Integrating the Corporate and Individual Income Tax Codes Is a Smart Move

This was an email I got from The Tax Foundation.  

"Recent reports indicate that Congressional lawmakers are in the process of drafting a plan to integrate the individual and corporate tax codes. Today, the nonpartisan Tax Foundation released a report explaining this concept and detailing how it would eliminate the double taxation of corporate income, level the playing field between different types of businesses, and increase U.S. tax competitiveness.

Currently, how a business chooses to structure and finance its operations affects whether its income is taxed twice. Corporate income that is funded by equity (stocks) faces double taxation, once when it is earned by the corporation and again when it is realized at the shareholder level. However, corporate income that is funded by debt is only taxed once at the individual income tax level. Additionally, pass-through businesses (sole proprietorships, S-corps, LLCs, and partnerships), are also only taxed once through the individual income tax code.

“As much as possible, the tax code should not distort business decisions,” said Tax Foundation Analyst Scott Greenberg. “The current double taxation of corporate income encourages investors to shift their investments from corporate to non-corporate businesses, leading to a less efficient allocation of capital. Furthermore, it incentivizes corporations to fund their operations with debt, rather than equity, leading to excessive leverage.”

Proposals to integrate the corporate and individual income tax codes would standardize the taxation of business income across legal forms and methods of financing. This would simplify the code, eliminate the double taxation of corporate income, and remove distortionary incentives.

The Tax Foundation’s report finds that:

• The combined top federal tax rate on equity-financed corporate income in the United States is 50.47 percent, compared to a top federal tax rate of 43.4 percent on other business income.
• Equity-financed corporate income is subject to a higher tax rate than other business income because it is subject to a double tax: once on the corporate level, through the corporate income tax, and once on the shareholder level, though the individual income tax on dividends.
• Taxing equity-financed corporate income at a higher rate encourages the misallocation of investment capital. Ideally, all business income would be subject to the same top tax rate, regardless of the legal form of the business or the method of financing.
• Short of reforming the entire U.S. tax code, integrating the corporate and individual income taxes could eliminate the double taxation of corporate income.
• There are several ways to integrate the corporate and individual tax codes, including allowing shareholders a credit for corporate taxes paid (credit imputation) or allowing corporations to deduct dividends paid (dividends paid deduction). Each of these strategies for corporate integration presents different opportunities and challenges.
• Corporate integration would accomplish many of the same goals as a corporate rate cut, such as making the U.S. business climate more competitive. It could also end several economic distortions created by the current tax code, including the tax preference for debt financing over equity financing.

“Corporate integration would not fix all, or even most of the problems with the U.S. business tax system. However, it could lead to several important incremental improvements to the current U.S. tax code,” added Greenberg. “Corporate integration would lower the combined tax burden on corporate income, which would increase investment and economic growth the United States. It would eliminate the tax code’s bias in favor of debt over equity, leading to better investment decisions. And it would put corporate investment on par with non-corporate investment, leading to a more efficient allocation of capital.”"