	Introduction

In January 2016, Senator Orrin Hatch, chairman of the Senate Finance Committee, announced plans for a tax reform that would explore corporate integration. Corporate integration involves the elimination or reduction of additional taxes on corporate equity investment that arise because corporate income is taxed twice. This system of taxation produces differential tax burdens, potentially discouraging the realization of gains on the sale of corporate stock and favoring noncorporate equity investment over corporate investment, debt finance over equity finance, and retained earnings over dividends. These firms' choices with respect to the location of investment and profits are affected by firm-level rather than shareholder-level taxes. A second change is that the fraction of shareholders who are not subject to U.S. shareholder taxes has increased, so that currently only about a quarter of corporate stock of U.S. firms is estimated to be owned by shareholders subject to U.S. individual taxes on dividends and capital gains (compared to about half at the time of the study). If all profits were taxed at the statutory rate, distributed as a dividend, and then taxed at ordinary rates to a shareholder in the 35% bracket, the total tax on a corporate investment would be 58% (a 35% corporate tax and an additional 35% on the remaining 65% of profit) compared with a tax rate of 35% on noncorporate investment, for a 23 percentage point difference. Tax-Exempt Shareholders

A large share of corporate income (estimated at 50% of the total) is not taxed at the shareholder level because it is held in tax-exempt, or largely tax-exempt, form, such as pensions, individual retirement accounts, annuities, and life insurance. Effective Tax Rates for Investments Financed with Both Debt and Equity

As the preceding analysis indicates, corporations are more heavily taxed on equity investment than are firms in the noncorporate sector, but are more favored in the case of debt finance. Overall tax rates in the corporate sector are lower than in the noncorporate sector because of tax preferences for intangible investments. Full Integration

Full integration would eliminate one of the levels of taxation and apply both to dividends and retained earnings. Taxing at the Shareholder Level: Mark to Market

Another approach to integration is to repeal the corporate tax entirely, tax dividends and capital gains at ordinary rates, and mark the value of stock to market, that is, tax capital gains on the stock regardless of whether it was sold and increase the basis of the stock for the future. Imputation Credit or Deduction with Withholding Tax and Credit

Some of these issues with the dividend deduction can be addressed by adopting the same type of system using the corporation to withhold taxes as in the modified partnership treatment. It excluded interest from, and disallowed interest deductions for both corporate and noncorporate businesses. Revenue Concerns

Revenue impacts are an important consideration in any tax reform proposal. Table 1 focused on domestic investment by U.S. firms. If the shareholder allocation prototype allowed for refundable credits for the corporate tax, then the effective tax rates would be the individual rates (times their shares) for each type of shareholder multiplied by the ratio of the firm's effective tax rate to the statutory rate (to measure the difference between the economic base and the taxable base) minus the foreign tax credit. The mark-to-market approach is uncertain in its impact. The full integration proposals, imposing only the corporate tax, or a mark-to-market approach achieve neutrality between retained earnings and capital gains. Thus having only a modest reduction (as in the shareholder allocation or dividend deduction with nonrefundable credits) would be most likely to achieve efficiency gains (or not make losses larger). The refundable allocation and dividend proposals have significant revenue losses. Conclusion

The proposals for integration in this report were examined in the light of revenue adequacy, administrative feasibility, and economic efficiency gains in reducing distortions. It also would address issues such as profit shifting and inversions. The mark-to-market proposal, because it taxes global economic income, eliminates a number of distortions both domestic and foreign.
In January 2016, Senator Orrin Hatch, chairman of the Senate Finance Committee, announced plans for a tax reform that would explore corporate integration. Corporate integration involves the elimination or reduction of additional taxes on corporate equity investment that arise because corporate income is taxed twice, once at the corporate level and once at the individual level. Traditional concerns are that this system of taxation is inefficient because it (1) favors noncorporate equity investment over corporate investment, (2) favors debt finance over equity finance, (3) favors retained earnings over dividends, and (4) discourages the realization of gains on the sale of corporate stock. Increasingly, international concerns such as allocation of investment across countries, repatriation of profits earned abroad, shifting profits out of the United States and into tax havens, and inversions (U.S. firms using mergers to shift headquarters to a foreign country) have become issues in any tax reform, corporate integration included.
This report first examines the four traditional efficiency issues by comparing effective tax rates. These estimates suggest that there is little overall difference between corporate and noncorporate investment or even favorable treatment of corporations, for several reasons. A larger share of corporate assets benefits from tax preferences. Moreover, only a quarter of shares in U.S. firms is held by taxable individuals; the remainder is held by tax-exempt and largely tax-exempt pension and retirement accounts, nonprofits, and foreigners. Additionally, tax rates on individual dividends and capital gains are lower than ordinary rates.
However, effective tax rates across assets differ markedly, with intangible assets most favored and structures least favored. Debt is treated favorably in both the corporate and noncorporate sectors, but more so in the corporate sector, so that the total stock of assets in the corporate sector is taxed less heavily than in the noncorporate sector when both debt and equity are considered. The distortion between debt and equity finance is large in each sector, with negative tax rates for debt finance in many cases, while differences in taxes affecting dividend payout choices or realization of capital gains on stock appear to be small because of low tax rates.
The report outlines several approaches to integration. Full integration would address both dividends and retained earnings. One approach would tax on a partnership basis by allocating income to shareholders and using the firm to withhold taxes. Credits for withheld taxes would be provided to shareholders, and credits could be made nonrefundable for tax-exempt and foreign shareholders. A different full integration approach would eliminate shareholder taxes and tax only at the firm level. A third would tax at the shareholder level and not the firm by imposing ordinary rates and taxing not only dividends and realized capital gains but also unrealized gains by marking shares to market prices (i.e., mark-to-market). Partial integration focuses on dividends and could provide either a dividend deduction by the firm (with a withholding tax and credits) or a dividend exclusion to the shareholder. Disallowing interest deductions in full or in part could be combined with most proposals.
The report compares these proposals with respect to impact on revenue, administrative feasibility, and effects on both traditional and international tax choices. Shareholder allocation or deductions with refundable credits produce relatively large revenue losses, as does mark-to-market. Nonrefundability and making modifications in mark-to-market can substantially reduce these revenue losses. Most proposals would have modest efficiency gains, and some would modestly increase efficiency losses. Mark-to-market would tax economic income and potentially produce a number of efficiency gains but may not be feasible on administrative grounds. Disallowing or restricting deductions for interest would lead to efficiency gains on a number of margins and provide revenue to help achieve revenue-neutral reforms.