Why not a dividends-paid deduction?

October 7th, 2011 by Joe Kristan

Tax life would be so much easier if corporations could deduct their dividends. It would at one stroke eliminate the double tax on corporate income, greatly simplify tax planning, and eliminate the bias for debt over equity in capitalizing a business. It’s good to see that policy wonks like Daniel Shaviro are starting to take the idea seriously, even if not necessarily embracing it.
Mr. Shaviro is focused, I think wrongly, on the accounting aspects:

Reuven argues that dividend deduction would be more effective than imputation in encouraging the managers to pay dividends, on the ground they often don’t especially care about shareholder taxes but love to get company-level deductions. Thus, even if the two methods of dividend deduction and imputation are in fact economically equivalent, the former will in fact induce greater payouts.
One could certainly challenge this view on multiple grounds, but the one I emphasized, in particular because I thought it was more of a new point, reflects accepting the basic premise (at least arguendo) but then asking what the managers really care about. A common answer, with considerable real world empirical support, would be that they appear to care more about financial accounting income than about income tax liability. So the entity-level tax benefit of dividend deductibility won’t affect their behavior as strongly as Reuven anticipates unless there is an accounting benefit. But would there be?

In my world, the land of non-public, non-banking companies, nobody much cares about financial statements. They do care about being able to get cash out of the business. We go to great efforts to enable businesses to distribute profits or appreciated property without paying the normal two levels of corporate tax. In my world, a dividends paid deduction would almost certainly have a huge affect on capital structures, management incentives (management in my world is usually the owners), and willingness to pay dividends.

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