Capital income taxation and progressivity in a global economy. Tax Policy Center, Urban Institute and Brookings Institution working paper

The increase in international capital mobility over the past two decades has put pressure on the tax treatment of corporate equity income. Corporate level taxes distort investment flows across locations and create opportunities for tax avoidance by shifting income across jurisdictions. Outward flows of capital shift part of the burden of the corporate level tax on equity income from capital to labor, thereby making its incidence less progressive. Individual level taxes on corporate equity income lower the after-tax return to savings but have less distorting effects on investment location and are more likely to fall on owners of capital than workers. This logic suggests there may be both efficiency gains and increases in progressivity from shifting taxes on corporate equity income from the corporate to the shareholder level. We discuss these effects and estimate the distributional effects of raising shareholder-level taxes on corporate equity income and using the revenue to cut the corporate tax rate. We find that taxing capital gains and dividends as ordinary income (subject to a maximum 28 percent rate on long-term capital gains) would finance a cut in the corporate tax rate from 35 percent to about 26 percent, assuming no behavioral responses. While the distributional effect depends on what one assumes about the incidence of the corporate income tax, our results suggest that even if the corporate income tax is paid entirely by capital income, the reform would make the tax system more progressive