction with withholding provides an important 

avenue for corporate tax reform today. Depending on a series of design decisions to 

be made, transforming the corporate tax into a withholding levy would reduce or 

eliminate the vexing domestic and international tax distortions with which we 

began this testimony. To be sure, the integration framework does not eliminate all 

the problems of current law, such as international transfer pricing, but it is fully 

consistent with additional measures to address such problems (Wells 2016). Foreign 

experience has shown that a shareholder credit can be effectively implemented in 

a major economy, and significant work has already been done on designing a shareholder credit or a dividend deduction with withholding for the United States. 

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Business Tax Reform: An Update (April 2016). 

PREPARED STATEMENT OF HON. ORRIN G. HATCH, 

A U.S. SENATOR FROM UTAH

WASHINGTON—Senate Finance Committee Chairman Orrin Hatch (R–Utah) today 

delivered the following opening statement at a hearing to examine corporate integration, and specifically, how allowing corporations to deduct dividends could create 

a more efficient and fairer system of taxation of corporate profits: 

I’d like to welcome everyone here this morning. 

Even a cursory examination of the business tax system demonstrates clearly the 

problems that arise from our out-of-step corporate tax, which contributes significantly to our anti-competitive business climate and leads sophisticated tax planners 

to engage in costly efforts—which some would call gamesmanship or tax avoidance—to either minimize their taxes or manage competitive tax pressures from 

abroad. Without significant reforms to the corporate tax system, we will continue 

to see an erosion in our overall tax base along with diminished growth and investment. 

Among the most significant—and inexplicable—inefficiencies in our business tax 

system is the fact that a significant portion of U.S. business income is taxed more 

than once. Under the current system, income earned only once by corporations—on 

behalf of its shareholders—is taxed twice, thanks to a fiction created in the law that 

treats a business and its owners as two separate, taxable entities. 

Specifically, when a corporation turns a profit, those earnings are taxed under the 

corporate income tax system, generally at a rate of 35 percent. When the corporation distributes a portion of those earnings to its shareholders in the form of dividends, we tax those earnings a second time at the individual level, with a maximum 

dividend tax rate approaching 25 percent. This, put simply, is a problem. 

We have this problem, in large part, due to the fact that rules for taxing corporations were written without taking into account the rules for taxing individuals, and 

vice versa. A better, more efficient system would be one that integrated the taxation 

of corporate and individual income. 

47 

That’s what we’re here to discuss today. 

The current system of double taxation has resulted in a number of unintended 

economic distortions that wouldn’t exist under a more integrated system. I’ll discuss 

just a few of those distortions here this morning. 

For example, the current system creates a bias in the choice of business entity, 

disfavoring the corporate model versus others. Of course, businesses—small and 

start-up businesses in particular—should have the flexibility to determine how to 

organize themselves. But, our tax code shouldn’t punish any particular business 

with double taxation simply because it was organized a certain way. 

Double taxation also discourages savings and investment and is a major factor in 

our current domestic savings and investment shortage. Savings and investment are 

essential to capital formation, increased job productivity, wage growth, and adequate retirement savings. Yet, we’ve created a system that essentially punishes 

those who save and invest. 

In addition, the current system explicitly favors debt-financed investment over 

equity-financed investment. In the United States, corporations can deduct interest 

paid to bond holders, but no similar deduction exists for dividends paid to stockholders. Now, in some situations, there may be strong reasons for a company to opt 

for debt-financing, but there is no real reason why the tax code should favor debt 

over equity. 

Double taxation also contributes to the problem of lock-out; that is, it discourages 

businesses from bringing income earned overseas back into the U.S. As many have 

already noted, with the highest corporate tax rate in the developed world, American 

multinational companies are often loath to repatriate their foreign earnings and 

subject them to U.S. taxes on top of the taxes they’ve already paid in foreign jurisdictions. And, their shareholders rarely demand that they do so, because those earnings will be taxed again if and when they are ever paid out as dividends. As a result, experts estimate that U.S. corporations have over $2 trillion in earnings that 

are locked out of the United States due, in large part, to our tax system. 

These problems—and there are many others—have been observed for years. And, 

as a result, many have argued for the elimination of double taxation and in favor 

of integrating the individual and corporate tax systems. We’re going to continue that 

discussion here today. 

In any discussion of an integrated system, the fundamental design choice that has 

to be made is whether the single instance of taxation should fall on the corporation 

or the shareholders. Given the substantial burdens our corporate tax system already 

imposes on U.S. businesses, coupled with the relatively high mobility of corporate 

residence in the age of globalization, as illustrated by the recent wave of inversions 

and foreign takeovers, some have questioned the wisdom of collecting the tax on the 

corporation side. 

Another method of integrating the two systems would be to impose a single layer 

of tax at the shareholder level by allowing companies to deduct any dividends they 

pay out. As I see it, there are a number of benefits to this approach. I’ll mention 

just a few. 

First, a deduction for dividends paid would allow businesses to cut their own effective tax rates. There is bipartisan agreement on the need to bring down corporate 

tax rates. A dividends paid deduction could accomplish the same goal without many 

of the trade-offs associated with a reduction in the statutory tax rate. 

Second, this type of deduction would create greater parity between debt and equity. As I noted earlier, current law generally allows corporations to deduct earnings 

paid out as interest on debt obligations. A dividends paid deduction would provide 

similar tax treatment for earnings paid out as dividends to investors, allowing companies to make debt-vs.-equity decisions after considering market conditions instead 

of simply referencing biases in the tax code. 

Third, a dividends paid deduction could help with some of our international tax 

problems by reducing the pressure on companies to invert and greatly reducing the 

lock-out effect. 

To hopefully take advantage of these and other benefits, I’ve been working for 

over a year now on a tax reform proposal that would eliminate double taxation of 

corporate income by providing this type of deduction. While I plan to unveil that 

proposal here in the next several weeks, I’m hoping we can inform this ongoing efVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00051 Fmt 6601 Sfmt 6621 R:\DOCS\25795.000 TIMD
48 

fort by having a more detailed discussion of these concepts and others during the 

course of today’s hearing. 

Before I conclude, I want to acknowledge that some groups—including tax-exempt 

entities and retirement plans—may have some concerns with a dividends paid deduction. However, at the end of the day, I believe we can craft a system where these 

parties will be treated in a manner that is comparable to current law or, in fact, 

in many cases, be better off. And at the same time, our overall tax system will, in 

the opinion of many, be very much improved. 

Still, I want everyone to know that, as I am preparing my integration proposal, 

I am aware of the concerns that these and other groups might raise and I am studying them very closely. Today, and going forward, we seek your comments and suggestions. 

With that, I just want to say that I appreciate this fine panel of witnesses being 

here today, sharing their knowledge and expertise with the committee. I think this 

is going to be a very informative hearing. 

PREPARED STATEMENT OF JUDY A. MILLER, DIRECTOR OF RETIREMENT POLICY FOR

THE AMERICAN RETIREMENT ASSOCIATION AND EXECUTIVE DIRECTOR OF THE AMERICAN SOCIETY OF PENSION PROFESSIONALS AND ACTUARIES, COLLEGE OF PENSION

ACTUARIES

The American Retirement Association (‘‘ARA’’) thanks Chairman Hatch, Ranking 

Member Wyden, and the other members of the Senate Finance Committee for the 

opportunity to testify regarding the impact of corporate integration on small business qualified retirement plans. 

The ARA is an organization of more than 20,000 members nationwide who provide consulting and administrative services to retirement plans that cover millions 

of American workers and retirees. ARA members are a diverse group of retirement 

plan professionals of all disciplines, including financial advisers, consultants, administrators, actuaries, accountants, and attorneys. The ARA is the coordinating entity 

for its four underlying affiliate organizations, the American Society of Pension Professionals and Actuaries (‘‘ASPPA’’), the National Association of Plan Advisors 

(‘‘NAPA’’), the National Tax-deferred Savings Association (‘‘NTSA’’) and the ASPPA 

College of Pension Actuaries (‘‘ACOPA’’). ARA members are diverse but united in 

a common dedication to America’s private retirement system. 

A workplace retirement plan is the single most important factor that determines 

whether or not workers accumulate significant savings for retirement. Data from 

the Employee Benefits Research Institute shows that workers earning between 

$30,000 and $50,000 per year are 15 times more likely to save at work than to go 

out and set up an IRA to save on their own. Because moderate income earners almost exclusively save at work through plans like the 401(k)—the most widely 

known section of the tax code—it is not surprising that Internal Revenue Service 

data shows that nearly 80% of participants in 401(k) and other profit sharing plans 

make less than $100,000 per year, and 43% of participants in these plans make less 

than $50,000 per year. Simply stated, saving at work, works. That is why it is so 

critical that businesses, especially small businesses, be encouraged to maintain 

workplace retirement plans. 

The tax incentives for employer-sponsored plans in place today do an efficient and 

effective job in allowing Americans across the income spectrum to build a secure retirement. These incentives play a critical role in encouraging small business owners 

to establish and maintain a qualified retirement plan. Nondiscrimination rules combined with compensation and contribution limits assure that non-highly compensated employees also benefit from these programs. Proposals such as corporate integration that would reduce the incentives for small business owners to save for themselves through a qualified retirement plan will discourage the establishment and 

maintenance of these retirement plans, and so reduce the availability of workplace 

retirement savings. 

BACKGROUND

What are the current tax incentives? 

Employer contributions made to qualified retirement plans are deductible to the 

employer when made. Income tax on investment earnings on those contributions is 

deferred until amounts are distributed from the plan. When a distribution is made 

49 

to a plan participant, all amounts are subject to ordinary income tax. Employer contributions made on a participant’s behalf are not subject to FICA. In addition, individuals with adjusted gross income (‘‘AGI’’) of less than $30,750, and married couples with AGI of less than $61,500, may qualify for a Saver’s Credit ranging from 

10% to 50% of the first $2,000 the individual contributes to an IRA or employersponsored defined contribution plan. 

Limits are placed on contributions to defined contribution plans, and on benefits 

payable from defined benefit plans: 

• Certain defined contribution plans permit employees to contribute on their 

own behalf by electing to have a certain dollar amount or percentage of 

compensation withheld from pay and deposited to the plan. These ‘‘elective 

deferrals’’ are excludable from income for income tax purposes, but FICA 

is paid on the amounts by both the employer and the employee. For 2016, 

the maximum elective deferral to a 401(k) or similar plan is $18,000. Employees age 50 or over can also make a ‘‘catch-up contribution’’ of up to 

$6,000. Elective deferrals to a SIMPLE plan are limited to $12,500, plus a 

$3,000 catch-up contribution for those age 50 or over. • If the employer also contributes to a defined contribution plan (such as a 

401(k) plan), the maximum contribution for any employee is $53,000. This 

limit includes any elective deferrals other than catch-up contributions. This 

means a participant that is age 50 or over, and who makes the full $6,000 

catch-up contribution, would have a total limit of $59,000. 

• The maximum annual benefit payable from a defined benefit plan cannot 

exceed the lesser of the average of 3 year’s pay or $210,000. If retirement 

is before age 62, the dollar limit is reduced. Employers can deduct the 

amount required to fund promised benefits. 

• Annual IRA contributions are limited to $5,500, plus ‘‘catch-up’’ contributions of $1,000 for those age 50 or over. 

Compensation in excess of $265,000 cannot be considered in calculating contributions or in applying nondiscrimination rules under either defined benefit or defined 

contribution plans. For example, if a business owner makes $400,000, and the plan 

provides a dollar for dollar match on the first 3% of pay the participant elects to 

contribute to the plan, the match for the owner is 3% of $265,000, not 3% of 

$400,000. 

What are the current nondiscrimination rules? 

The higher contribution limits for qualified retirement plans—both defined contribution and defined benefit plans—come with coverage and non-discrimination requirements. For example, a small business owner with several employees cannot 

simply put in a defined contribution plan and contribute $53,000 to his or her account. Other employees who have attained age 21 and completed 1 year of service 

with at least 1,000 hours of work must be taken into consideration, and the employer must be able to demonstrate that benefits provided under the plan do not 

discriminate in favor of ‘‘Highly Compensated Employees’’ (‘‘HCEs’’), which would 

include the owner. 

Generally, contributions or benefits that are proportionate to an individual’s compensation are considered fair. Age can also be considered when determining the 

amount of contributions that can be made on a participant’s behalf. A larger contribution (as a percentage of pay) can be made for older employees because the contribution will have less time to earn investment income before the worker reaches 

retirement age (usually age 65). Safe harbors are also available. For example, if all 

employees covered by a 401(k) plan are provided with a contribution of 3% of pay 

that is fully vested, the HCE can make the maximum elective deferral, regardless 

of how much other employees choose to contribute on their own behalf. 

These nondiscrimination rules, coupled with the limit on compensation that can 

be considered under these arrangements, are designed to ensure that qualified 

employer-sponsored retirement plans do not discriminate in favor of HCEs. Nondiscrimination rules do not apply to other forms of tax-favored retirement savings. 

For example: 

• IRAs share the incentive of tax deferral. However, if a small business 

owner makes a personal contribution to an IRA, there is no corresponding 

obligation to contribute to other employees’ IRAs. However, under the current rules, the contribution limit for IRAs is set low enough (and the limit 

for employer-sponsored plans high enough) to make a qualified retirement 

plan attractive to a business owner who can afford it. 

50 

• Annuities purchased outside of a qualified plan share the benefit of ‘‘inside 

buildup’’—the deferral of income tax on investment earnings until distributed from the arrangement—but have no limit on contributions or benefits, 

and no non-discrimination requirements. 

This means the attraction of a qualified retirement plan for a small business owner 

is heavily dependent on the interaction of non-discrimination rules and the tax incentives for saving through a qualified retirement plan. 

CORPORATE INTEGRATION

For purposes of this discussion, we consider a corporate integration proposal 

under which mandatory 35% withholding would apply to dividends and interest paid 

on all domestic stocks and bonds, regardless of the tax status of the holder of the 

securities. Taxpayers with a marginal tax rate of less than 35% would not be able 

to recover any portion of the withholding. 

How would corporate integration affect the tax incentives for qualified retirement 

plans? 

The tax incentive for saving through a qualified retirement plan is the deferral 

of income tax on the contributions made to the plan, and on investment earnings 

on those contributions, for so long as the funds are held in trust by the plan. Distributions from the plan are then included in ordinary income when payments are 

made from the plan, usually when the plan participant has retired. Corporate integration would result in taxation of dividends and interest earned by the plan’s investments while held in the plan, with the contributions and remaining investment 

earnings taxed again when the amounts are withdrawn from the plan. The result 

would be a substantial reduction in the tax incentive to save through a qualified 

retirement plan relative to current law. 

For example, consider a small business owner with $10,000 to contribute to a traditional account in a 401(k) plan. Assume the contribution earns a 5% annual rate 

of investment return. The initial investment is 50% stocks and 50% bonds, with 

dividends and interest reinvested in the same type of security. Under current law, 

the contribution and investment earnings will accumulate tax free until the employee terminates employment and begins to withdraw the account balance. If the 

accumulation period is 10 years, the account balance attributable to that contribution will have grown to $16,289. In 20 years, the balance would be $26,533. Income 

tax will be paid upon withdrawal. Assuming a marginal rate of 28%, the after-tax 

balance attributable to that contribution would be $11,728 after 10 years and 

$19,104 after 20 years. 

If the business owner chose not to contribute the $10,000 to the 401(k) plan, but 

invested the after-tax amount outside of a plan, the initial investment would be 

$7,200 ($10,000 less $2,800 income tax). Dividends received would be taxed at a 15% 

rate, and interest at 28%, so the net rate of return on stocks would be 4.25%, and 

3.6% on bonds. The balance after 10 years would be $10,586, which is $1,142 less 

than the after-tax 401(k) plan amount. The balance after 20 years would be $15,579, 

which is $3,535 less than the after-tax amount from the 401(k) plan after 20 years. 

In other words, assuming 5% rates of return, the business owner would gain 22.6% 

over 20 years by investing in the 401(k) plan. 

Now assume a corporate integration proposal with mandatory 35% withholding is 

adopted. Instead of earning 5% per year, net investment return on the amount invested in the 401(k) plan is only 3.25% (65% of 5%). After 10 years with 3.25% rates 

of return, the $10,000 contribution would accumulate to $13,769. After 20 years, the 

balance would be $18,958. Income tax will still be paid upon withdrawal. Assuming 

a marginal rate of 28%, the after-tax balance attributable to that contribution would 

be $9,914 after 10 years and $13,650 after 20 years. 

In other words, corporate integration will have reduced the value of a retirement 

contribution by 15% after 10 years, and 27% after 20 years. In fact, corporate integration without recovery of amounts withheld on dividends and interest paid to a 

qualified retirement plan’s trust effectively eliminates the tax incentive for saving 

through a qualified retirement plan to the extent investment earnings are attributable 

to dividends and interest. Assume the $10,000 is not contributed to a 401(k) plan. 

Income tax at the 28% rate would be paid on that amount, leaving $7,200 to be invested. After 10 years with a net investment earnings rate of 3.25%, the $7,200 

would accumulate to $9,914—the same as the after-tax accumulation in the 401(k) 

plan. After 20 years, the accumulation outside the plan would be $13,650—same as 

the 401(k) plan. Amounts invested outside of a qualified retirement plan are not 

51 

subject to the restriction for accessing monies in a 401(k) or similar account, so 

without the tax incentive, investing outside of the 401(k) plan could be more attractive than contributing to the plan. 

In theory, with corporate integration, dividends could be grossed up to reflect that 

the corporation no longer has to pay income tax on the dividends. If that were true, 

the net dividend paid with corporate integration would equal amount of dividend 

that would have been paid under current law. Assuming this is true, the accumulated balance attributable to the $10,000 contribution to the 401(k) plan would be 

$15,029 after 10 years and $22,746 after 20 years. Assuming a 28% rate, the aftertax amounts would be $10,821 and $16,377 respectively. The reduction in the value 

of the contribution as compared to current law would be 7% after 10 years and 14% 

after 20 years. However, the tax incentive for saving through a 401(k) plan instead 

of outside of the plan would still be eliminated. An investment of $7,200 outside of 

the plan would also yield $10,821 after 10 years and $16,377 after 20 years. 

For simplicity, these examples assume all investment earnings are comprised of 

interest and dividends on domestic securities. To the extent investment earnings include capital gains, the impact would be lessened. 

How would the reduced tax incentive affect small business retirement plans? 

The current tax incentives play a critical role in encouraging small business owners to establish and maintain a qualified retirement plan. Because of the nondiscrimination rules, a business owner can only save through the plan if other employees are also benefitting. As a result, a decision to establish and maintain a plan 

such as a 401(k) plan not only involves taking on fiduciary responsibilities and administrative costs, but often the cost of making contributions for the non-highly 

compensated employees who participate in the plan. For example, very small employers are often ‘‘top heavy,’’ and are required to make contributions of 3% of pay 

for all eligible non-key employees—whether or not the employees contribute on their 

own behalf. Other small business owners contribute 3% of pay to satisfy a 401(k) 

nondiscrimination testing safe harbor. Still others contribute 5% of more to be eligible to apply other nondiscrimination testing approaches. The cost of these contributions can be significant, and the availability of the tax incentives to offset all or part 

of the cost is critical to the decision to maintain a qualified retirement plan. 

Consider the following situation: 

ABC Company has been in operation for 5 years. The owner has some retirement savings in an IRA, but has never taken time to think about retirement. 

The business has five other employees earning from $35,000 to $75,000, with 

total payroll of $300,000. The owner takes compensation of $10,000 per month 

during the year, then takes a year-end bonus of the amount of company profits, 

which amount to $65,000 for the current year. The owner will pay individual 

income taxes on the full amount of the profits at a marginal rate of 28%, leaving $46,800 after paying taxes in the amount of $18,200. 

Before taking the bonus, the owner meets with a retirement plan consultant. 

The owner is older than most of the other workers, so the consultant recommends a safe harbor 401(k) plan with an additional ‘‘cross-tested’’ contribution. With this type of plan the owner could contribute $50,000 of the profits 

to the plan on her own behalf. Thanks to the nondiscrimination rules that apply 

to qualified retirement plans, putting $50,000 of the profits into the 401(k) plan 

for the owner means the owner must contribute at least 5% of pay for the employees, which is $15,000. So, instead of taking home $46,800 and sending IRS 

a check for $18,200, the owner will contribute $50,000 to the plan on her own 

behalf and $15,000 for the employees. A tax credit for the cost of setting up and 

operating a new plan will help defray any startup and initial operating costs. 

Under current law, the arrangement makes sense for the small business 

owner. Instead of sending a check to IRS, she can make a contribution of 

$15,000 for her employees. The deferral of tax on investment earnings means 

the amount the owner will have accumulated in after-tax savings in 20 years 

is similar to what she would have if she paid taxes now on the $65,000, and 

invested the remainder outside of the qualified plan. If the owner is in the 28% 

tax bracket at retirement, she will have about $10,000 less from the plan than 

if she saved outside of the plan, but if she is in a lower tax bracket, she will 

come out ahead because she chose to set up and contribute to the plan. In short, 

both the owner and the employees are on the road toward a secure retirement. 

How would this scenario change with corporate integration? The deduction for the 

contribution would still largely cover the costs of the contribution, but the longerVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00055 Fmt 6601 Sfmt 6621 R:\DOCS\25795.000 TIMD
52 

term view would lead to a very different conversation. The owner would be advised 

that if she just paid tax on the $65,000 now and invested the difference without setting up a plan, she would end up with significantly more savings 20 years from now 

than if she put in the plan, even if she is down to a 15% marginal rate in retirement. 

She would also have more flexibility by holding those savings outside of a qualified 

plan. If she put the money in a 401(k) plan and needed it before she reached retirement age, she would have to prove hardship, or even go through the formal process 

of terminating the plan, in order to get to her account. She would also have to pay 

a 10% penalty if she chose to withdraw it before retirement, death or disability. In 

other words, with corporate integration the owner would have less expense, less liability, more flexibility and more long term savings by just saying ‘‘no’’ to setting up 

a 401(k) plan. 

The following table summarizes the 20-year projections of the value of the owner’s 

contributions based on both 28% and 15% marginal rates at retirement. For purposes of this illustration, it was assumed that with corporate integration, dividends 

would be increased to absorb the 35% mandatory withholding. Note that if the 

owner is in the 28% bracket at retirement, under the proposal she could increase 

her savings by 30% by not sponsoring a 401(k) plan. 

Table 1 

Invested 

amount 

20-year 

balance 

Net amount with marginal rate at retirement of 

28% 15% 

Current law 

401(k) plan $50,000 $132,665 $95,520 $112,765 

Nonqualified account $46,800 $101,264 $101,264 $101,264 

Proposal 

401(k) plan $50,000 $113,728 $81,884 $96,670 

Nonqualified account $46,800 $106,450 $106,450 $106,450 

The loss of deferral of income tax on dividends and interest with corporate integration would significantly reduce, and for more conservative investors even eliminate, the tax incentive for saving through a qualified retirement plan. Given the 

costs and obligations that come with sponsoring a qualified retirement plan, the result would be a reduction in the number of plans sponsored by small businesses, 

and a loss of coverage, and retirement security, for small business employees. 

Small business employees would not be the only ones to suffer, however. The lack 

of deferral of income tax on dividends and interest will reduce the account balances 

of any participant whose account is invested in an asset that pays interest (or dividends to the extent dividends payable on the investments held by the plan do not 

increase sufficiently to cover the withholding), and do serious harm to the retirement security of American workers. 

SUMMARY

Access to a retirement plan at work is the key to successfully preparing for retirement. Reducing the tax incentives to save through a qualified retirement plan will 

discourage small business owners from establishing and maintaining qualified retirement plans, and so reduce the availability of workplace savings. A corporate integration proposal under which mandatory 35% withholding would apply to dividends and interest paid on all domestic stocks and bonds, regardless of the tax status of the holder of the securities, including securities held in qualified retirement 

plans would substantially reduce the tax incentives for these plans, and so discourage plan formation and maintenance. 

We thank you for the opportunity to submit these comments. The ARA would be 

pleased to work with this Committee to assure the tax incentives for qualified retirement plans are maintained or enhanced as this or other proposals move forward. 

53 

1The views expressed are my own and should not be attributed to the Tax Policy Center or 

the Urban Institute, its board, or its funders. I would like to acknowledge the suggestions of 

Alan Auerbach, Lydia Austin, Richard Auxier, Len Burman, Frank Clemente, Howard Gleckman, Joe Rosenberg, Frank Sammartino, Steve Shay, Eric Toder, and Bob Williams. 2For a complete discussion, see Steven M. Rosenthal and Lydia S. Austin, ‘‘The Dwindling 

Taxable Share of U.S. Corporate Stock,’’ Tax Notes (May 16, 2016). I attach this article for the 

record. 

PREPARED STATEMENT OF STEVEN M. ROSENTHAL,1 SENIOR FELLOW, 

URBAN-BROOKINGS TAX POLICY CENTER, URBAN INSTITUTE

Chairman Hatch, Ranking Member Wyden, and members of the committee, thank 

you for inviting me to appear today to discuss integrating the corporate and individual tax systems. 

In my testimony, I first describe how taxes on corporate earnings have dropped 

because of corporate moves to avoid taxes and because of shareholder shifts from 

taxable to nontaxable accounts. Both trends are important to thinking about corporate tax integration—particularly in the form of a dividends paid deduction. The 

shareholder shift is less obvious because the published data are hard to parse, leading even sophisticated analysts to overstate the taxable share of U.S. stock. 

Second, I describe how a lower estimate of the taxable share of U.S. stock complicates attempts to integrate corporate and individual taxes further. Finally, I suggest some areas for further research on the competitiveness of U.S. corporate taxes. 

U.S. STOCK OWNERSHIP TRENDS

The usual story we tell is that corporate earnings are generally subject to two levels of tax: first, the company pays the corporate income tax; second, the shareholders pay individual income tax on dividends and realized capital gains. Yet reality may differ from that simple story. 

Many commentators have noted the sharp decline at the first level: corporate tax 

receipts fell from 3.6 percent of gross domestic product in 1965 to 1.9 percent in 

2015. However, observers have overlooked the substantial erosion at the second 

level of taxation of corporate income. Over the same 50-year period, U.S. retirement 

accounts and foreigners have largely displaced taxable accounts as the owners of 

stock issued by U.S. corporations (figure 1).2 As a result, corporate earnings are 

largely exempt at this level. 


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54 

3 In constant (2015) dollars, we estimate that total household ownership increased slightly 

from $4.5 trillion to $5.5 trillion from 1965 to 2015, while total outstanding stock increased more 

than fourfold from $5.4 trillion to $22.8 trillion. I am attaching this paper for the record. 

My colleague Lydia Austin and I estimate that the share of corporate stock issued 

by U.S. corporations that is held in taxable accounts fell more than two-thirds over 

the past 50 years, from 83.6 percent in 1965 to 24.2 percent in 2015.3 Our estimates 

are based on data from the Federal Reserve Board’s Financial Accounts of the 

United States (often called the Flow of Funds Accounts) and other sources. The Flow 

of Funds Accounts, which go back to 1965, are the most common source used to 

measure U.S. stock ownership. 

U.S. STOCK OWNERSHIP HIGHLIGHTS

There are two major factors in the decline in the share of corporate stock held 

in taxable U.S. accounts. The first is the increase held in tax-favored retirement accounts such as IRAs, 401(k) plans, and traditional defined-benefit pension plans. We 

estimate that share is now about 37 percent of U.S. corporate stock. The second is 

the increase in portfolio investment by foreigners; that share is about 26 percent 

of corporate stock (the foreign share would be greater if we included foreign direct 

investment, which is a controlling interest in a U.S. corporation, 10 percent or 

more). Foreigners generally pay no U.S. tax on capital gains from the sale of U.S. 

corporate stock, and the U.S. withholding taxes they pay on dividends are often reduced greatly by treaty. 

Retirement Account/Plan Holdings 

Retirement accounts and plans held about 37 percent of U.S. stock in 2015, worth roughly $8.4 trillion. Over the past 30 years, IRAs grew faster than other components, largely because of rollovers of assets from defined contribution plans (figure 

2). 

Income accrued within retirement accounts, including both (i) Roth and traditional IRAs and (ii) defined-contribution and defined-benefit retirement plans, is effectively tax-free. In general, investment returns in these retirement accounts are 

tax-free in two different manners. Contributions to Roth IRAs and Roth 401(k) are 

nondeductible, and withdrawals are nontaxable. Alternatively, contributions to traditional IRAs or 401(k) plans are deductible and earnings are taxable upon withdrawal. If account owners face the same tax rate when they contribute to or withdraw from their accounts, the two forms of retirement savings are economically 


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4Similarly, we and the Fed do not count U.S. intercompany holdings. 

5See Joint Committee on Taxation, Description of Revenue Provisions Contained in the President’s Fiscal Year 2004 Budget Proposal, JCS–7–03 (2003), at 18–33. 

equivalent to the individual (given the same after-tax contribution); the benefit of 

a Roth plan’s full tax exclusion for withdrawals equals the benefit of a traditional 

IRA or 401(k) plan’s tax deduction for contributions. 

Foreign Holdings 

Foreigners owned about 26 percent of U.S. stock in 2015, worth about $5.8 trillion 

(figure 3). Foreign multinational corporations own another $4.6 trillion of ‘‘direct’’ 

investments in U.S. companies. Like the Fed, we counted portfolio stock in corporate 

equity but not foreign direct investment, although direct investment is growing as 

fast as portfolio investment.4

We treat foreigners as nontaxable, as their income from stock generally is not 

subject to U.S. tax—or subject to just a little tax. Their stock gains almost always 

are exempt from taxation. Their dividends are subject to a 30 percent U.S. withholding tax for portfolio investments, which is typically reduced by treaty to 15 percent or, for direct investment, to 5 percent (or sometimes to zero). 

IMPLICATIONS FOR CORPORATE INTEGRATION

As I observed at the start, corporate earnings are ostensibly taxed twice, first to 

the corporation and second to the shareholders. Having two levels of tax distorts 

business decision-making in several important ways: whether to establish as a corporation, partnership, or other business form; whether to finance with debt or equity; and whether to retain or distribute earnings. 

Many reformers propose to end double-taxation by integrating corporate and 

shareholder taxes on corporate earnings. For example, the United States could tax 

corporate earnings (1) just to the corporation, (2) just to the shareholders, or (3) to 

both the corporation and the shareholders, but with a credit to the shareholders for 

taxes paid by the corporation. 

In 2003, Treasury proposed the first option: to tax corporate earnings just to corporations by excluding dividends to shareholders from taxation at the individual 

level.5 At that time, Congress chose instead to reduce the top tax rate on qualified 


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6 Jobs and Growth Tax Relief Reconciliation Act of 2003, Pub. L. No. 108–27, 108th Cong., 

1st Sess. (May 28, 2003). 7 Avi-Yonah, Reuven, ‘‘And Yet It Moves: Taxation and Labor Mobility in the Twenty-First 

Century,’’ 67 Tax. L. Rev. 169 (2014). 8 Citizens for Tax Justice, ‘‘Fortune 500 Companies Hold a Record $2.4 Trillion Offshore,’’ 

March 4, 2016, http://ctj.org/ctjreports/2016/03/fortune_500_companies_hold_a_record_24_ trillion_offshore.php#.VzMBv4QrJD8. See also Richard Rubin, ‘‘U.S. Companies Are Stashing $2.1 Trillion Overseas to Avoid Taxes,’’ Bloomberg, March 4, 2015, https://www.bloomberg.com/ 

news/articles/2015-03-04/u-s-companies-are-stashing-2-1-trillion-overseas-to-avoid-taxes. 9 Individuals face an exit tax on expatriating under Code sec. 877A, which Congress passed 

unanimously as part of the Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART 

Act), Pub. L. No. 110–245, 110th Cong., 2nd Sess. (June 17, 2008). 10For example, Congress could treat part or all of the dividends and capital gains from stock 

of U.S. corporations as unrelated business taxable income for tax-exempts. 11For a discussion, see Republican Staff of the Senate Finance Committee, Comprehensive Tax 

Reform for 2015 and Beyond, at 201–203, 113th Cong. S. Prt. No. 113–31 (Dec. 2014). 12 Congress might also treat part or all of the dividends and capital gains from stock of foreign 

corporations as unrelated business taxable income to address this problem. 13See, for example, Jane G. Gravelle, International Corporate Tax Rate Comparisons and Policy Implications (Washington, DC: Congressional Research Service, 2014), comparing and describing corporate statutory, effective, and marginal tax rates, but not shareholder tax rates. 

dividends to the same rate permitted for long-term capital gains.6 Both are now 

taxed at a maximum rate of 23.8 percent (rather than the 43.4-percent tax rate that 

applies to other forms of income). 

Because of the trends in stock ownership, and the reduction in tax rates, corporate earnings now face a very low effective tax rate at the shareholder level. 

Three-fourths goes untaxed, by our estimate, and much of the rest faces low rates. 

Further, the tax on any gain can be deferred or eliminated if the stock is held until 

death or donated to charity. So, the United States effectively tries to collect the bulk 

of the tax on corporate earnings at the corporate level. 

But many commentators have observed that taxing earnings only to corporations 

is problematic in today’s environment, and I agree. Corporations are mobile—generally more so than individuals.7 As a result, some U.S. corporations have shifted 

their residence abroad to avoid U.S. taxes (‘‘inversions’’). Others shift their income 

to lower-taxed jurisdictions through transfer pricing. The United States makes this 

possible by delaying the tax on these overseas earnings until they are repatriated 

(‘‘deferral’’). U.S. multinationals now have stockpiled huge amounts of earnings 

overseas—$2.4 trillion by some estimates.8

An alternative approach would tax corporate earnings only to shareholders, who 

cannot expatriate easily or shift their income to foreign affiliates.9 The United 

States could move to such a system in a couple of different ways. 

The United States could allow corporations to deduct dividends paid to shareholders. That would reduce the taxable income of corporations and increase that of 

shareholders. By our calculations, however, only about a quarter of dividends are 

paid to taxable accounts. So, the shift might generate relatively little revenue. To 

keep reform revenue neutral, Congress would need to substantially increase the tax 

rate on dividends and capital gains—perhaps both to individuals and tax-exempt accounts and institutions.10

Equivalently, the United States might tax corporate earnings at the entity level 

but allow the shareholders to claim a credit for the tax paid by the corporation (or, 

alternatively, permit a dividends paid deduction coupled with a withholding tax on 

dividends paid to shareholders).11 Presumably, the credit or withholding tax would 

be nonrefundable to prevent a windfall for tax-exempt shareholders. But if these 

taxes were nonrefundable, tax-exempt shareholders, who represent the largest block 

of shareholders, might still pressure their corporations to shift income to lower-tax 

jurisdictions—or to move abroad.12

FINAL THOUGHTS FOR BUSINESS INCOME TAX REFORM: 

IS THE U.S. CORPORATE INCOME TAX UNCOMPETITIVE?

A key reason often given to pursue business tax reform is to lower U.S. corporate 

tax rates in order to make U.S. corporate taxes more competitive with the corporate 

taxes of other countries. Many commentators gauge U.S. corporate tax competitiveness by comparing U.S. corporate income taxes to foreign corporate income taxes 

(whether statutory, effective, or marginal).13 But, as noted earlier, the effective tax 

rate on corporate earnings depends on both the corporate and shareholder income 

taxes. Today, in the United States, relatively few shareholders pay the second level 

57 

of tax on corporate earnings. Those that do, face a reduced rate on qualified dividends and long-term capital gains. 

To fully compare the U.S. tax burden on corporate earnings to foreign tax burdens, we should also compare the combined corporate and shareholder effective 

taxes. In some instances, this comparison may provide a better gauge of U.S. tax 

competitiveness. For example, some countries may tax corporate earnings more fully 

at the shareholder level, and that could increase the cost of corporate capital in 

their countries (if their corporations depend substantially on local capital markets). 

More research is necessary to gauge the effective combined U.S. and foreign tax burden on corporate earnings. 

Table 1. Comparing Effective Tax Rates Across Countries 2015 

Corporate 

Income Tax 

Rate 

Personal 

Dividend 

Income Tax 

Rate 

Capital 

Gains Tax 

Rate 

Effective 

Corporate and 

Shareholder 

Tax Rate 

Integrated 

Tax System 

Canada 26.3% 39.3% 22.6% ? Full credit imputation 

France 34.4% 44.0% 34.4% ? Partial dividend exemption 

Germany 30.2% 26.4% 25.0% ? Classical 

Italy 27.5% 26.0% 26.0% ? Classical 

Japan 32.1% 20.3% 20.3% ? Modified classical system 

United Kingdom 20.0% 30.6% 28.0% ? Partial credit imputation 

United States 39.0% 30.3% 28.7% ? Modified classical system 

G7 excluding U.S.* 29.1% 29.1% 25.5% ? 

* Weighted by 2015 GDP. 

Sources: OECD Tax Database, Tables II.1 and II.4; OECD Quarterly National Accounts: Historical GDP—expenditure approach; Tax Foundation, ‘‘Eliminating Double Taxation through Corporate Integration.’’ 

Note: Tax rates are combined national and subnational. 

SPECIAL REPORT 

Tax Notes 

May 16, 2016 

The Dwindling Taxable Share of U.S. Corporate Stock 

By Steven M. Rosenthal and Lydia S. Austin 

Steven M. Rosenthal is a senior fellow and Lydia S. Austin is a research 

assistant at the Urban-Brookings Tax Policy Center. The authors wish to 

thank Leonard Burman for his encouragement and suggestions on earlier 

drafts. They are also grateful to Alan Auerbach, Gerry Auten, Richard 

Auxier, Paul Burnham, Tim Dowd, Howard Gleckman, John McClelland, 

Robert McClelland, Peter Merrill, Jim Nunns, Frank Sammartino, Mike 

Schler, Steve Shay, Eric Toder, and Bob Williams. The views and mistakes 

herein are the authors’ and not those of the Tax Policy Center, the Urban 

Institute, the Brookings Institution, or any other entity or person. 

In this report, Rosenthal and Austin demonstrate that the share of U.S. 

stocks held by taxable accounts has declined sharply over the last 50 years, 

and they urge lawmakers to carefully consider this shareholder base erosion when determining how best to tax corporate earnings. 

Copyright 2016 Steven M. Rosenthal and Lydia S. Austin. 

All rights reserved. 

I. Introduction 

Corporate earnings are generally subject to two levels of tax—first, the company 

pays a corporate income tax; second, the shareholders pay an individual income tax 

on dividends and capital gains. 

58 

1Office of Management and Budget, ‘‘Table 2.3—Receipts by Source as Percentages of GDP: 

1934–2021.’’ 2 Also, the returns on the stock of the remaining shareholders are taxed lightly. The tax rates 

are reduced for qualified dividends and long-term capital gains. Tax on gains from appreciated 

stock is deferred until the stock is sold or disposed—and gains are eliminated if the stock is 

held until death. 3 In constant (2015) dollars, we estimate that total taxable ownership increased slightly from $4.5 trillion to $5.5 trillion, while total outstanding stock increased more than fourfold from $5.4 

trillion to $22.8 trillion. 4 Congressional Budget Office, ‘‘Taxing Capital Income: Effective Marginal Tax Rates Under 

2014 Law and Selected Policy Options’’ (December 2014). 5See, e.g., Michael J. Graetz and Alvin C. Warren Jr., ‘‘Unlocking Business Tax Reform,’’ Tax 

Notes, November 10, 2014, p. 707; Harry Grubert and Rosanne Altshuler, ‘‘Shifting the Burden 

of Taxation From the Corporate to the Personal Level and Getting the Corporate Tax Rate 

Down to 15 Percent’’ (2015); and Eric Toder and Alan D. Viard, ‘‘Major Surgery Needed: A Call 

for Structural Reform of the U.S. Corporate Income Tax,’’ American Enterprise Institute (2014). 

Many commentators have noted the sharp decline at the first level: corporate tax 

receipts fell from 3.6 percent of GDP in 1965 to 1.9 percent in 2015.1 However, observers have overlooked the substantial erosion at the second level of taxation of 

corporate income. Over the same 50-year period, retirement plans and foreigners 

displaced taxable accounts as the owners of U.S. stocks. (See Figure 1.) As a result, 

corporate earnings are largely exempt at this level.2

We estimate that the share of U.S. corporate stock held in taxable accounts fell 

more than two-thirds over the last 50 years, from 83.6 percent in 1965 to24.2 percent in 2015.3 We document this decline using data from the Federal Reserve’s ‘‘Financial Accounts of the United States,’’ previously the ‘‘Flow of Funds Accounts,’’ 

which is the most commonly used data source for measuring U.S. stock ownership. 

Figure 1 reflects data back to 1965, but we focus on stock held in 2015, the year 

for which the most recent data are available. 

Understanding the erosion of the taxable shareholder base is critical for determining how best to tax corporate earnings—and capital more generally.4 Acknowledging the decline is particularly important for evaluating proposals to reform (or 

eliminate) the corporate income tax and collect taxes exclusively from shareholders.5

These corporate tax reforms are much more difficult if few shareholders pay tax. 

Prior literature suggests that taxable stock ownership ranges from 44 percent to 

68 percent, which we review in Section II of this report. Our estimates are 22 percent to 37 percent for the corresponding years, and we describe our estimates in SecVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00062 Fmt 6601 Sfmt 6621 R:\DOCS\25795.000 TIMD

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6Federal Reserve, ‘‘Financial Accounts of the United States: Flow of Funds, Balance Sheets, 

and Integrated Macroeconomic Accounts, Fourth Quarter 2015,’’ March 10, 2016. 7The Fed counts only the U.S. residents’ ownership of foreign stock, not the foreign residents’ 

ownership of foreign stock. Foreign stock includes American depository receipts, which are trust 

interests that trade in the United States that represent beneficial ownership of shares in a foreign corporation. 8 Chris William Sanchirico, ‘‘As American as Apple Inc.: International Tax and Ownership Nationality,’’ 68(2) Tax L. Rev. 207 (2015) (discussing the challenge of distinguishing categories of 

shareholders, including problems with classifications in the data). 9Federal Reserve, supra note 6, at Table L.223, line 11. These holdings are generally not taxable, except that taxable individuals may own, indirectly, the stock held by insurance companies 

and mutual funds. 10See Amanda Sneider et al., ‘‘An Equity Investor’s Guide to the Flow of Funds Accounts,’’ 

Goldman Sachs Group Inc., March 11, 2013. 11Federal Reserve, supra note 6, at Table L.223, line 11. 12 Id. at Table B.101.e, line 14. 13Poterba, ‘‘Taxation and Corporate Payout Policy,’’ 94(2) Am. Econ. Rev. 171 (2004). For 2003 

we estimated that taxable accounts held 29.6 percent of U.S. corporate stock. 14See Auerbach, ‘‘Who Bears the Corporate Tax? A Review of What We Know,’’ in Poterba 

(ed.), Tax Policy and the Economy, Volume 20, 1–40, Table 1 (2006). By comparison, for 2004, 

we estimate that taxable accounts held 28.9 percent. Auerbach netted the U.S. resident holdings 

of foreign equity against foreign resident holdings of U.S. equity, and we do not. 15See id. at 4–8. 16See Sneider, supra note 10, at 8. 

tion III (and the appendices). Our estimates are only approximations, based on the 

best available data and reasonable assumptions. In Section IV, we analyze the sensitivity of our estimates by varying the assumptions. Finally, at the end of this report, we suggest areas for further research in light of our new estimates. 

II. Previous Estimates 

The Fed reported that ‘‘households’’ own most of the value of the outstanding 

stock issued by U.S. corporations.6 Many view the household share of corporate equity holdings as a good proxy for the taxable share of ownership. However, the Fed 

included a substantial amount of equity in the households category that is not subject to income tax. 

The Fed reported both the ownership of all stock issued by U.S. corporations and 

the holdings by U.S. investors of stock issued by foreign corporations.7 It then 

disaggregated these figures into stock ownership by different categories of institutional and foreign investors: 8 state and local governments, defined benefit and contribution plans, life insurance companies, foreigners, and others (including mutual 

funds, exchange-traded funds (ETFs), and closed-end funds (CEFs)).9 The Fed allocated the remaining balance to households, including stock held in IRAs and by nonprofit institutions. In other words, the Fed treated households as ‘‘a plug for all assets not classified into other sectors.’’ 10

The Fed reported that in 2015, households directly owned 37.3 percent of corporate equity.11 Households owned another 13 percent indirectly through mutual 

funds (and more through ETFs and CEFs).12 In total, the Fed reported that households owned more than 50.3 percent of the value of outstanding U.S. stock. 

The economics literature generally uses the Fed’s figures for household ownership, 

including both direct and indirect holdings, as a measure of equities held in taxable 

accounts. James M. Poterba added stock owned directly by the household sector 

with stock beneficially held through mutual funds—and estimated that the taxable 

household share of corporate equity was 57.2 percent in 2003.13 In so doing, Poterba 

counted stock owned by IRAs and nonprofits in his taxable sector. 

Similarly, Alan J. Auerbach estimated that U.S. households (including IRAs) directly owned about 42 percent of the market value of U.S. corporations and 26 percent more through mutual funds in 2004.14 In his paper, Auerbach flagged the difficulty of tracing corporate taxes through to individual shareholders using the Fed 

data.15

Goldman Sachs observed that the Fed’s ‘‘broad category definitions can make it 

difficult to use Flow of Funds data to analyze trends in the domestic public equity 

market.’’ 16 Instead, Goldman used company-specific ownership data from LionShares to estimate that retail investors (including IRAs) directly owned 23 percent 

of public U.S. single-stock equities in 2013 (and indirectly owned much more 

through mutual funds and pension funds). 

60 

17Gale, ‘‘About Half of Dividend Payments Do Not Face Double Taxation,’’ Tax Notes, November 11, 2002, p. 839. 18 Rosenberg, ‘‘Corporate Dividends Paid and Received, 2003–2009,’’ Tax Notes, September 17, 

2012, p. 1475. 19See also Jane G. Gravelle and Donald J. Marples, ‘‘The Effect of Base-Broadening Measures 

on Labor Supply and Investment: Considerations for Tax Reform,’’ Congressional Research Service, at 27 (October 22, 2015) (estimating that 25 percent of U.S. dividends appear on U.S. personal returns by comparing dividends received by individuals (as reported by the IRS Statistics 

of Income division) and dividends reported in the National Income and Product Accounts). 

Gravelle and Marples offer little information on their methods. 20Gale used dividends reported in the National Income and Product Accounts, and Rosenberg 

used dividends reported on corporate tax returns (Form 1120). 21 Rosenberg, supra note 18. We estimate 36.9 percent and 21.7 percent for 2000 and 2009, 

respectively. 22We can reduce Rosenberg’s number to 34 percent by subtracting foreign dividends from his 

numerator, assuming foreign dividends/total dividends equals foreign stock/total stock (23.3 percent, the share of foreign equity in 2009). In practice, the dividend yield on foreign stock may 

be much higher than the yield on U.S. stock. If so, we would reduce the estimate further. 23Our estimate (24.2 percent in 2015) of taxable holdings is most appropriate to evaluate an 

integration plan with shareholder credits limited to U.S. taxes paid, as under the plan suggested 

by Graetz and Warren, supra note 5. If individual taxes on capital gains and dividends are increased as part of an integration plan, a more appropriate estimate (28.6 percent) would include 

U.S. holdings of foreign stock. Grubert and Altshuler, supra note 5. 24There are also S corporations and M corporations (regulated investment companies, REITs, 

ETFs, and CEFs), which are generally not separately taxable—and are named based on their 

location in the tax code. 25We simply look through to attribute the underlying stock held by these passthrough corporations to the beneficial owners of the passthrough corporations, which is how the Fed treats 

mutual funds. That is, the Fed already excludes mutual funds, which are also passthrough corporations, from its issuers of corporate equity. 26We do not add back stock for REITs, which generally hold only real estate and mortgages. 27We treat only accounts of investors that are subject to tax on their capital gains and dividends as ‘‘taxable accounts.’’ We consider the other categories nontaxable. For example, insurIn lieu of using Fed data, William G. Gale 17 and Joseph Rosenberg 18 used data 

from tax returns to estimate the taxable share of U.S. stock by individuals.19 They 

measured the ratio of total qualified dividends reported on individual tax returns 

(Forms 1040) divided by total dividends.20 Gale estimated that individuals received 

46 percent of dividends paid by U.S. corporations in 2000, and Rosenberg estimated 

44 percent in 2009.21 Gale and Rosenberg included both domestic and foreign dividends in the qualified dividends received by U.S. individuals in their numerator but 

only dividends paid by U.S. corporations in their denominator.22

III. Our Estimate 

The Fed’s household sector is too broad for our purposes and thus overestimates 

the ownership of U.S. stock in taxable accounts. To more accurately measure taxable ownership, we adjusted the Fed’s data in several important respects: 

1. We excluded foreign equity held by U.S. residents—and measured only 

U.S. stock.23

2. We measured only the stock of corporations that are separately taxable 

under subchapter C of the IRC.24 We excluded passthrough corporations 

such as mutual funds, S corporations, ETFs, CEFs, and real estate investment trusts, which generally are not separately taxable.25

3. We excluded stock held by nonprofits from the household sector. 

4. We excluded stock held by IRAs and section 529 accounts (as well as defined benefit and defined contribution plans, which the Fed already does). 

5. We added back stock that taxable individuals held beneficially through 

mutual funds, ETFs, and CEFs (that is, in the underlying portfolios of these 

passthrough corporations).26

The first two steps isolate the stock of corporations that are subject to U.S. tax 

and, potentially, a double layer of U.S. taxation. Step 3 removes extraneous 

amounts from the residual household sector. Step 4 excludes holdings in IRAs and 

section 529 accounts, which is consistent with the Fed’s method. Finally, step 5 combines indirect ownership with direct ownership by taxable accounts. 

After these adjustments, we reallocated stock ownership to several categories: taxable accounts, foreigners, insurance companies, nonprofits, defined benefit plans, defined contribution plans, IRAs, and other investors.27 We followed the procedures 

61 

ance companies hold stock in segregated reserves to fund annuity contracts and whole life insurance of their beneficiaries, but the companies themselves are not subject to tax on the income 

from the segregated accounts. Rather, the beneficiaries themselves will generally be subject to 

tax to the extent payments exceed basis. 28Direct investments are controlling blocks of stock in a company, which means 10 percent 

or more ownership. For example, foreign multinational corporations often hold direct investments in stock of their U.S. affiliates. 29Passthrough corporations are corporations that are generally not subject to the U.S. corporate income tax, such as S corporations, mutual funds, ETFs, CEFs, and REITs. 30Federal Reserve, supra note 6, at Table L.223. At our request, the Fed recently published 

its estimate of the value of stock issued by S corporations from 1996 to 2015 (Table L.223, line 

30), which we subtract. The Fed also estimates the value of stock issued by ETFs and CEFs 

(Table L.123) but not REITs, which we obtained back to 1971 from the National Association of 

Real Estate Investment Trusts, all of which we subtract. 31The Fed already subtracts stock issued by mutual funds. See id. at Table L.223, n.1. 32 By comparison, for 2013, the Fed’s Survey of Consumer Finances determined that households held $8 trillion of both domestic and foreign equity outside retirement accounts. Federal 

Reserve, ‘‘2013 Survey of Consumer Finances,’’ October 20, 2014. The Fed conducts the survey 

every 3 years, independent of its Financial Accounts estimates. If we estimate and subtract the 

foreign equity, the survey estimate is only $6.16 trillion. For 2013, we estimated $5.4 trillion 

in taxable accounts. 33We describe our methods, data sources, and assumptions in more detail in Appendix 1. 

detailed below (and in Appendix 1) to estimate ownership for 2015 as well as for 

previous years back to 1965. We calculated that the total value of outstanding U.S. 

corporate stock is $22.8 trillion, of which $5.5 trillion is held in taxable accounts, 

or 24.2 percent of the total. 

A. Outstanding C Corporation Stock 

The Financial Accounts data for 2015 show a total of $35.7 trillion of corporate 

equity, which excludes U.S. intercorporate holdings of public stock and foreign direct 

investments in U.S. companies.28

The Fed included (1) some foreign stock held by U.S. residents and (2) stock 

issued by U.S. passthrough corporations.29 Because we wanted to measure only the 

outstanding stock of corporations that are taxable by the United States, we subtracted both.30 As a result, we estimated that $22.8 trillion of stock issued by domestic C corporations was outstanding in 2015 (see Table 1).31

Table 1. C Corporation Equity Outstanding 

(2015, market value in billions) 

Total foreign and domestic corporate stock (including stock issued by C and S corporations, 

ETFs, CEFs, and REITs) $35,687 

• Foreign stock held by U.S. residents ($6,732) 

• Stock issued by passthrough entities 

• S corporations ($2,838) 

• Exchange-traded funds ($2,106) 

• Closed-end funds ($260) 

• REITs ($939) 

All outstanding C corporation stock $22,812 

B. C Corporation Stock in Taxable Accounts 

The Fed allocated corporate stock to households but not to taxable accounts. We 

estimated that taxable accounts held $5.5 trillion in 2015, 24.2 percent of the $22.8 

trillion of outstanding C corporation stock (see Table 2).32 We detail these adjustments in Appendix 1.33

62 

Table 2. Total Taxable Holdings of C Corporation Stock 

(2015, market value in billions) 

Outstanding C corporation stock (from Table 1) $22,812 

Less: 

Stock held by pensions, mutual funds, insurance companies, and others $11,487 

Stock held by foreign residents $5,543 

Equals: C corporation stock held directly by U.S. residents $5,781 

Less: 

Stock held directly by U.S. nonprofits $956 

Equals: C corporation stock held directly by U.S. households $4,826 

Less: 

Stock held in IRAs $1,479 

Stock held in section 529 plans $89 

Equals: Taxable C corporation stock held directly in U.S. taxable accounts $3,274 

Plus: 

Taxable C corporation stock held indirectly by U.S. households $2,268 

Equals: Total holdings of taxable C corporation stock in U.S. taxable accounts $5,525 

The Fed’s household category includes the U.S. stock holdings of U.S. partnerships. It excludes the U.S. stock holdings of foreign partnerships, which the Fed 

counts in the holdings of foreign residents. Thus, the classification of the U.S. stock 

of a partnership (such as a hedge fund or a private equity fund) turns on the domicile of the partnership, not the domicile of the beneficiaries. 

We did not distribute the stock held through hedge funds and private equity (or 

the tax-exempt holdings through these funds), as we explain in Appendix 2. (In 

short, we believe we can reasonably net the share of the U.S. stock of foreign funds 

that is held beneficially in U.S. taxable accounts against the share of U.S. stock of 

U.S. funds held beneficially by nontaxable accounts.) 

IV. Sensitivity Analysis 

Although we varied our assumptions in several ways, we found only a few adjustments that are potentially significant. 

A. Stock Issued by Passthrough Corporations 

We subtracted the stock issued by passthrough corporations and distributed the 

stock held by these corporations to their beneficial owners. If we did not subtract 

the stock issued by S corporations, ETFs, CEFs, or REITs (but subtracted only the 

stock issued by mutual funds, as the Fed had done), all U.S. corporate equity would 

total $29 trillion in 2015, and taxable accounts would hold $9.6 trillion, or 33.3 percent. Thus, subtracting stock issued by passthrough corporations substantially reduced our estimate. 

B. Beneficial Ownership 

To distribute the equity held by passthrough corporations to their beneficial owners, we used the ownership proportions for mutual funds to estimate the ownership 

proportions of ETFs and CEFs. The Fed provided data only on ownership of mutual 

63 

34Federal Reserve, supra note 6, at Table L.224. ETFs, CEFs, and mutual funds are very 

similar: they are diversified pools of stocks and bonds and are taxed identically under subchapter M of the code. 35Our 4.9-percent estimate seems about right because we estimate for 2012 that nonprofits 

owned about $1.06 trillion of U.S. stock, while the IRS estimated for 2012 that nonprofits owned 

$1.04 trillion of public securities—and the IRS estimate included Treasury and corporate bonds 

and excluded other securities like private equity and hedge funds, which would offset. 

funds, and we could not find data on ETFs and CEFs elsewhere.34 In 2015 the Fed 

reported ‘‘households’’ owned about 63 percent of mutual funds, so we assumed that 

households also owned 63 percent of ETFs and CEFs, and we distributed the equity 

holdings accordingly. If we instead assumed that households held less (50 percent) 

or more (70 percent) of passthrough corporations, we would decrease our estimate 

to 22 percent or increase it to 25.8 percent. Thus, our estimate of taxable ownership 

of corporate equity is somewhat sensitive to our assumptions about ownership of 

CEFs and ETFs. 

C. Nonprofit Ownership 

Our estimate of taxable ownership is sensitive to our calculation of nonprofit ownership, which was $1.4 trillion, or 4.9 percent of corporate equity. For example, if 

we shifted our estimate of nonprofit share from 4.9 percent in 2015 to 4.4 percent 

or 5.7 percent in 2015 (which is the range we observed for 1987–2001), we would 

increase or reduce our estimate of taxable share to 24.7 percent or 23.4 percent.35

V. Areas for Further Research 

A. Retirement Account and Plan Holdings 

Retirement accounts and plans held about 37 percent of U.S. stock in 2015, worth 

roughly $8.4 trillion. Over the last 30 years, IRAs grew faster than other components, partly due to rollovers of assets from defined contribution plans. 

Retirement accounts are effectively nontaxable, including both (i) Roth and traditional IRAs and (ii) defined-contribution and defined-benefit retirement plans. In 

general, investment returns in these retirement accounts are tax-free in two different manners: either (1) contributions to Roth IRAs and Roth 401(k) plans are 

nondeductible and earnings are nontaxable; or (2) contributions to traditional IRAs 

or 401(k) plans are deductible and earnings are taxable upon withdrawal. If account 

owners face the same tax rate when they contribute to or withdraw from their accounts, the two forms of retirement savings are economically equivalent; the benefit 

of a Roth plan’s full tax exclusion for withdrawals equals the benefit of a deductible 

plan’s tax deduction for contributions. 


51716.005
64 

36 Individuals typically make portfolio investments. Corporations, such as foreign multinationals, typically make direct investments, which are controlling interests of a U.S. company. 

The Fed’s exclusion of foreign direct holdings is consistent with its exclusion of intercorporate 

holdings of public securities. 37 In limited instances, foreign shareholders are subject to tax on their gains under section 

897 (the 1980 Foreign Investment in Real Property Tax Act). 38 If we added foreign direct investment to our denominator, the taxable ownership of U.S. 

stock would fall from 24.2 percent to 19.9 percent. If we added U.S. intercompany holdings, our 

share would drop even further. 

B. Foreign Holdings 

Foreigners owned about 26 percent of U.S. stock in 2015, worth about $5.8 trillion. Foreign multinational corporations owned another $4.6 trillion of ‘‘direct’’ investments in U.S. companies (direct interests are controlling interests in U.S. companies, 10 percent or more). Like the Fed, we counted portfolio stock in corporate 

equity but not foreign direct investment (just as we do not count U.S. intercompany 

holdings).36

We treated foreigners as nontaxable as their income from stock generally is not 

subject to U.S. tax—or subject to just a little tax.37 Their stock gains almost always 

are exempt from taxation. Their dividends are subject to a 30 percent U.S. withholding tax for portfolio investments, which is typically reduced, by treaty, to 15 

percent, or for direct investment, to 5 percent (or sometimes to zero). Further research is necessary to unravel the foreign ownership trend, especially the sizable 

increase in direct ownership (which might suggest more foreign multinational holdings of U.S. companies, perhaps resulting from inversions).38

C. Nonprofit Holders 

From 1988 to 2000, the Fed used data from the IRS and surveys to separate holdings of corporate equities by nonprofits from holdings by households. We could not 

find better data on holdings by nonprofits, so we extended the 4.9 percent average 

from the earlier nonprofit Fed data to more recent estimate holdings. However, in 

recent years, nonprofits have shifted the mix of equities they own. Starting in 2006, 

the IRS separated security holdings of nonprofits into publicly traded securities 

(which include both stock and bonds) and other securities (which include holdings 

of private equity funds and hedge funds). Over the 6-year period for which data are 

available, nonprofit holdings of other securities have nearly tripled. Further research might help unravel this trend. 

D. Cost of Corporate Capital Across Countries 

A key reason to pursue business tax reform is to lower U.S. corporate tax rates, 

in order to make U.S. corporate taxes more competitive with other countries. Many 


51716.006
65 

39 Jane G. Gravelle, ‘‘International Corporate Tax Rate Comparisons and Policy Implications,’’ 

Congressional Research Service, Jan. 6, 2014 (comparing and describing corporate statutory, effective, and marginal tax rates, but not shareholder tax rates). 

commentators gauge U.S. tax competitiveness by comparing just corporate income 

taxes to foreign corporate income taxes (whether statutory, effective, or marginal).39

But, as noted earlier, the effective tax rate on corporate earnings depends on both 

the corporate and shareholder income taxes. Today, in the United States, relatively 

few shareholders pay the second level of tax on corporate earnings. Those few only 

pay at the reduced rate for qualified dividends and long-term capital gains. 

To fully compare the U.S. tax burden on corporate earnings to foreign tax burdens, we might also compare the combined corporate and shareholder effective 

taxes. In some instances, this comparison may provide a better gauge of U.S. tax 

competitiveness. For example, some countries may tax corporate earnings more fully 

at the shareholder level, which could increase the cost of corporate capital in their 

countries (if their corporations depend substantially on local capital markets). More 

research is necessary to determine the relative U.S. and foreign tax burden on corporate earnings. 

Figure 4. Comparing Effective Tax Rates Across Countries, 2015 

Corporate 

Income Tax 

Rate 

Personal 

Dividend 

Income Tax 

Rate 

Capital 

Gains Tax 

Rate 

Effective 

Corporate 

and 

Shareholder 

Tax Rate 

Integrated 

Tax System 

Canada 26.3% 39.3% 22.6% ? Full credit imputation 

France 34.4% 44% 34.4% ? Partial dividend exemption 

Germany 30.2% 26.4% 25% ? Classical 

Italy 27.5% 26% 26% ? Classical 

Japan 32.1% 20.3% 20.3% ? Modified classical system 

United Kingdom 20% 30.6% 28% ? Partial credit imputation 

United States 39% 30.3% 28.7% ? Modified classical system 

G–7 excluding U.S.* 29.1% 29.1% 25.5% ? 

* Weighted by 2015 GDP. 

Note: Tax rates are combined national and subnational. 

Sources: OECD Tax Database, Tables II.1 and II.4; OECD Quarterly National Accounts: Historical GDP—Expenditure Approach; Tax Foundation, ‘‘Eliminating Double Taxation Through Corporate Integration.’’ 

VI. Conclusion 

The Fed’s Financial Accounts data, as well as economic observers, report that 

households own most of the market value of outstanding corporate equity. While 

correct, that category is much different from taxable accounts. After adjusting the 

data in several important respects, we estimated that taxable accounts held only 

24.2 percent of C corporation equity in taxable accounts in 2015. Our exercise revealed that the share of U.S. stocks held by taxable accounts declined sharply over 

the last 50 years, by more than two-thirds. 

This sizable decrease affects many of the current tax policy debates, including 

how to structure a revenue-neutral corporate integration regime and, more generally, how we tax capital. We believe policymakers should carefully consider this 

decline. 

Appendix 1: Methods, Data Sources, and Assumptions 

To estimate the fraction of C corporation stock held in taxable accounts, we started with the measure of corporate equity reported by the Fed and subtracted the foreign and passthrough equity issues. We next subtracted stock holdings of nonprofits, 

IRAs, and section 529 accounts. Finally, we added the stock held in taxable accounts 

(indirectly) through mutual funds, CEFs, and ETFs. In total, for 2015, we estimated 

66 

40See Federal Reserve, supra note 6, at Table L.223, n.5. Thus, foreign stock is 22.45 percent 

of the holdings of U.S. residents ($6,732 /($35,687–$5,707)). 

that taxable accounts held $5.5 trillion of the $25.8 trillion of C corporation stock, 

or 24.2 percent. 

First, we subtracted the $6.7 trillion of foreign stock held by U.S. residents from 

the $35.7 trillion of total outstanding corporate stock. We assumed thatU.S. investors held the same proportion of domestic and foreign stock and, thus, subtracted 

the $6.7 trillion proportionately from their holdings. We did not subtract any foreign 

stock from the $5.7 trillion of foreign holders because the Fed does not count the 

foreign stock held by foreigners.40

Step 1. Subtract Foreign Stock Held by U.S. Residents 

(2015, market value in billions of dollars) 

All Corporate Equity ¥ Foreign Equity = U.S. Equities 

All holders $35,687 ($6,732) $28,955 

Household and nonprofit $13,311 ($2,989) $10,322 

Insurance companies $2,087 ($469) $1,618 

Defined benefit plans $3,295 ($740) $2,555 

Defined contribution plans $1,623 ($364) $1,258 

Foreigners $5,707 $0 $5,707 

Other $481 ($108) $373 

Mutual funds $7,327 ($1,645) $5,682 

Closed-end funds $100 ($22) $77 

Exchange-traded funds $1,756 ($394) $1,362 

Step 2. Subtract Passthrough Holdings From Investors 

(2015, market value in billions of dollars) 

Take Out Passthroughs 

U.S. 

Equities ¥ S Corporation Equity ETFs CEFs REITs = 

U.S. 

C Corporation 

Equity 

All holders $28,955 ($2,838) ($2,106) ($206) ($939) $22,812 

Household and nonprofit $10,322 ($2,838) ($1,331) ($164) ($207) $5,781 

Insurance companies $1,618 ($43) ($5) ($131) $1,439 

Defined benefit plans $2,555 ($297) ($37) ($33) $2,189 

Defined contribution 

plans 

$1,258 ($275) ($34) ($33) $917 

Foreigners $5,707 ($95) ($12) ($56) $5,543 

Other $373 ($64) ($8) ($56) $245 

Mutual Funds $5,682 ($310) $5,372 

Closed-end funds $77 $77 

Exchange-traded funds $1,362 ($113) $1,249 

67 

41 As a general matter, nonprofits do not own S corporations because of a special tax on the 

income of S corporations for nonprofits—which does not apply to employee stock ownership 

plans. 42Federal Reserve, supra note 6, at Table L.224. 43See Citi Research, ‘‘REITs for Sale,’’ at Figure 4 (September 11, 2015) (available upon request). REITs own a pool of real estate assets, not stocks. Moreover, the profile of the investors 

that own REITs differs somewhat from the profile of investors in mutual funds, ETFs, and 

CEFs. 44The other cross-holdings are small. Legally, mutual funds, ETFs, and CEFs can hold only 

a small amount of shares of each other. See section 12(d)(1) of the Investment Company Act 

of 1940. 45Later, we distribute some of the mutual funds’ and exchange-traded funds’ holdings of 

REITs to the household sector. 46See Federal Reserve, supra note 6, at Table L.101.a, lines 13–14. Total securities from IRS 

Forms 990 included U.S. and foreign stocks and bonds. 47See EY, ‘‘Contribution of S ESOPs to Participants’ Retirement Security’’ (March 2015). 48The Fed follows this method to value closely held stock. 

Second, we subtracted the value of stock issued by S corporations, ETFs, CEFs, 

and REITs. Because only individuals and some nonprofits hold S corporation stock, 

we subtracted the $2.8 trillion of S corporation equity from only the household and 

nonprofit categories.41

The Financial Accounts data do not allocate ETF and CEF equity across owners. 

Instead, we assumed investors owned the ETFs and CEFs in the same proportions 

as the investors that own mutual funds, which the Fed reports. For 2015 households 

and nonprofits held 63 percent of mutual funds, so we assumed the households and 

nonprofits likewise held 63 percent of ETFs and CEFs, or $1.5 trillion.42

We estimated the investor ownership of REITs based on a 2015 Citibank report.43

According to that report, mutual funds and ETFs are the predominant owners of 

REITs.44 We subtracted $207 billion of outstanding REIT issues in 2015 from the 

household sector and another $732 billion from other investors, after redistributing 

the mutual fund and ETF holdings of REITs.45

Third, we subtracted nonprofit holdings from the Fed’s household category. From 

1988 to 2000, the Federal Reserve estimated corporate equities held by nonprofits 

based primarily on Forms 990 that nonprofits filed with the IRS.46 During that period, the share of equities held by nonprofits as a share of all domestic and foreign 

C corporation equities ranged from 4.4 percent to 5.7 percent. From 2001 to 2015 

and before 1988, we used the 4.9 percent average ratio to estimate domestic and 

foreign equity holdings of nonprofits, which totaled $1.5 trillion in 2015. 

We added our estimate of $327 billion of foreign equities held by nonprofits to the 

$1.5 trillion to avoid removing those equities twice (once as foreign stock and again 

as nonprofit stock). We also adjusted nonprofit holdings by $49 billion to reflect that 

we previously subtracted issues of CEFs, ETFs, and REITs from the household and 

nonprofit sector. 

We also added back to our estimate of nonprofit equity their holdings of S corporation equity through employee stock ownership plans, using data from EY and 

the Labor Department.47 We estimated that the market value of ESOPs was double 

the amount of net assets and attributed this entire amount, $124 billion in 2015, 

to the nonprofit sector.48

Step 3. Subtract Stock Held by Nonprofits 

(2015, market value in billions of dollars) 

Total household and nonprofit holdings of C corporation equity $5,781 

¥Nonprofit holdings of corporate equity (other than mutual funds) ($1,455) 

+ Foreign stock held by nonprofits, already subtracted $327 

+ ETFs held by nonprofits, already subtracted $18 

+ CEFs held by nonprofits, already subtracted $2 

68 

49See Investment Company Institute, ‘‘Report: The U.S. Retirement Market, Fourth Quarter 

2015,’’ at Table 7 (March 24, 2016). 50 Brad M. Barber and Terrance Odean, ‘‘Are Individual Investors Tax Savvy? Evidence From 

Retail and Discount Brokerage Accounts,’’ 88 J. Pub. Econ. 419 (2003) (finding that 74 percent 

of brokerage assets were stock). 51 (C corporation equity/(the sum of C corporation equity, REIT equity, ETF equity, and CEF 

equity)). 52Federal Reserve, supra note 6, at Table B.101. 53 Id. at Table B.101.e. 

Step 3. Subtract Stock Held by Nonprofits—Continued 

(2015, market value in billions of dollars) 

+ REITs held by nonprofits, already subtracted $28 

+ S Corp shares held by ESOPs, already subtracted $124 

Household direct holdings of C corporation equities $4,826 

Fourth, we subtracted the stock held in self-directed IRAs based on data from the 

Investment Company Institute, which lists IRA assets by type of institution: mutual 

funds, bank and thrift deposits, life insurance companies, and ‘‘other assets’’ (selfdirected accounts).49

To estimate the amount of C corporation equity in other assets, we took a few 

extra steps: 

1. We assumed that 75 percent of the other assets are stock held through selfdirected accounts.50

2. We assumed that equity in self-directed accounts comprises C corporation equity, ETF equity, CEF equity, and REIT equity. We focused on C corporation 

equity (because we had previously removed the other issuances). We assumed 

self-directed accounts held C corporation equity in the same proportion as the 

equity universe.51 In 2015 that was 87 percent. 

3. We reduced our estimate for foreign equity ownership (assuming that all U.S. 

investors held the 22.45 percent of their equity in foreign equity). As a result, 

we removed $1.5 trillion of C corporation equity held in IRAs from the household sector. 

We also subtracted equity holdings of section 529 accounts that are included in 

the residual household sector. The Fed separates assets held in section 529 college 

plans into assets held in college savings plans and assets held in prepaid tuition 

plans.52 We assumed that half of the assets in college savings plans were C corporation equity and subtracted $89 billion from household holdings in 2015. 

Step 4. Subtract Holdings by IRAs and Section 529 Accounts of C Corporation Stock 

(2015, market value in billions of dollars) 

Household direct holdings of C corporation equities (from Step 3) $4,826 

• Corporate equities in self-directed IRAs ($1,479) 

• Corporate equities held in 529 plans ($89) 

Taxable direct C corporation holdings $3,257 

Finally, we added the stock that taxable accounts held beneficially through mutual funds, CEFs, and ETFs. 

The Fed categorized mutual funds as a separate holder of corporate equity.53 We 

added $1.6 trillion of the mutual funds’ holdings of corporate stock to taxable accounts. We did not add the stock holdings of mutual funds that are attributable to 

nonprofits, IRAs, insurance companies, pension funds, and foreigners. 

69 

54 Id. at Table L.223, lines 18 and 19. 

The Fed also separately listed ETFs and CEFs as owners of corporate equity.54

We assumed that the household sector held 63 percent of ETF and CEF assets. 

Thus, we added $645 billion of CEF and ETF holdings to the household sector (but 

excluded the equity holdings of nonprofits, IRAs, insurance companies, pension 

funds, and foreigners). 

Step 5. Add Indirect Holdings of C Corporation Equity 

(2015, market value in billions of dollars) 

Taxable C corporation holdings $3,257 

+ Mutual fund holding of equities (except those mutual funds held by nonprofits, IRAs, insurance companies, pension funds, and foreigners) $1,600 

+ Closed-end fund holding of equities (except those CEFs held by nonprofits, IRAs, insurance 

companies, pension funds, and foreigners) $39 

+ ETF holding of equities (except those ETFs held by nonprofits, IRAs, insurance companies, 

pension funds, and foreigners) $630 

Taxable account direct and indirect C corporation holdings $5,525 

Thus, we calculated that taxable accounts hold $5.5 trillion, or 24.2 percent of the 

$22.8 trillion in taxable accounts of C corporation stock. 

Appendix 2: Hedge Fund/Private Equity Holdings 

In theory, we should (1) subtract from taxable accounts the share of U.S. stock 

of U.S. funds held beneficially by nontaxable accounts (the blue box in Figure A1) 

and (2) add to taxable accounts the share of the U.S. stock of foreign funds that 

is held beneficially by U.S. taxable accounts (the orange box in Figure 6). However, 

the actual holdings, owners, and residence of the funds are not publicly available, 

so we could not estimate the size of the boxes. Because we lacked detailed data, we 

did not adjust for the misallocation of the partnership holdings in our main estimates. 


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55 U.S. and foreign funds with 50 percent U.S. taxable partners are plausible, because both 

U.S. general partners and U.S. limited partners may be U.S. taxable investors. For example, 

a general partner often gets a profits interest to manage a fund (the ‘‘20’’ in ‘‘2 + 20’’). As a 

result, a U.S. general partner typically earns capital gains and dividend income on its profits 

interest, which is taxed at reduced rates. That said, U.S. limited partners generally invest 

through U.S. funds, and nonprofits and foreigners generally invest through foreign funds. 56 In theory, we still ought to slightly adjust the holdings of subcategories of tax-exempt owners (e.g., nonprofits, foreigners, etc.)—which we lack the data to accomplish. 57Preqin, ‘‘2016 Global Private Equity and Venture Capital Report’’; and BarclayHedge, 

‘‘Hedge Fund Industry—Assets Under Management.’’ 58Michael Cooper et al. recently tried to untangle the ownership of partnerships, with some 

difficulty. They explain that partnerships ‘‘constitute the largest, most opaque, and fastest growing type of pass-through.’’ Cooper et al., ‘‘Business in the United States: Who Owns It and How 

Much Tax Do They Pay?’’ (October 2015). 

As illustrated in Figure A1, for our estimate, we could assume the assets, owners, 

and residence funds are split evenly.55 As a result, the blue and orange boxes are 

the same size and cancel each other out. Thus, by adjusting in this manner, our 

estimate would remain at 24.2 percent.56

We could test the sensitivity of our estimate by varying the split of assets, owners, 

and residence of hedge funds and private equity funds. From industry sources, we 

estimated that the total assets managed by hedge funds and private equity funds 

were $5.8 trillion in 2015.57 In Figure A2, we again split the assets and residence 

of the hedge funds and private equity funds evenly—but assumed only 25 percent 

U.S. taxable owners of the foreign funds. With this change, our taxable share fell 

to 22.7 percent in 2015. 

However, U.S. and foreign assets under the management of hedge funds and private equity funds have increased greatly over the last few years—highlighting their 

growing importance for stock ownership (see Figure A3). Further research and data 

on their assets, partners, and residence would help provide a clearer picture of who 

owns U.S. corporate stock.58


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1See e.g., Michael J. Graetz and Alvin C. Warren, Integration of the U.S. Corporate and Individual Income Taxes: The Treasury Department and the American Law Institute Reports (1998). 2See Republican Staff of the Senate Finance Committee, Comprehensive Tax Reform for 2015 

and Beyond at 122–237, 113th Cong., S. Prt. No. 113–31 (December 2014). 3See Joint Committee on Taxation, Overview of Approaches to Corporate Integration at 32 

(JCX–44–66) (May 13, 2016). 4These same tax challenges exist whether or not Congress adopts a dividends paid deduction 

regime, retains its classic double taxation of corporate earnings, or bolts on a territorial tax reContinued 

PREPARED STATEMENT OF BRET WELLS, ASSOCIATE PROFESSOR OF LAW, LAW CENTER, UNIVERSITY OF HOUSTON

My name is Bret Wells, and I am an Associate Professor of Law at the University 

of Houston Law Center. I would like to thank Chairman Hatch, Senator Wyden, and 

the other members of the committee for inviting me to testify. I am testifying in 

my individual capacity, and so my testimony does not represent the views of the 

University of Houston Law Center or the University of Houston. I request that my 

full written testimony be included in the record. 

Our tax system is in need of fundamental tax reform. Finding a path to rationalize the taxation of active business income in the United States is an important 

goal, and integration of shareholder and corporate taxation can achieve that goal. 

Corporate integration has been extensively studied for decades by prior administrations, the American Law Institute, and numerous highly respected academics—one 

of whom joins me on this panel.1 As this committee’s staff has recently written,2

a broad consensus exists that significant efficiencies can be achieved through corporate integration. Thus, before one gets enmeshed in the important details of how 

to create an appropriately functioning corporate integration regime, it is important 

to say that reform along these lines can significantly improve our tax system. Focusing specifically on the dividends paid deduction regime, this particular method of 

achieving corporate integration would, as to distributed earnings, harmonize the tax 

treatment between debt and equity and would level the playing field between passthrough entities and C corporations.3 There is much to commend this proposal. 

I. THREE KEY INTERNATIONAL TAX CHALLENGES

But, notwithstanding the potential benefits of a corporate integration regime, the 

reality is that business tax reform must carefully consider the international tax implications of any new paradigm, and to that end the United States must ensure that 

its tax regime withstands at least the following three systemic international tax 

challenges.4


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gime to either of these two paradigms. For a more in-depth analysis of my views of the base 

erosion and profit shifting challenges created under a territorial tax regime, see Bret Wells, 

‘‘Territorial Taxation: Homeless Income is the Achilles Heel,’’ 12 Hous. Bus. and Tax L.J. 1 

(2012). 5My views on the genesis of the ‘‘Homeless Income mistake’’ and its solution are set forth 

in Bret Wells and Cym Lowell, Tax Base Erosion and Homeless Income: Collection at Source 

is the Linchpin, 65 Tax Law Rev. 535 (2012). 6For a more in-depth discussion of my views on the corporate inversion phenomenon and 

what it means to U.S. tax policy, see Bret Wells, ‘‘Corporate Inversions and Whack-a-Mole Tax 

Policy,’’ 143 Tax Notes 1429 (June 23, 2014); Bret Wells, ‘‘Cant and the Inconvenient Truth 

About Corporate Inversions,’’ 136 Tax Notes 429 (July 23, 2012); Bret Wells, ‘‘What Corporate 

Inversions Teach Us About International Tax Reform,’’ 127 Tax Notes 1345 (June 21, 2010). 7For a more in-depth assessment of my views on the international tax implications of a dividends paid deduction proposal, see Bret Wells, ‘‘International Tax Reform By Means of Corporate Integration,’’ 19 Fla. Tax Rev. (2016) (forthcoming), available at http://papers.ssrn.com/ 

sol3/papers.cfm?abstract_id=2766618. 8 Consequently, companies in this posture may forgo the dividend deduction allowed under the 

dividends paid deduction regime and instead rely on the U.S. foreign tax credit regime to offset 

a substantial portion of its corporate level tax and in turn might then distribute cash to shareholders through share repurchases that are eligible for section 302 treatment. This strategy 

would provide shareholders the potential for favorable capital gains treatment and in any event 

First, a critical international tax challenge is the inbound earning stripping challenge,5 and this earning stripping challenge can be further categorized along the following types of base erosion strategies: (1) related party Interest Stripping Transactions; (2) related party Royalty Stripping Transactions; (3) related party Lease 

Stripping Transactions; (4) Supply Chain restructuring exercises; and (5) related 

party Service Stripping Transactions. 

The second key international tax challenge relates to corporate inversions.6 Corporate inversions are often categorized as a discreet, stand-alone tax policy problem, 

but, in my view, the corporate inversion phenomenon provides unmistakable evidence of the enormity of the inbound earning stripping advantage that exists for all 

foreign-based multinational corporations. A foreign-based multinational corporation 

can engage in an inbound related party Interest Stripping Transaction, an inbound 

related party Royalty Stripping Transaction, and an inbound related party Lease 

Stripping Transaction without any concern about the U.S. subpart F regime, whereas these very same inbound transactions would create a subpart F inclusion if conducted by a U.S. multinational corporation. Corporate inversions represent an effort 

by U.S. multinational corporations to place their U.S. businesses into an overall corporate structure that affords them the full range of inbound U.S. earning stripping 

techniques without being impeded by the backstop provisions of the U.S. subpart 

F rules. 

Third, fundamental tax reform must deal with the so-called lock-out effect. 

II. INTERNATIONAL IMPLICATIONS OF DIVIDENDS PAID DEDUCTION REGIME 7

As to the earning stripping challenge and its alter ego the corporate inversion 

phenomenon, the dividends paid deduction regime, by itself, does not equalize the 

tax position of a U.S. multinational corporation with that of a foreign-based multinational corporation. Even though the dividends paid deduction regime provides a 

corporate level tax deduction for dividend payments, the dividend payment is subject to a corresponding shareholder withholding tax. In comparison, a foreign-based 

multinational corporation can engage in all five of the previously enumerated earning stripping strategies to create a comparable U.S. corporate tax deduction without 

incurring a corresponding withholding tax. Thus, the dividends paid deduction regime does not eliminate the financial advantages that motivate earning stripping 

or that fuel the corporate inversion phenomenon. In order to address these two key 

international tax challenges, the United States must impose an equivalent withholding tax, or a surtax, on all of the related party base erosion strategies and not 

just on Interest Stripping Transactions or Royalty Stripping Transactions. 

As to the lock-out effect, the dividends paid deduction regime should substantially 

eliminate the lock-out effect with respect to the repatriation of low-tax foreign earnings. For companies that repatriate a significant amount of low-tax foreign income, 

the dividends paid deduction regime will likely represent a net benefit versus existing law. But, outside that low foreign tax context, the interplay of the dividends 

paid deduction regime with the U.S. foreign tax credit regime creates complex tradeoffs. In particular, where a high percentage of a company’s total income constitutes 

foreign income that has been subjected to high foreign taxes, the dividends paid deduction regime likely represents a net cost over existing law.8

73 

avoids the new shareholder dividend withholding tax. The interplay of whether to utilize the 

foreign tax credit regime to offset corporate level tax or instead to rely on the dividend paid 

deduction regime creates a new complexity. 

Finally, under a dividends paid deduction regime, a new tax design challenge will 

be added to our tax laws. In this regard, to the extent that the shareholder withholding tax can be cross-credited against the shareholder’s residual income tax liability arising from other income, the marketplace will attempt to structure transactions that will exploit that cross-crediting opportunity and, if successful, will create a new set of tax distortions to plague the U.S. tax laws. Thus, if a dividends 

paid deduction regime were adopted, it would be important to ensure that the incidence of the shareholder dividend withholding tax cannot be shifted, cross-credited 

against other shareholder income, monetized, or reduced. Congress is likely to receive pleas from various constituencies to exempt specific sympathetic groups from 

the shareholder dividend withholding tax or the complimentary taxes that would 

need to be imposed on all base erosion payments, but Congress must resist those 

calls or else another source of tax distortions will be created through the tax system. 

III. CONCLUSION

Let me conclude my oral testimony by stating that an appropriately structured 

corporate integration regime has much to offer. The committee is to be commended 

for considering fundamental business tax reform, but at the same time this committee must ensure that the dividends paid deduction regime is structured to withstand the systemic international tax challenges that face the United States. Thank 

you for allowing me to speak at today’s hearing. I would be happy to answer any 

of your questions. 

PREPARED STATEMENT OF HON. RON WYDEN, A U.S. SENATOR FROM OREGON

This morning the Finance Committee will discuss the concept of corporate integration, which isn’t exactly a topic that comes up at summer picnics. But this issue 

is important to the tax reform debate, and I want to thank Chairman Hatch and 

his staff for putting a whole lot of sweat equity into this topic. I’m glad the committee will have this opportunity today to dig into the specifics. Today I want to 

begin mostly with questions about what corporate integration would mean for 

middle-class families and small businesses looking for opportunities to get ahead. 

Corporate integration is about eliminating what some people call double taxation, 

where income is taxed once at the corporate level and again at the individual level. 

Once in place, this kind of tax change would allow companies to write off payments 

they make to shareholders in the form of dividends. The theory goes, the profit corporations bring in would go out as dividends, and corporate tax bills would shrink. 

But to finance that big corporate tax cut, 35 percent of the money paid out in dividends and bond interest would be withheld automatically by the Treasury. 

Now this raises a question with respect to retirement savings. 

It looks, on its face, like this proposal could go from double taxing corporate income to double taxing retirement plans. Here’s why. Today, most middle-class savers put their money into retirement plans that are tax-deferred. It’s a good deal for 

workers, and this country’s savings crisis would probably be a lot worse without it. 

Retirement plans invest in a lot of stocks and bonds. But under a corporate integration plan, when you withhold a chunk of the dividends and interest payments that 

go to retirement plans, suddenly they could get hit with a big, new tax bill for the 

first time. Their special tax-deferred status—which today is the key that unlocks opportunities to save for millions of Americans—would go away. 

Right now, most savers already face a tax bill when they take money out of their 

accounts. Corporate integration could often add a second tax hit up front. So if 

you’re an electrician in Medford or a teacher in Salem and you’ve got an IRA or 

a 401(k), you’d have to wonder if this system says the dollar you socked away is 

worth less than it used to be. If the math on retirement plans suddenly looks worse 

to small business owners, there’s a possibility they might think twice about offering 

a plan to their employees. 

There is another question whether corporate integration could wind up picking 

winners and losers in how it affects businesses. Companies that run airlines and 

wind farms, which need capital to invest and operate, would face higher costs if inVerDate Mar 15 2010 17:15 Jun 13, 2017 Jkt 000000 PO 00000 Frm 00077 Fmt 6601 Sfmt 6621 R:\DOCS\25795.000 TIMD
74 

terest rates jump. And start-ups may not necessarily want to pay dividends to 

shareholders because they need to turn their earnings into growth instead of dividends. A corporate integration plan might look great to established companies with 

lots of cash, but not so hot to the small businesses that dominate the economic landscape in Oregon and in hundreds of communities across the country. These are big 

issues to discuss today. 

I want to thank our witnesses for being here this morning, and I look forward 

to hearing their testimony. And before I conclude, I want to recognize one of our 

witnesses today, Judy Miller, who is retiring at the end of the summer. Judy served 

as a senior pension advisor to this committee under Senator Baucus for 41⁄2 years. 

She’s also testified before the committee a number of times. I’d like to congratulate 

and thank Judy for her service and invaluable advice over the years and wish her 

well in the future. 

(75) 

COMMUNICATION

CENTER FOR FISCAL EQUITY

237 Hannes Street, Silver Spring, Maryland 20901 

Comments for the Record by Michael Bindner 

Chairman Hatch and Ranking Member Wyden, thank you for the opportunity to address this topic. The Center for Fiscal Equity believes that dealing with the question 

of taxing dividends is a key issue in constructing tax reform legislation and ultimately in achieving comprehensive deficit reduction. 

As always, our proposals come within the context of our four-point tax reform and 

deficit reduction plan: 

• A Value Added Tax (VAT) to fund domestic military spending and domestic discretionary spending with a rate between 10% and 13%, which makes sure very 

American pays something. 

• Personal income surtaxes on joint and widowed filers with net annual incomes 

of $100,000 and single filers earning $50,000 per year to fund net interest payments, debt retirement and overseas and strategic military spending and other 

international spending, with graduated rates between 5% and 25% in either 5% 

or 10% increments. Heirs would also pay taxes on distributions from estates, 

but not the assets themselves, with distributions from sales to a qualified ESOP 

continuing to be exempt. 

• Employee contributions to Old-Age and Survivors Insurance (OASI) with a 

lower income cap, which allows for lower payment levels to wealthier retirees 

without making bend points more progressive. 

• A VAT-like Net Business Receipts Tax (NBRT), essentially a subtraction VAT 

with additional tax expenditures for family support, health care and the private 

delivery of governmental services, to fund entitlement spending and replace income tax filing for most people (including people who file without paying), the 

corporate income tax, business tax filing through individual income taxes and 

the employer contribution to OASI, all payroll taxes for hospital insurance, disability insurance, unemployment insurance and survivors under age 60. 

We do not believe that providing a tax cut for dividends to corporations is appropriate at this or any other time. Such a tax cut could not be duplicated for passthrough businesses, partnerships and sole proprietorships—the majority of business 

taxpayers. It would foreclose the possibility of enacting consumption taxes, which 

tax labor and capital at the same rate. Indeed, such a deduction would essentially 

turn consumption taxes into a payroll tax, provided that all profits were distributed 

as dividends (which is actually a proposal for followers of Louis Kelso and his Two 

Factor Theory). This proposal is exactly the wrong way to go in this Congress, where 

it would be vetoed by the sitting President. 

The Center for Fiscal Equity believes that lower dividend, capital gains, and marginal income taxes for the wealthy actually destroy more jobs than they create. This 

occurs for a very simple reason—management and owners who receive lower tax 

rates have more an incentive to extract productivity gains from the work force 

through benefit cuts, lower wages, sending jobs offshore or automating work. As 

taxes on management and owners go down, the marginal incentives for cost cutting 

go up. As taxes go up, the marginal benefit for such savings go down. It is no accident that the middle class began losing ground when taxes were cut during the 

Reagan and recent Bush administrations, both of which saw huge tax cuts. Keeping 

these taxes low is also part of why we are experiencing a recovery performing at 

half speed now. 

76 

As long as management and ownership benefit personally from cutting 

jobs, they will continue to do so. Tax reform must reverse these perverse 

incentives. 

Tax cuts on capital also produce a host of bad investments that would not otherwise 

occur. Every major asset bubble, including the 2008 recession, arose from dividend 

and capital gains taxes that were too low. If capital is needed for business because 

of a demand driven expansion, the Federal Reserve is quite able to make this happen. Fiscal policy is not, and never has been, the answer to making credit available 

for expansion. 

Our Principal Analyst served on the Computer-Aided Manufacturing—International 

Cost Management System Project, part of which was the Multi-Attribute Decision 

Model for investment. Cost of capital was not a major driver. Customers who are 

able and willing to spend had a much greater impact on why investment should 

take place. There is one word which typifies an investment manager who follows 

supply-side economic theory in recommending business investments: unemployed. 

Double-taxation of dividends by taxing as value-added and as income to the 

shareholder is a myth, and a bad one at that. 

If corporate income taxes were expanded to be a subtraction VAT or net business 

receipts tax that all firms pay, an additional tax on shareholders is merely a surtax 

paid because there is no other way to fully tax profit at the business level without 

doing major damage to equity and privacy. 

In testimony before the Senate Budget Committee, Lawrence B. Lindsey explored 

the possibility of including high income taxation as a component of a Net Business 

Receipts Tax. The tax form could have a line on it to report income to highly paid 

employees and investors and pay surtaxes on that income. 

The Center considered and rejected a similar option in a plan submitted to President Bush’s Tax Reform Task Force, largely because you could not guarantee that 

the right people pay taxes. If only large dividend payments are reported, then diversified investment income might be under-taxed, as would employment income from 

individuals with high investment income. Under collection could, of course, be overcome by forcing high income individuals to disclose their income to their employers 

and investment sources—however this may make some inheritors unemployable if 

the employer is in charge of paying a higher tax rate. For the sake of privacy, it 

is preferable to leave filing responsibilities with high income individuals. 

Accomplishing deficit reduction with income and inheritance surtaxes recognizes 

that attempting to reduce the debt through either higher taxes on or lower benefits 

to lower income individuals will have a contracting effect on consumer spending, but 

no such effect when progressive income taxes are used. Indeed, if progressive income 

taxes lead to debt reduction and lower interest costs, economic growth will occur as 

a consequence. 

Using this tax to fund deficit reduction explicitly shows which economic strata owe 

the national debt. Only income taxes have the ability to back the national debt with 

any efficiency. Payroll taxes are designed to create obligation rather than being useful for discharging them. Other taxes are transaction based or obligations to fictitious individuals. Only the personal income tax burden is potentially allocable and 

only taxes on dividends, capital gains and inheritance are unavoidable in the long 

run because the income is unavoidable, unlike income from wages. 

Even without progressive rate structures, using an income tax to pay the national 

debt firmly shows that attempts to cut income taxes on the wealthiest taxpayers do 

not burden the next generation at large. Instead, they burden only those children who will have the ability to pay high income taxes. In an increasingly 

stratified society, this means that those who demand tax cuts for the wealthy 

are burdening the children of the top 20% of earners, as well as their children, with the obligation to repay these cuts. That realization should have 

a healthy impact on the debate on raising income taxes rather than carving 

out even more tax breaks for the wealthy, such as making dividends deductible in the corporate income tax. 

Thank you for the opportunity to address the committee. We are, of course, available for direct testimony or to answer questions by members and staff. 

Æ