One reason for the huge income gap between the rich and the poor in the U.S. is that we don't tax corporate income properly. We have a corporate income tax, but to the corporation, it is just another business expense. Instead of hitting wealthy stockholders, it gets passed on to everyone else - mostly, corporate customers. In effect, we are taxing ourselves rather than the corporation. A May 2013 GAO report put it this way (page 9):

The economic burden of some or all of the taxes on a corporation may be shifted to the firm’s customers or workers, as well as to other firms and other workers. Any remaining burden is borne by the corporation’s shareholders or other owners of capital.

Here are the corporate income tax rates for 2014 (source):

Of course, corporations don't really pay taxes at the 35% rate. The average effective rate is only 12.6%. (source: May 2013 GAO report, page 14)

Corporate stockholders do pay income tax on dividends and capital gains, but at a reduced rate. From 2005 through 2012, the top rate was 15%. That is why Mitt Romney paid a 14 percent rate in 2010 on nearly $22 million in income. (source)

Starting with the 2013 tax year, the rate went up to 20% for singles earning over $400,000 and couples earnings over $450,000.

(Note in the above table that for low income taxpayers, there's no tax at all on dividends. Also exempt are distributions from a mutual fund that is not subject to income tax. (source) This table seems to indicate that over all, tax-exempt dividends cost the U.S. Treasury about $50 billion a year.)

In addition to the rate increase, a 3.8% investment income tax was applied to singles earning over $200k and couples earning over $250k (source), bringing the total for those with higher incomes to 23.8% - still less than the tax on ordinary income (below):

The solution would be to eliminate the corporate income tax - which, in effect, is a tax on ourselves - and start taxing dividends and capital gains at the same rate as ordinary income (wages, etc.) After all, one of the justifications for the lower tax rate on dividends and capital gains was that the income is being taxed twice, once with the corporate income tax and again on dividends and capital gains.

But we can't stop there, because only a portion of corporate income is distributed as dividends. At the site of the Federal Reserve Bank of St. Louis, I found total annual before-tax corporate profit for 2014 estimated from earnings for the first quarter. The total: $2,365.8 billion. On the same site, I found estimated undistributed corporate profits: $1,045.1 billion.

Although corporate profits belong to the stockholders, corporations are not required to distribute those profits as dividends. They may choose to use them to purchase new machinery, spend on research and development, etc. When profits are "retained" - not distributed - the stockholders avoid paying taxes on that income. An attempt was made to deal with this issue during the Roosevelt administration. This is from Wikipedia:

The undistributed profits tax was enacted in 1936 by the United States administration of President Franklin D. Roosevelt (FDR), during the Great Depression. The UP tax was a revenue program for FDR's New Deal. The act was controversial even within FDR's United States Treasury Department, as some economists such as Alfred G. Buehler thought that it would harm the ability of business to put capital towards company growth. In particular, Buehler reasoned that the UP tax would hit small business especially hard, as smaller businesses have fewer options in raising capital than large ones, usually by keeping a percentage of their profits for re-investment back into the business. The UP Tax was part of FDR's "Second New Deal".

 

The bill established the principle that retained corporate earnings could be taxed. The idea was to force businesses to distribute profits in dividend and wages, instead of saving or reinvesting them. In the end, Congress watered down the bill, setting the tax rates at 7 to 27% and largely exempting small enterprises.

 

Conservative critics of the New Deal considered this a burden on business growth. Facing widespread and fierce criticism, the tax was reduced to 2½ percent in 1938 and completely eliminated in 1939.

Currently, there is an "accumulated earnings tax" which increased from 15% to 20% for the 2013 tax year. It is applied to the amount retained that is "deemed to exceed the corporation's ordinary and reasonable business needs." (source)

Rather than an undistributed profit tax or an accumulated earnings tax, I would require immediate distribution of all profits so they can be taxed as individual income. Stockholders should not be given the option of not taking their income as dividends any more than wage earners should be allowed to delay paying taxes on wages. All corporate earnings should be distributed as dividends, and those distributions should occur at least quarterly. As for the problem of raising capital for investment, the corporation can borrow it.

Corporations should also be required to withhold taxes from dividends, just as taxes are withheld from wages. They already do so for dividends paid to foreigners:

Companies and individuals who make certain types of payments to foreign persons must withhold Federal income tax on those payments. Foreign persons include nonresident aliens, foreign corporations, and foreign partnerships. Payments subject to withholding include compensation for services, interest, dividends, rents, royalties, annuities, and certain other payments. Tax is withheld at 30% of the gross amount of the payment. This withholding rate may be reduced under a tax treaty. (source)

Note that the amount withheld from these payments to foreigners is 30%. Using a estimated rate of 30% to calculate the tax on the $2,365.8 billion total corporate profit for 2014, I get $709.74 billion. Total distributed corporate profit (dividends) for 2014 is $2,365.8 - $920.5 = $1,445.3 billion. At the current top rate of 20%, that will generate $264.1 billion in taxes. Add that to the $332.7 billion in corporate taxes estimated for 2014 (source) and we get $596.8 billion. So my scheme will generate $112.9 billion more than the current system. And keep in mind that most of that $332.7 in corporate taxes actually comes out of our pockets; the lost revenue will be offset in part by a reduction in prices for corporate goods and services.

If we eliminate the corporate income tax, require all corporate profits to be distributed, and tax dividends at the same rate as ordinary income, here are some of the benefits:

• Since all income will be taxed, all at the rate at which ordinary income is taxed, the gap between the rich and the poor will narrow. "In 2013, an estimated 94 percent of the tax benefit of low rates on capital gains will go to taxpayers with cash incomes over $200,000, and three-fourths of the benefits will accrue to millionaires." (source: Tax Policy Center) In addition, rich and poor alike will no longer be stuck with the $332.7 billion in corporate taxes that is passed on in the form of increased prices for corporate goods and services.

• At the current rates for ordinary income, total federal tax collections will increase by about $112 billion. That would take a nice hunk out of this year's $583 billion federal deficit.

• State and local governments with income taxes based on federal Adjusted Gross Income will get a revenue boost. States that rely on the sales tax - Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming - won't.

• Without the added expense of the corporate income tax, U.S. corporations will be better able to compete with foreign companies, and that will reduce our trade deficit.

• U.S. corporations won't be looking for ways to shift profits to foreign tax havens like Switzerland, Ireland, Bermuda and the Cayman Islands.

• Since corporations will be forced to distribute all profits as dividends, current stockholders will be flush with cash from dividends, even after individual income taxes have been withheld. They can use that cash to buy more stock.

For the other side's view on this subject, see the article The United States’ High Tax Burden on Personal Dividend Income on the site of the Tax Foundation.

Send comments to stevenrharry@gmail.com.