The Story of Double Taxation: A Clash Over the Control of Corporate Earnings
Steven A. Bank
University of California, Los Angeles (UCLA) - School of Law
BUSINESS TAX STORIES, Foundation Press, 2005
This chapter examines the circumstances leading up to repeal of the dividend exemption and the introduction of full double taxation. In the Revenue Act of 1936, President Roosevelt introduced a radical plan to combat corporate hoarding of earnings by replacing the corporate income tax with an undistributed profits tax and a repeal of the dividend exemption. If distributed as dividends, corporate income would only be subject to the individual income tax. If retained, however, corporate income would be subject to both a punitive undistributed profits tax and, upon distribution in later years, the individual income tax as well. In the face of opposition from managers and concerns about revenue if the corporate income tax was abandoned, Congress settled on a compromise. It adopted a more modest version of Roosevelt's plan for an undistributed profits tax while retaining the corporate income tax. No effort was made, though, to restore the dividend exemption. Thus, for the first time corporate earnings were fully subject to both the corporate and individual income taxes. This tax on dividends survived the repeal of the undistributed profits tax a few years later.
Some have called the introduction of double taxation under the circumstances of the Revenue Act of 1936 inadvertent or a case of business talk[ing] itself into a higher tax bill. The story, however, is much more complicated than that, involving a clash over the control of corporate earnings. As this chapter will explain, the threat posed to managers by the undistributed profits tax led to the retention of the corporate income tax and the repeal of the dividend exemption. Far from being a typical New Deal assault on big business or an inadvertent by-product of the compromise over Roosevelt's original proposal, double taxation was a pro-manager measure adopted to blunt the force of the undistributed profits tax. Business leaders and their allies in Congress hoped that the repeal of the dividend exemption and the resulting imposition of double taxation would aid in aligning management-shareholder attitudes toward the retention of corporate earnings. Double taxation thus became a tool in the campaign against the undistributed profits tax.
This paper will be published as a chapter in a book entitled Business Tax Stories, to be published by Foundation Press later this year (2005).
Date posted: April 18, 2005