Shared Economic Growth Reveals the Myth:

Americans Have Been Fooled into Thinking CorporateTax is a Tax on the Rich

The Stealth Tax

Corporations are not living things, they are the collective investments of a group of people. They do not bear the burden of tax . Instead, corporations pay tax on behalf of their shareholders. Absent the corporate tax, the shareholders would earn 54% more on their investments. That applies equally to every shareholder, rich or poor, including those who hold their investment through an IRA, 401(k), or other supposedly tax free retirement fund.

If high income shareholders received the corporate earnings directly, they would pay tax on them at a 35% rate (which will go up to 39.6% once the Bush tax cuts expire at the top end). Middle class shareholders would pay tax at a rate of 28% or less. Compared with direct taxation, then, the corporate tax is not progressive, because it taxes everyone at the same rate.

Worse than that, though, it taxes people's supposedly tax free pension savings. This is where the math becomes interesting. As explained in the  draft bill and summary, if we eliminate special capital gains rates, if we stop giving U.S. corporate shareholders credit for foreign taxes the same way that foreign countries have stopped giving their corporate shareholders credit for U.S. taxes,  and if foreign investors are held tax neutral, then once the individual rates go back up to their prior levels, a dividends paid deduction would pay for itself except for the fact that a little over 28% of all U.S. stock is held by IRAs, pension funds, and other retirement accounts which don't pay tax on the dividends they receive. To offset this revenue leak, the Shared Economic Growth proposal would put a new 7.65% tax on individual income in excess of $500,000 per year - a figure equivalent to the employment taxes that apply to the full wage income of ordinary workers but that does NOT apply to income in excess of $106,800 per year. That offset is actually generous, but it leaves room for the inevitable political compromises.

But think about what this means. If the special provisions that cause capital gains to be more lightly taxed than wages are eliminated, then the only cost of permitting corporations to have a dividends paid deduction is that a 7.65% marginal tax needs to be imposed on very high income taxpayers  solely to make up for removing the hidden 35% tax on pension savings. When the dividends paid deduction has been raised before, policymakers had exactly that discussion. "A large portion of the dividends go to non-taxable pension funds. People are not complaining about pension investments being subjected to a 35% tax, because they don't understand it. But if we impose a new individual level tax to make up for that loss, people will complain. So let's just forget about the dividends paid deduction."

Congress and the American people have a straightforward choice: Is it better to impose a 35% tax on the income from the pension savings of all working Americans, or to impose a 7.65% tax on individual income in excess of $500,000 per year?. If Congress prefers the 35% tax on pension earnings, then Congress should impose that tax in an open and straightforward way rather than by sneaking it in as a "corporate" tax and pretending it is a tax on the rich. If Congress thought that the American people would support that choice when it was clearly put to them, then Congress would be free to tax the pension income directly rather than to impose the AGI tax. Either way, though, there is no reason not to enact the dividends paid deduction and remove the tremendously harmful burden that the corporate tax places on the American economy. While one may grant that politicians may sometimes legitimately hide the ball a little on subjects that are difficult to explain to the public, surely no lawmaker could comfortably say, "I want to impose a 35% tax on the pension earnings of working Americans, but I don't want them to realize that I am doing it, so I am going to hide it behind a smoke screen that makes U.S. operations 54% less profitable than foreign ones and that seriously reduces the efficiency of our economy. It is important enough to fool the taxpayers into believing that we don't tax their pension earnings that the resulting huge cost to the U.S. economy from this smoke screen is worth it." Yet that statement, in essence, is the only argument for opposing a dividends paid deduction. Until now, this is the choice that both political parties have been making.