A Political Theory of Corporate Taxation

By Arlen, Jennifer; Weiss, Deborah M. | The Yale Law Journal, November 1995 | Go to article overview

A Political Theory of Corporate Taxation


Arlen, Jennifer, Weiss, Deborah M., The Yale Law Journal


I. Introduction

The American tax system imposes a double tax on the profits of corporations. This two-tier taxation is unusual,(1) unfair,(2) and inefficient. The ill-effects of the double tax are well known in Washington. Congress regularly considers legislation to eliminate the double tax by integrating the personal and corporate taxes into a single system. These initiatives have had the support of tax scholars, the Treasury, the public, and several Presidents. Yet proposals to integrate the tax system invariably die a quiet death.

The persistence of the double-level tax is puzzling. To be sure, the tax code contains many provisions in desperate need of revision. Typically, though, these provisions are supported by a well-organized interest group that lobbies vigorously to retain its cherished preference. The corporate tax, in contrast, appears to benefit no one directly and to hurt the corporate sector, which is large, well organized, and generally able to defend its own interests. Nor does the double tax persist because of public support. Opinion polls regularly show public opposition to double taxation.

In this Article, we argue that the resilience of the corporate tax is a manifestation of the most enduring source of problems in corporate law, the separation between ownership and control of large corporations. Large corporations might be expected to lead the fight against the double tax. Their managers, however, have chosen not to lobby vigorously for integration, even though shareholders often would benefit from integration. In this managerial diffidence lies the key to explaining the failure of integration efforts.

Managers' lack of interest in integration, we argue, results from the fact that managers and shareholders pursue different objectives when firm ownership is separated from control. Shareholder objectives are served both by new investments and by higher returns on old investments. Managerial objectives, in contrast, are served primarily by new investments. This difference in objectives leads shareholders and managers to have different views on corporate investments and on tax policy. Shareholders benefit both from measures such as integration that provide windfalls to their existing shares and from measures such as accelerated depreciation (ACRS)(3) and investment tax credits (ITCs) that increase the return on new investments. Managers, in contrast, benefit only from policies that stimulate new investment. Thus, while many managers support integration, they would rather devote corporate resources to lobbying for tax preferences, such as ACRS and the ITC, that encourage new investment.(4)

The separation of ownership and control may have an even more surprising consequence. Some managers, we argue, may actively oppose integration because the double tax serves their interests. These managers may support the double tax for one of the very reasons that reformers oppose it: Double taxation traps earnings in the corporation. This retained earnings trap enables managers to pursue investments from which they benefit at the expense of shareholders.

Understanding the failure of past reform efforts is key to the success of future efforts. Managers have been the only vocal public participants in earlier debates. Reformers, we believe, must secure the support of managers in their quest for integration. Managers, in our view, can be persuaded to support integration by the introduction of proposals that avoid windfalls and, perhaps, those that lock in earnings.

Part II examines alternative explanations of the double tax, including various populist arguments. Parts III and IV examine our hypothesis that the separation of ownership and control explains managerial apathy - and sometimes antipathy - towards integration. Part III examines why most managers have so little enthusiasm for integration: Integration provides a windfall for existing equity, whereas managers would prefer to lobby for tax preferences that promote new investment. …

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