President Bush has proposed cutting taxes on corporate earnings distributed as dividends. The administration’s plan to exclude dividends from tax at the individual level would save taxpayers a projected $364 billion over the next 10 years. Dividend tax cuts would boost the stock market, lessen the tax code bias against savings, and reduce incentives for firms to take on too much debt and to excessively retain earnings.
The Bush plan responds to the serious problem that earnings distributed as dividends can face very heavy taxation. Earnings are first hit with the 35 percent corporate income tax and may then face the individual income tax, which has a top rate of 38.6 percent. State and local taxation is piled on top. By contrast, interest is deductible to the corporation and thus only taxable at the individual level.
U.S. Has the Second Highest Dividend Tax Rate in the OECD
Nearly all major nations allow full or partial relief of dividend double taxation, and thus have lower top dividend tax rates than the United States. Indeed, the latest data show that this country has the second highest dividend tax rate in the 30-nation Organization for Economic Cooperation and Development (see Figure 1). The figure shows official OECD data for the top dividend tax rate, including corporate and individual taxes imposed by both national and sub-national governments. The top U.S. rate of 70.1 percent exceeds every country except Japan. Our NAFTA trading partner, Mexico, imposes a top rate on dividends of just 35 percent - half the top U.S. rate.
Methods of Relieving Double Taxation
All in all, 27 of 30 OECD countries have adopted one or more ways of reducing or eliminating dividend double taxation. Only Ireland, Switzerland, and the United States do not relieve double taxation. However, Ireland and Switzerland have corporate tax rates of just 12.5 percent and 24.5 percent, respectively, which are much lower than the U.S. federal corporate rate of 35 percent. (See January 7, 2003, Nearly All Major Countries Provide Dividend Tax Relief).
One popular method of dividend tax relief is to set the individual tax rate on dividends much lower than the ordinary top rate on wages. That approach is used in Austria, Belgium, Italy, Korea, the Netherlands, Poland, Portugal, Sweden, and other countries. Another approach is to provide an individual dividend exclusion. Germany and Luxembourg provide a 50 percent exclusion. Greece provides a 100 percent individual exclusion, which is the reform approach President Bush has proposed.
Numerous countries provide individuals a dividend tax credit to offset the corporate tax paid on the earnings. Countries offering partial credits include Canada, France, and the U.K. Countries providing credits that fully offset double taxation include Australia, Finland, Italy, Mexico, New Zealand, and Norway.
An approach that should be considered by Congress as it examines dividend tax relief is to simply provide corporations with a full deduction for dividends paid. That approach may be the simpliest method of providing treatment parallel to the corporate interest deduction. Currently, the Czech Republic and Iceland allow a partial dividend deduction to corporations.
Capital Income Taxes Should be Reduced
High dividend tax rates add to the income tax code’s general bias against savings and investment. That bias reduces U.S. economic growth and is becoming increasingly out-of-step with the tax structures of other nations. Indeed, there is a global trend toward lower statutory tax rates on all forms of capital income, including corporate income taxes and individual taxes on dividends and capital gains. For example, data from KPMG show that the United States has the fourth highest corporate tax rate in the world. Or consider that numerous countries have tax rates of zero percent on individual capital gains, including Hong Kong, the Netherlands, New Zealand, and Taiwan. Zero is much lower than the 20 percent U.S. rate on capital gains.
Clearly, policymakers elsewhere are recognizing that high capital income taxes are economically counterproductive. President Bush’s bold proposal, or an alternate plan such as a corporate dividend deduction, should be taken up by Congress to help us catch up to the pro-competitive tax reforms of our trading partners.