    [Senate Hearing 114-654]
    [From the U.S. Government Publishing Office]

                                                            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

                                   __________

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                Printed for the use of the Committee on Finance

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                              COMMITTEE ON FINANCE

                         ORRIN G. HATCH, Utah, Chairman

    CHUCK GRASSLEY, Iowa                 RON WYDEN, Oregon
    MIKE CRAPO, Idaho                    CHARLES E. SCHUMER, New York
    PAT ROBERTS, Kansas                  DEBBIE STABENOW, Michigan
    MICHAEL B. ENZI, Wyoming             MARIA CANTWELL, Washington
    JOHN CORNYN, Texas                   BILL NELSON, Florida
    JOHN THUNE, South Dakota             ROBERT MENENDEZ, New Jersey
    RICHARD BURR, North Carolina         THOMAS R. CARPER, Delaware
    JOHNNY ISAKSON, Georgia              BENJAMIN L. CARDIN, Maryland
    ROB PORTMAN, Ohio                    SHERROD BROWN, Ohio
    PATRICK J. TOOMEY, Pennsylvania      MICHAEL F. BENNET, Colorado
    DANIEL COATS, Indiana                ROBERT P. CASEY, Jr., Pennsylvania
    DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
    TIM SCOTT, South Carolina

                         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)

                         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 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 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 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 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 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.*
    ---------------------------------------------------------------------------
        * 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.
    ---------------------------------------------------------------------------
        [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.

                 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
    double-taxing 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.
        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 4\1/2\ 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.
        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
    employer-
    sponsored 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 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 non-dividend
    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 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.

    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
    retirement 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 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?

        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.

       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 foreign-based 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 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
    lock-out 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
    lock-out 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 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
    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.''
        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?
        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 tax-deferred 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.
        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 rifle-shot 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 vacuum? 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 non-repatriated 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 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 middle-
    income 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 encourage 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.
        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 tax-
    exempt. 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.
        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?
        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 community 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.
        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, tax-
    exempts 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 tax-exempts, 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.
        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.
        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 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 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?
        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 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.
        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.]

                                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.
    ---------------------------------------------------------------------------
        \1\ This testimony represents only the views of Michael J. Graetz
    and not any organization with which I am or have been affiliated.

        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.
          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.
    ---------------------------------------------------------------------------
        \2\ Internal Revenue Code section 1(h)(11).

        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.

        The remainder of my written testimony here is taken from an article
    on corporate-shareholder 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
    shareholder-credit 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\
    ---------------------------------------------------------------------------
        \3\ For the Treasury report's discussion, see U.S. Treasury
    (1992a), in Graetz amd Warren (2014b) at Amazon Location 1771.

        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.

        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).
    ---------------------------------------------------------------------------
        \4\ See, for example, Liu and Altshuler (2013), Cronin et al.
    (2013), and 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 shareholder-
    credit 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 about 25% of U.S. corporate stock is held in individuals'
    taxable accounts. (Austin, Berman, and Rosenthal, 2014).
    ---------------------------------------------------------------------------
        \5\ Thirty-five percent plus 23% tax on $65 dividend equals 54.47%.
        \6\ Thirty-five percent plus 30% withholding on $65 dividend equals
    54.5%.
    ---------------------------------------------------------------------------
    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 pre-withholding 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 2-line 3)             -15      -10        5
    ------------------------------------------------------------------------
    5. Net shareholder cash ($65-line 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.
    ---------------------------------------------------------------------------
        \7\ The 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).

        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 shareholder-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 PWith 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).
    ------------------------------------------------------------------------
                                                                 Dividend
                                                Imputation     deduction and
            Taxpayer            Present Law       credit        withholding
                                                                    tax
    ------------------------------------------------------------------------
    CORPORATION
    1. Taxable income before         $100.00         $100.00         $100.00
     dividend
    2. Corporate tax before           $35.00          $35.00          $35.00
     dividend
    3. Corporate cash before          $65.00          $65.00          $65.00
     dividend
    4. Declared dividend              $30.00          $30.00          $46.15
    5. Corporate tax to be                NA          $16.15              NA
     imputed to shareholder
     (35/65 x line 4)
    6. Dividend withholding               NA              NA          $16.15
     (35% x line 4)
    7. Tax reduction due to               NA              NA          $16.15
     dividend deduction (35%
     x line 4)
    8. Total corporate tax            $35.00          $35.00          $18.85
     (line 2-line 7)
    9. Remaining corporate            $35.00          $35.00          $35.00
     cash (line 3-line 4 +
     line 7)
    10. Reduction in                  $30.00          $30.00          $30.00
     corporate cash (line 3-
     line 9)
    11. Effective corporate              35%             35%          18.85%
     tax rate * (line 8/line
     1)

    U.S. SHAREHOLDER
    12. Cash dividend (line           $30.00          $30.00          $30.00
     4-line 6)
    13. Taxable dividend              $30.00          $46.15          $46.15
     (line 4 + line 5)
    14. Shareholder tax                $6.00          $18.46          $18.46
     before imputation or
     withholding credit
    15. Imputation or                      0          $16.15          $16.15
     withholding credit
     (line 5 or 6)
    16. Net shareholder tax            $6.00           $2.31           $2.31
     (line 14-line 15)
    17. Net shareholder cash          $24.00          $27.69          $27.69
     (line 12-line 16)

    COMBINED CORPORATE AND
     SHAREHOLDER TAXES
    18. Total tax (line 6 +           $41.00          $37.31          $37.31
     line 8 + line 16)
    19. Corporate tax on              $16.15          $16.15               0
     distributed income [(35/
     65 x line 10)-line 7]
    20. Shareholder tax on             $6.00           $2.31          $18.46
     distributed income
     (line 16 + line 6)
    21. Total tax on                  $22.15          $18.46          $18.46
     distributed income
     (line 19 + line 20)
    22. Pre-tax distributed           $46.15          $46.15          $46.15
     income (line 10/.65)
    23. Total effective tax              48%             40%             40%
     rate on distributed
     income * (line 21/line
     22)
    ------------------------------------------------------------------------
    * 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 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).
    ------------------------------------------------------------------------
                                                                 Dividend
                                                Imputation     deduction and
            Taxpayer            Present Law       credit        withholding
                                                                   tax
    ------------------------------------------------------------------------
    CORPORATION
    1. Taxable income before         $100.00         $100.00         $100.00
     dividend
    2. Corporate tax before           $35.00          $35.00          $35.00
     dividend
    3. Corporate cash before          $65.00          $65.00          $65.00
     dividend
    4. Declared dividend              $19.50          $19.50          $30.00
    5. Corporate tax to be                NA          $10.50              NA
     imputed to shareholder
     (35/65 x line 4)
    6. Dividend withholding               NA              NA          $10.50
     (35% x line 4)
    7. Tax reduction due to               NA              NA          $10.50
     dividend deduction (35%
     x line 4)
    8. Total corporate tax            $35.00          $35.00          $24.50
     (line 2-line 7)
    9. Remaining corporate            $45.50          $45.50          $45.50
     cash (line 3-line 4 +
     line 7)
    10. Reduction in                  $19.50          $19.50          $19.50
     corporate cash (line 3-
     line 9)
    11. Effective corporate              35%             35%           24.5%
     tax rate* (line 8/line
     1)

    U.S. SHAREHOLDER
    12. Cash dividend (line           $19.50          $19.50          $19.50
     4-line 6)
    13. Taxable dividend              $19.50          $30.00          $30.00
     (line 4 + line 5)
    14. Shareholder tax                $3.90          $12.00          $12.00
     before imputation or
     withholding credit
    15. Imputation or                      0          $10.50          $10.50
     withholding credit
     (line 5 or 6)
    16. Net shareholder tax            $3.90           $1.50           $1.50
     (line 14-line 15)
    17. Net shareholder cash          $15.60          $18.00          $18.00
     (line 12-line 16)

    COMBINED CORPORATE AND
     SHAREHOLDER TAXES
    18. Total tax (line 6 +           $38.90          $36.50           36.50
     line 8 + line 16)
    19. Corporate tax on              $10.50          $10.50              $0
     distributed income [(35/
     65 x line 10)-line 7]
    20. Shareholder tax on             $3.90           $1.50          $12.00
     distributed income
     (line 16 + line 6)
    21. Total tax on                  $14.40          $12.00          $12.00
     distributed income
     (line 19 + line 20)
    22. Pre-tax distributed           $30.00          $30.00          $30.00
     income (line 10/.65)
    23. Total effective tax              48%             40%             40%
     rate on distributed
     income * (line 21/line
     22)
    ------------------------------------------------------------------------
    * 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.

        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 disadvantage 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.
    ---------------------------------------------------------------------------
        \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.
    ---------------------------------------------------------------------------
    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.
    ---------------------------------------------------------------------------
        \10\ Whether 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.

        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\
    ---------------------------------------------------------------------------
        \11\ For an overview of the proposal including the DRIP option, see
    Burman and Rohaly (2003).
    ---------------------------------------------------------------------------
    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
    tax-
    induced 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.
    ---------------------------------------------------------------------------
        \12\ For more, see the discussion in Part 6, Proposal 9 in Warren
    (1993), and in Graetz and Warren (2014b) at Amazon Location 10906.

        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).
    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.
    ---------------------------------------------------------------------------
        \13\ See Part 7 in Warren (1993), available in Graetz and Warren
    (2014b) at Amazon Location 10959.
        \14\ See the discussion in Chapter 7 in U.S. Treasury (1992a), in
    Graetz and Warren (2014b) at Amazon Location 2853.

        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\
    ---------------------------------------------------------------------------
        \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).

        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).
    ---------------------------------------------------------------------------
        \16\ See Part 4, Proposal 7 in Warren (1993), in Graetz and Warren
    (2014b) at Amazon Location 10667.

        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\
    ---------------------------------------------------------------------------
        \17\ We are indebted to Peter Merrill for this point.

    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 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.
    ---------------------------------------------------------------------------
        \18\ See 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).
    ---------------------------------------------------------------------------
    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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    Methodology,'' 66 National Tax Journal 239-262.

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    Graetz, Michael J. and Alvin C. Warren Jr., 1999. ``Integration of
    Corporate and Individual Income Taxes: An Introduction,'' 84 Tax Notes
    1767-1777 (September 27, 1999).

    Graetz, Michael J. and Alvin C. Warren Jr., 2006. ``Income Tax
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    Graetz, Michael J. and Alvin C. Warren Jr., 2007. ``Dividend Taxation
    in Europe: When the ECJ Makes Tax Policy,'' 44 Common Market Law Review
    1577-1623.

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    Grubert, Harry and Altshuler, Rosanne, 2016. ``Shifting the Burden of
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    Hertzfeld, Mindy, ``New Analysis: Could Integration Be the Antidote to
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    Joint Committee on Taxation, 2003. ``Description of Revenue Provisions
    Contained in the President's Fiscal Year 2004 Budget Proposal'' (March,
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    Liu, Li and Rosanne Altshuler, 2013. ``Measuring the Burden of
    Corporate Income Tax Under Imperfect Competition,'' 66 National Tax
    Journal 215-237.

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    Action 4: Interest Deductions and Other Financial Payments, Public
    Discussion Draft, http://www.oecd.org/ctp/aggressive/discussion-draft-
    action-4-interest-deductions.pdf.

    Sullivan, Martin A., 2005. ``The Tax Reform Plan that Won't Sell.'' 106
    Tax Notes 1014-1017.

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    or Integrate?'' 150 Tax Notes 156-176 (January 11, 2016).

    Sullivan, Martin A., 2016b. ``Economic Analysis: Corporate Integration
    Would Tilt Investment to the U.S.'' 150 Tax Notes 739-743 (February 16,
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    with an Accrual Tax on Shareholder Income'' (in this symposium).

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                                     ______

                  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.

        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 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. 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 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 employer-sponsored 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. Non-
    discrimination 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.

              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 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 after-tax 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 longer-
    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
    ------------------------------------------------------------------------
                                                          Net amount with
                                                         marginal rate at
                                 Invested   20-year        retirement of
                                  amount    balance  -----------------------
                                                          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.

                                     ______

         Prepared Statement of Steven M. Rosenthal,\1\ Senior Fellow,
               Urban-Brookings Tax Policy Center, Urban Institute
    ---------------------------------------------------------------------------
        \1\ The 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.
    ---------------------------------------------------------------------------
        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.
    ---------------------------------------------------------------------------
        \2\ For 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.

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        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.
    ---------------------------------------------------------------------------
        \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.
    ---------------------------------------------------------------------------
                        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).

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        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 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\
    ---------------------------------------------------------------------------
        \4\ Similarly, we and the Fed do not count U.S. intercompany
    holdings.

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        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 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).
    ---------------------------------------------------------------------------
        \5\ See 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.
        \6\ Jobs and Growth Tax Relief Reconciliation Act of 2003, Pub. L.
    No. 108-27, 108th Cong., 1st Sess. (May 28, 2003).

        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\
    ---------------------------------------------------------------------------
        \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.

        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.
    ---------------------------------------------------------------------------
        \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).

        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\
    ---------------------------------------------------------------------------
        \10\ For 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.

        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\
    ---------------------------------------------------------------------------
        \11\ For 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.
    ---------------------------------------------------------------------------
                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 of tax on corporate earnings.
    Those that do, face a reduced rate on qualified dividends and long-term
    capital gains.
    ---------------------------------------------------------------------------
        \13\ See, 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.

        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
    ----------------------------------------------------------------------------------------------------------------
                                                                             Effective
                                   Corporate     Personal       Capital      Corporate
                                  Income Tax     Dividend      Gains Tax        and         Integrated  Tax System
                                     Rate       Income Tax       Rate       Shareholder
                                                   Rate                      Tax Rate
    ----------------------------------------------------------------------------------------------------------------
    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.

        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\
    ---------------------------------------------------------------------------
        \1\ Office 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.

        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.
    ---------------------------------------------------------------------------
        \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.

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        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.
    ---------------------------------------------------------------------------
        \4\ Congressional Budget Office, ``Taxing Capital Income: Effective
    Marginal Tax Rates Under 2014 Law and Selected Policy Options''
    (December 2014).
        \5\ See, 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).

        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 Section 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.
    ---------------------------------------------------------------------------
        \6\ Federal Reserve, ``Financial Accounts of the United States:
    Flow of Funds, Balance Sheets, and Integrated Macroeconomic Accounts,
    Fourth Quarter 2015,'' March 10, 2016.

        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\
    ---------------------------------------------------------------------------
        \7\ The 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).
        \9\ Federal 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.
        \10\ See Amanda Sneider et al., ``An Equity Investor's Guide to the
    Flow of Funds Accounts,'' Goldman Sachs Group Inc., March 11, 2013.

        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.
    ---------------------------------------------------------------------------
        \11\ Federal Reserve, supra note 6, at Table L.223, line 11.
        \12\ Id. at Table B.101.e, line 14.

        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.
    ---------------------------------------------------------------------------
        \13\ Poterba, ``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.

        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\
    ---------------------------------------------------------------------------
        \14\ See 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.
        \15\ See id. at 4-8.

        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).
    ---------------------------------------------------------------------------
        \16\ See Sneider, supra note 10, at 8.

        In 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\
    ---------------------------------------------------------------------------
        \17\ Gale, ``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.
        \19\ See 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.
        \20\ Gale 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.
        \22\ We 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.
    ---------------------------------------------------------------------------

                               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\
    ---------------------------------------------------------------------------
        \23\ Our 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.

            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\
    ---------------------------------------------------------------------------
        \24\ There 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.
        \25\ We 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.

            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\
    ---------------------------------------------------------------------------
        \26\ We do not add back stock for REITs, which generally hold only
    real estate and mortgages.

        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 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.
    ---------------------------------------------------------------------------
        \27\ We 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, insurance 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.
    ---------------------------------------------------------------------------

    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\
    ---------------------------------------------------------------------------
        \28\ Direct 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.

        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\
    ---------------------------------------------------------------------------
        \29\ Passthrough 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.
        \30\ Federal 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.
        \31\ The Fed already subtracts stock issued by mutual funds. See
    id. at Table L.223, n.1.

                    Table 1. C Corporation Equity Outstanding
                        (2015, market value in billions)
    ------------------------------------------------------------------------

    ------------------------------------------------------------------------
    Total foreign and domestic corporate stock (including stock     $35,687
     issued by C and S corporations, ETFs, CEFs, and REITs)
    ------------------------------------------------------------------------
     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\
    ---------------------------------------------------------------------------
        \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.
        \33\ We describe our methods, data sources, and assumptions in more
    detail in Appendix 1.

             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               $11,487
       companies, and others
    ------------------------------------------------------------------------
      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.                $4,826
     households
    ------------------------------------------------------------------------
    Less:
    ------------------------------------------------------------------------
      Stock held in IRAs                                             $1,479
    ------------------------------------------------------------------------
      Stock held in section 529 plans                                   $89
    ------------------------------------------------------------------------
    Equals: Taxable C corporation stock held directly in U.S.        $3,274
     taxable accounts
    ------------------------------------------------------------------------
    Plus:
    ------------------------------------------------------------------------
      Taxable C corporation stock held indirectly by U.S.            $2,268
       households
    ------------------------------------------------------------------------
    Equals: Total holdings of taxable C corporation stock in         $5,525
     U.S. taxable accounts
    ------------------------------------------------------------------------

        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 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.
    ---------------------------------------------------------------------------
        \34\ Federal 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.
    ---------------------------------------------------------------------------

    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\
    ---------------------------------------------------------------------------
        \35\ Our 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.

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                         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.

    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\
    ---------------------------------------------------------------------------
        \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.

        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\
    ---------------------------------------------------------------------------
        \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.

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    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 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.
    ---------------------------------------------------------------------------
        \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).

        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
    ----------------------------------------------------------------------------------------------------------------
                                                                             Effective
                                   Corporate     Personal       Capital      Corporate
                                  Income Tax     Dividend      Gains Tax        and         Integrated  Tax System
                                     Rate       Income Tax       Rate       Shareholder
                                                   Rate                      Tax Rate
    ----------------------------------------------------------------------------------------------------------------
    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 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\
    ---------------------------------------------------------------------------
        \40\ See 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)).

                                  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                     $13,311                             ($2,989)                          $10,322
     nonprofit
    ----------------------------------------------------------------------------------------------------------------
    Insurance companies                $2,087                               ($469)                           $1,618
    ----------------------------------------------------------------------------------------------------------------
    Defined benefit                    $3,295                               ($740)                           $2,555
     plans
    ----------------------------------------------------------------------------------------------------------------
    Defined                            $1,623                               ($364)                           $1,258
     contribution plans
    ----------------------------------------------------------------------------------------------------------------
    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                    $1,756                               ($394)                           $1,362
     funds
    ----------------------------------------------------------------------------------------------------------------

                                  Step 2. Subtract Passthrough Holdings From Investors
                                      (2015, market value in billions of dollars)
    ----------------------------------------------------------------------------------------------------------------
                                                           Take Out Passthroughs
                     -----------------------------------------------------------------------------------------------
                                                    S                                                      U.S.  C
                         U.S.          -       Corporation     ETFs        CEFs        REITs       =     Corporation
                       Equities                  Equity                                                    Equity
    ----------------------------------------------------------------------------------------------------------------
    All holders         $28,955                  ($2,838)    ($2,106)      ($206)      ($939)               $22,812
    ----------------------------------------------------------------------------------------------------------------
    Household and       $10,322                  ($2,838)    ($1,331)      ($164)      ($207)                $5,781
     nonprofit
    ----------------------------------------------------------------------------------------------------------------
    Insurance            $1,618                                 ($43)        ($5)      ($131)                $1,439
     companies
    ----------------------------------------------------------------------------------------------------------------
    Defined benefit      $2,555                                ($297)       ($37)       ($33)                $2,189
     plans
    ----------------------------------------------------------------------------------------------------------------
    Defined              $1,258                                ($275)       ($34)       ($33)                  $917
     contribution
     plans
    ----------------------------------------------------------------------------------------------------------------
    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      $1,362                                                        ($113)                $1,249
     funds
    ----------------------------------------------------------------------------------------------------------------

        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\
    ---------------------------------------------------------------------------
        \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.

        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\
    ---------------------------------------------------------------------------
        \42\ Federal Reserve, supra note 6, at Table L.224.

        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\
    ---------------------------------------------------------------------------
        \43\ See 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.
        \44\ The 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.
        \45\ Later, we distribute some of the mutual funds' and exchange-
    traded funds' holdings of REITs to the household sector.

        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.
    ---------------------------------------------------------------------------
        \46\ See 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.

        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\
    ---------------------------------------------------------------------------
        \47\ See EY, ``Contribution of S ESOPs to Participants' Retirement
    Security'' (March 2015).
        \48\ The Fed follows this method to value closely held stock.

                    Step 3. Subtract Stock Held by Nonprofits
                   (2015, market value in billions of dollars)
    ------------------------------------------------------------------------

    ------------------------------------------------------------------------
    Total household and nonprofit holdings of C corporation          $5,781
     equity
    ------------------------------------------------------------------------
      -Nonprofit holdings of corporate equity (other than          ($1,455)
       mutual funds)
    ------------------------------------------------------------------------
      + Foreign stock held by nonprofits, already subtracted           $327
    ------------------------------------------------------------------------
      + ETFs held by nonprofits, already subtracted                     $18
    ------------------------------------------------------------------------
      + CEFs held by nonprofits, already subtracted                      $2
    ------------------------------------------------------------------------
      + 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'' (self-directed accounts).\49\
    ---------------------------------------------------------------------------
        \49\ See Investment Company Institute, ``Report: The U.S.
    Retirement Market, Fourth Quarter 2015,'' at Table 7 (March 24, 2016).

        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 self-directed accounts.\50\
    ---------------------------------------------------------------------------
        \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).

        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.
    ---------------------------------------------------------------------------
        \51\ (C corporation equity/(the sum of C corporation equity, REIT
    equity, ETF equity, and CEF equity)).

        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.
    ---------------------------------------------------------------------------
        \52\ Federal Reserve, supra note 6, at Table B.101.

         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        $4,826
     Step 3)
    ------------------------------------------------------------------------
     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.
    ---------------------------------------------------------------------------
        \53\ Id. at Table B.101.e.

        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).
    ---------------------------------------------------------------------------
        \54\ Id. at Table L.223, lines 18 and 19.

              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        $1,600
       funds held by nonprofits, IRAs, insurance companies,
       pension funds, and foreigners)
    ------------------------------------------------------------------------
      + Closed-end fund holding of equities (except those CEFs         $39
       held by nonprofits, IRAs, insurance companies, pension
       funds, and foreigners)
    ------------------------------------------------------------------------
      + ETF holding of equities (except those ETFs held by            $630
       nonprofits, IRAs, insurance companies, pension funds,
       and foreigners)
    ------------------------------------------------------------------------
    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.

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    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.

        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\
    ---------------------------------------------------------------------------
        \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.

        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.
    ---------------------------------------------------------------------------
        \57\ Preqin, ``2016 Global Private Equity and Venture Capital
    Report''; and BarclayHedge, ``Hedge Fund Industry--Assets Under
    Management.''

        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\
    ---------------------------------------------------------------------------
        \58\ Michael 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).

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                                     ______

         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 pass-through entities
    and C corporations.\3\ There is much to commend this proposal.
    ---------------------------------------------------------------------------
        \1\ See 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).
        \2\ See 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).
        \3\ See Joint Committee on Taxation, Overview of Approaches to
    Corporate Integration at 32 (JCX-44-66) (May 13, 2016).
    ---------------------------------------------------------------------------
                   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\
    ---------------------------------------------------------------------------
        \4\ These 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 regime 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).

        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.
    ---------------------------------------------------------------------------
        \5\ My 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).

        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.
    ---------------------------------------------------------------------------
        \6\ For 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).

        Third, fundamental tax reform must deal with the so-called lock-out
    effect.
     ii. international implications of dividends paid deduction regime \7\
    ---------------------------------------------------------------------------
        \7\ For 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.

        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 trade-offs. 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\
    ---------------------------------------------------------------------------
        \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 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 interest 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 4\1/2\ 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.

                                     ______

                                 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 pass-through 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.

    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.