Senate Finance Committee Chair Orrin Hatch, R-Utah, worked to mollify the concerns of tax-exempt investors at two hearings to discuss his forthcoming proposal on corporate integration.
Hatch is planning to release a discussion draft in early June that would provide corporations with a deduction against their 35% rate for dividends paid to shareholders. At the same time, Hatch would propose a nonrefundable 35% withholding tax on the dividends. The proposal is meant to end the double tax on distributions of corporate earnings, which are currently taxed at 35% at the corporate level and at a rate as high as 23.8% when distributed to individual shareholders as dividends.
The economists testifying at the hearings generally praised the idea, saying it could encourage multinationals to repatriate and distribute overseas earnings, improve the international competitiveness of the U.S. tax system and end the current tax code's harmful bias against equity financing. Corporations often prefer to raise capital through borrowing because interest is deductible whereas dividends paid to equity investors are not. Hatch's plan is expected to try to achieve parity further by extending the 35% nonrefundable withholding tax to interest as well as dividends.
Even supportive witnesses warned that the change could create treaty problems and would not be a panacea, but the biggest opposition came from representatives of tax-exempt investors like pensions and higher education endowments. Hatch anticipated some resistance and argued that the 35% withholding tax would not be a new tax on tax-exempt investors. He said those earnings have always been subject to tax at the corporate level, and his proposal is merely shifting the incidence of tax.
This did not satisfy the supporters of tax-exempt investors. They pointed out that the new 35% withholding tax on interest would represent a brand new tax on their income. Corporate earnings distributed as interest payments to tax-exempt investors currently are deductible for corporations with no additional tax to the tax-exempt investor. Tax-exempt investors argued that the plan also could undermine incentives for retirement savings.
Under current law, the earnings of stock held directly by individual investors face a second level of tax when distributed as dividends, but the earnings of stock held in tax-free retirement plans do not. Under Hatch's plan, dividends paid to both kinds of investments would effectively escape corporate taxation and be subject to the same 35% nonrefundable withholding tax. All investors would enjoy the tax-favorable treatment of dividends currently enjoyed only by tax-exempt investors, although tax-favored retirement vehicles would still have the major advantage of tax-free stock sales.
Democrats appeared to line up with tax-exempt investors, with ranking minority member Ron Wyden, D-Ore, repeatedly echoing their concerns. Hatch acknowledged the problems, and said that because his initial proposal raised revenue, they have room to explore changes that would allay concerns.
Hatch does not expect the proposal to be enacted this year, but said he hopes it can be incorporated as part of future tax reform efforts. House Ways and Means Committee Chair Kevin Brady, R-Texas, said he welcomed Hatch's efforts, but he is more focused on crafting a tax reform blueprint as part of the House Republican task force process. House Speaker Paul Ryan, R-Wis., said the task force is on track to release a plan in June, and that it will include a framework for international reform.
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