Integrate the Corporate and Individual Tax Systems Through a Dividend Deduction

The US tax code taxes business income differently depending on business structure and financing method. Noncorporate business profits (sole proprietorships, partnerships, S corporations) are passed through to individual owners’ tax returns and taxed through the individual income tax. C corporations face taxation at both the entity and shareholder levels. Equity-financed income is taxed twice (when earned, then again when distributed as dividends), while debt-financed income faces a lighter burden because interest payments are partially deductible. These disparities distort business decisions, encouraging excess borrowing and influencing choices about organizational form.

This option reforms the taxation of business profits by allowing corporations to deduct the dividends they pay to their shareholders from corporate taxable income. This results in one layer of tax on corporate profits distributed to shareholders, which would face the same individual-level taxes as under current law, resulting in treatment like the one layer of tax that applies to pass-through profits at the individual level. By reducing the cost of capital, this reform would spur additional capital investment and increase output.

On a conventional basis, this option would increase the primary deficit by $2,010.0 billion over the budget window. Long-run GDP would rise by 0.7 percent, and long-run GNP by 0.4 percent. On a dynamic basis, the primary deficit would increase by $1,590.5 billion from 2027 through 2036, $419.5 billion less than the conventional estimate. Incorporating changes in interest costs, the publicly held debt-to-GDP ratio would be higher than baseline, reaching 186.7 percent by 2056.

On average, taxpayers would see increases in their after-tax incomes in 2036 of 1.0 percent. The top quintile of taxpayers would experience a 1.1 percent increase, whereas the bottom quintile would experience a 0.8 percent increase. On a long-run dynamic basis, taxpayers would see a 1.5 percent increase on average.