The Administration’s Proposal to Cut Dividend and Capital Gains Taxes

Peter R. Orszag and
Peter R. Orszag Vice Chairman of Investment Banking, Managing Director, and Global Co-Head of Healthcare - Lazard
William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

January 20, 2003


In the United States, some corporate income is never taxed, some is taxed once (either at the individual or the corporate level), and some is taxed twice. Many economists—ourselves included—would prefer a system that taxed all corporate income, but taxed it once and only once, at non-preferential tax rates. Such a system would modify the tax incentives for various types of corporate behavior in important ways. In this paper, we focus on two crucial dimensions of corporate incentives affected by the tax system: the incentive to shelter corporate income from taxation and the incentive to retain corporate earnings rather than pay dividends.

As we argue, the Administration’s recent tax proposal does not eliminate, and may not even reduce to a significant degree, the incentives that exist under the current tax system to shelter corporate income from taxation and then to retain the earnings. Despite the Administration’s rhetoric to the contrary, its proposal does not represent tax reform. The Administration’s proposal does the “easy” part of tax reform: it cuts taxes. It fails, however, to do the difficult part of any serious tax reform effort: broadening the tax base and eliminating the share of corporate income that is never taxed (or taxed at preferential rates). That difference is what distinguishes “tax reform” from “tax cuts.”