The President’s Jobs and Growth Plan: Increasing Savings and Investment
The President’s Jobs and Growth plan would strengthen the economy and help generate more jobs. A centerpiece of the plan is the proposal to eliminate the double taxation of corporate earnings. Addressing this bias reduces the cost of capital and increases savings and investment.
The Problem
When a corporation earns a profit, it pays a tax as high as 35 percent on those earnings.
When that corporation pays dividends to its shareholders, they in turn pay tax on those distributions.
Alternatively, if the corporation retains those after tax-earnings, shareholders are taxed on the increased value of their shares due solely to after-tax retained earnings.
In both cases, income earned by corporations is taxed twice, both at the corporate and shareholder level. The cumulative tax is up to 60 percent on dividends and up to 48 percent on retained earnings.
This double taxation creates a bias in financial markets against the payment of dividends, equity financing, and capital accumulation in the corporate sector. The result is less investment, a lower capital stock, and lower wages for American workers.
The Solution
The President’s plan would eliminate the double taxation of corporate income. Corporate income that has been taxed once would not be taxed a second time.
For corporations that pay dividends out of after-tax earnings, those dividends would not be taxable at the shareholder level.
For corporations that retain and invest their after-tax profits, the value of the shareholders’ stock would be increased to reflect the value of those retained earnings. When shareholders sell their stocks, their capital gains and the corresponding tax would be reduced.
Most shareholders will learn of these changes the same way they learn about such things today, through their mutual funds, stockbrokers, and other account managers. These professionals already calculate taxable dividends and changes to the cost basis of stock shares, and they will continue to do so under the President’s plan.
The Benefits
Increased Jobs: The Council of Economic Advisors (CEA) estimates the President’s entire Jobs and Growth plan, including the dividend exclusion, would help the economy create 1.4 million jobs by the end of 2004. A large share of that job creation is attributed to eliminating the double tax on corporate earnings.
Better Wages: The double tax on corporate income increases the cost of capital for corporations. According to the CEA, the President’s plan would reduce the cost of capital investments in equipment by more than 10 percent. For investment in structures – the weakest part of the economy today – the cost of corporate equity capital would be cut by more than one-third. This reduction will encourage higher levels of corporate investment and capital accumulation, resulting in greater productivity increases and, therefore, higher wages for workers.
Fewer Bankruptcies: Eliminating the double taxation of corporate earnings will result in a decrease in corporate debt relative to corporate equity. Corporations with less debt are better positioned to survive economic downturns. The plan will reduce corporate debt levels relative to equity, thereby reducing capital market risks and instability.
Improved Corporate Governance: Eliminating double taxation of corporate earnings would improve corporate governance by reducing the incentive for bad actors to misinform investors, increase transparency in corporate accounting, and discourage some of the aggressive corporate tax strategies that have raised concerns in the past.
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