What Kind of Tax Reform Do We Really Need?

Abstract

>. The Treasury's well-leaked September options paper set forth several proposals affecting corporations, among them an extension of the investment tax credit to include bricks and mortar, a small reduction in the basic corporate tax rate, relief from the double taxation of corporate dividends and elimination of the infamous lunch as a tax deductible expense. The most novel proposal is the reduction in the double taxation of dividends. Under most approaches to the of corporate and shareholders' income taxation, shareholders would gain. In addition to the corporation's dividend, each would receive, for some portion of the actual U.S. taxes paid by the corporation, a tax credit of the same dollar amount per share. The shareholder could use this credit to reduce his federal tax liability, dollar for dollar, on wages and salary as well as on dividend income. Unfortunately, partial integration has several drawbacks. To begin with, the importance of the tax credit depends on the investor's marginal income tax bracket: A per-share credit of a given amount will offset a larger portion of the lower tax bracket investor's tax. Then too, net of the credit, the low bracket investor's tax will be an even smaller fraction of the higher bracket investor's than it is now-a result that hardly seems compatible with the President's avowed intention of creating a fairer tax code. Furthermore, the tax credit will have no value at all to investors who do not pay U.S. income taxes. Corporations that pay low effective U.S. income taxes, such as financial institutions holding taxexempt municipals and multinational corporations paying the bulk of their taxes to foreign governments, would be at a disadvantage in competing for capital against corporations bearing the same overall tax rate, but paying a higher proportion of their total tax bill to the U.S. government. The simple way to benefit corporate capital investment is to cut the basic 48 per cent tax rate. Coupled with some trimming in personal income tax rates, such a cut could speed up the pace of economic activity, eventually generating higher revenues that would largely offset the Treasury's initial revenue loss. A reduction in the corporate tax rate would also reduce the value of business tax preferences and expense deductions including three-martini lunches. o