Arnold Kling

Taxation and Corporate Behavior

Arnold Kling, Great Questions of Economics
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Brink Lindsey endorses the views of Paul Gompers, Andrew Metrick, and Jeremy Siegel that eliminating the double taxation of dividends would reduce the incentives of corporations to take on too much debt and grow too quickly.

But while financial reporting can doubtless be improved, I don't think that's the biggest problem with capital markets at present. The main problem, I believe, is unfavorable tax treatment for dividends. Because dividends are taxed twice, first as corporate income and then upon payout as shareholder income, managers have added incentive to hang on to retained earnings, with the resulting blow to accountability which that entails. And investors look more to capital gains than to dividends for return on investment, exacerbating the difficulties caused by imperfect financial reporting and stock valuation.

An even better idea would be to abolish the corporate income tax altogether.

Discussion Question. In general taxation induces substitution. When financial entities are taxed, substitution is easy, leading to a high ratio of distortions relative to revenue collected. How does this relate to the corporate income tax?

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