The Dividend Divide in Anglo-American Corporate Taxation

By Bank, Steven A. | Journal of Corporation Law, Fall 2004 | Go to article overview

The Dividend Divide in Anglo-American Corporate Taxation


Bank, Steven A., Journal of Corporation Law


ABSTRACT

Why did the United States and the United Kingdom-two countries with similarly developed economies and corporate cultures-originally diverge in their approaches to corporate income taxation, with the U.S. taxing corporate income twice and the British only once, and why have they continued to vacillate on this issue over time? This Article concludes that it is a result of a divergence in firm dividend policies in the two countries. While firms in both countries maintained liberal dividend policies during the nineteenth century, U.S. firms began to retain more earnings after the turn-of-the-century, and this necessitated a change in the method of taxing corporate income. In subsequent years, both countries have undergone major corporate tax reforms during periods of concern about the direction of firm dividend policies in their respective countries. I suggest that this has important implications for predictions about the future of corporate income tax design.

I. INTRODUCTION

There are a variety of approaches to taxing corporations and their shareholders.1 On this spectrum of choices, the United States and British corporate income taxes have traditionally stood at opposite ends. The U.S. has what is called a "classical" corporate income tax,2 where corporate income is subject to tax at both the corporate level when earned and the shareholder level when distributed as a dividend.3 By contrast, the United Kingdom has historically had a shareholder imputation system, where shareholders are provided a credit for dividend payments.4 Depending upon the size of this credit, it reduces or eliminates the second layer of tax.

This chasm between the two systems, however, has not always existed, and both countries have made movements to close the gap at various points during the past century. During the nineteenth century, both the U.S. and the U.K. had a pass-through approach to taxing corporate income. While the U.S. switched to the classical approach in the early twentieth century, integration of the corporate and individual income taxes has been proposed several times, most recently by President George W. Bush in 2003. This latest effort culminated in a significant reduction in the double tax burden.5 Conversely, the U.K. has frequently experimented with a more classical approach, even adopting the U.S. system itself between 1965 and 1973. In 1997, the U.K. all but abandoned the shareholder imputation approach in a move that has nudged its system closer to a classical corporate income tax.6 Why did the U.S. and U.K.-two countries with similarly developed economies and corporate cultures-diverge in their approaches to corporate income taxation, and why do the two countries continue to veer toward and away from each other on this issue? One possible explanation is that the different methods of taxing corporate income are a reflection of the different theories of the corporation.7 According to this view, the U.S. system reflects the notion that the corporation is a real entity, while the U.K.'s system suggests the corporation is a mere aggregate of its individual shareholders. Under closer examination, however, entity theory has not proven to be a significant factor in corporate income tax design, at least in the United States.8

This Article concludes that the divide between the American and British corporate tax systems can be explained by a real and perceived divergence in corporate dividend policies. During much of the nineteenth century, corporations in both the United States and the United Kingdom distributed most of their profits as dividends each year and raised capital through the debt or equity markets.9 Around the turn-of-the-century, however, a fundamental change in U.S. corporate finance began to occur-corporations started to retain an increasing percentage of their earnings as an internal method of financing expansion and other needs.10 During this same period, no such change occurred in U. …

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