[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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                          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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                                 ______
                                 
              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.

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