The Triple Taxation of Corporate EquityProfits

Atlantic Economic Journal (2005)33:337358 * IAES 2005DOI: 10.1007/s11293-005-8174-8

RICHARD MARLIAVE*AbstractIn the absence of liquidations and share repurchases, the value of corporate equity is

the net present value of all future dividends. This net present value is subject to three

taxes: the corporate income tax, the dividend income tax, and the capital gains tax.

Algorithms are developed for calculating the aggregate tax rate on corporate equity net

present value. Although the lowest aggregate tax rate occurs when all earnings are paid

as dividends, corporations increase shareholder value by reinvesting earnings whenever

the after-tax returns of doing so exceed the discount rate. It is these high return

investments that are subject to the highest aggregate tax rates, potentially exceeding 90

percent of pre-tax value under current law. (JEL H22)IntroductionCorporate1 equity is the major form of commercial investment in the United States.

Taxes on corporate equity impact the incentives to invest, which, in turn, impact

economic growth. The economic analysis of public finance, therefore, is dependent upon

an accurate understanding of the aggregate impact of the three taxes on corporate equity

profits: the corporate income tax, the dividend income tax, and the capital gains tax. This

paper attempts to further that understanding by showing how this aggregate impact can

be quantified under a triple taxation model.It is commonly recognized that dividends are distributed corporate income, thus

justifying the assertion that dividends are double taxed by the corporate income and the

dividend income taxes. It is less often observed that capital gains reflect the value created

by reinvested corporate earnings, which also results in a double-taxation due to the

combined impact of corporate income and capital gains taxes. If it is further recognized

that capital gains reflect expected dividend growth based on rising profits from

reinvested earnings, then it becomes clear that all three of these taxes (on corporate

income, dividends, and capital gains) apply to the same corporate equity profits. Hence,

these profits are subject to triple taxation.Although it is often assumed that dividends and capital gains are two independent

sources of equity income (for example, see Zodrow, 1991), the idea that capital gains

reflect future corporate payments to investors is not new. Ray Ball [1984] explains how

capital gains taxes duplicate the taxation of the future investment...