Members and witnesses expressed concern during a Senate Finance Committee hearing on May 24, 2016, that a corporate integration plan with a dividends paid deduction would, by reducing corporate tax liability, diminish the effectiveness of current tax incentives like the research credit and accelerated depreciation, and disadvantage start-up companies that are more likely to retain their earnings rather than pay dividends to shareholders.

The Committee's second hearing on corporate integration, intended to focus on debt and equity financing issues, also included mentions of concerns from the first hearing last week that the 35% withholding tax expected to be included in Chairman Orrin Hatch's (R-UT) forthcoming corporate integration proposal would penalize tax-exempt entities like retirement plans and deter foreign investment in the United States. In his opening statement (as well as at the end of the hearing), Chairman Hatch attempted to "clear up some misunderstandings" about these issues that were left over from the first hearing, acknowledging that "there's a graveyard near the White House filled with corporate integration proposals."

Witnesses at the hearing were:

— Alvin C. Warren, Jr., Ropes & Gray Professor of Law, Harvard Law School, Harvard University, Cambridge , MA

— John Buckley, Former Chief Tax Counsel, Committee on Ways and Means, United States House of Representatives, Washington, DC

— Jody K. Lurie, CFA, Vice President, Corporate Credit Analyst, Fixed Income Strategy and Research, Janney Montgomery Scott LLC, Philadelphia, PA

— John McDonald, Partner, Baker & McKenzie LLP, Chicago, IL

Warren acknowledged that corporate integration would pose numerous design issues, including the treatment of tax-exempt shareholders like retirement accounts, foreign income and foreign shareholders. He said such a plan could, however, reduce or eliminate distortions under the current system, including those caused by differences in the taxation of corporate debt and equity.

Buckley said there are several aspects of corporate integration that should cause the Committee to approach the issue with caution and skepticism, including that it would effectively repeal incentives like accelerated depreciation and the research credit and, by imposing new withholding taxes on foreign investors, would be inconsistent with and potentially in violation of tax treaties and perhaps invite retaliatory action affecting US investment overseas.

Lurie said corporate integration would provide an incentive for companies to give back to shareholders through dividend distributions, at the expense of long-term capital investments that would have a more favorable effect on job creation, long-term expansion, and investments in long-term domestic projects that would better support the economy.

During questioning from Ranking Member Ron Wyden (D-OR), Buckley said retained earnings are necessary to finance future growth, particularly for new companies that do not have great access to credit markets and do not want to issue stock to dilute ownership in the business. In a very bizarre way, he said, a dividends paid deduction would result in those corporations paying a higher rate of corporate tax than mature companies that can afford to increase dividends and eliminate tax liability.

Senator Wyden further asked whether there is reason to be concerned that bipartisan tax incentives like the research credit would be diminished by integration proposals that would potentially allow corporations to fully wipe out their tax liability by paying all earnings as dividends. He also expressed concern that eliminating tax liability would compromise current tax incentives to hire disadvantaged workers and invest in communities. Buckley said corporate integration would effectively repeal most tax incentives for the bulk of corporations because corporate income taxes could be eliminated. Incentives like the research credit and accelerated depreciation tilt the playing field in favor of investment in the United States and lawmakers should be very cautious about the effect of a shareholder dividend deduction on those incentives, he said.

Under questioning from Senator Ben Cardin (D-MD) about continued investment in economic growth for challenged communities, Buckley said tax incentive provisions require tax liability to be effective and, with elimination of all corporate tax liability, different mechanisms of delivering subsidies would need to be developed. Other approaches include refundable tax credits or direct spending programs, though neither would be expected to gain sufficient support in the current political environment, he suggested. Questioned by Senator Bob Casey (D-PA) over whether integration would adversely affect investment, Buckley said accelerated depreciation is not neutral but does spur investment in the United States. "I think the tax code should be neutral, but neutral only insofar as it tilts the playing field in favor of investment in the US," Buckley said, later noting that he "favor[s] tax reform that lowers the corporate rate and eliminates distortive tax preferences."

Senator Mark Warner (D-VA) also expressed concern that integration would exacerbate "short-termism" among corporations, which are sometimes reluctant to make long-term capital investments in human capital and equipment.

Chairman Hatch concluded the hearing with a lengthy line of questioning during which he challenged the notion that retained earnings are preferable over dividends, and said the dividends paid deduction under the corporate integration proposal would not be mandatory: companies would not be forced to pay out their taxable income in dividends, and some would decide to retain all or some of their income and benefit from tax preferences. He also took issue with suggestions that a corporate integration plan would violate US tax treaties with other nations, suggesting that it would be a new system to which treaties would not apply.

Asked by Chairman Hatch why corporate integration has failed to gain momentum in the past, Buckley said it is because of opposition from the corporate community, or at least indifference: corporations do not want an incentive to distribute earnings, they prefer to grow and retain their earnings, and other incentives like a corporate tax rate reduction are more attractive. During his testimony, Buckley said indifference or opposition from the corporate community played a large role in the defeat of the corporate integration proposals made by the Reagan, George H.W Bush, and George W. Bush Administrations.

Chairman Hatch expressed general exasperation at the resistance to the corporate integration concept, asserting that tax reform can never seem to be accomplished because of a desire to "throw up roadblocks" rather than working with the committee to improve his proposal. "I can't see why anybody would be against what we are trying to do here," Chairman Hatch said, adding that the United States has a "lousy tax system" that is not competitive on a global basis. Buckley said the best approach going forward is broad-based reform with corporate rate reduction. Hatch responded that such a reform cannot happen under the current political environment and that he is trying to make incremental progress with integration until comprehensive reform can be pursued over the next couple years.

Hatch also asked Buckley whether his criticism of the interest withholding feature in Hatch's corporate integration plan would similarly apply to the expense allocation rule in the tax reform bill that former House Ways and Means Committee Chairman Charlie Rangel (D-NY) introduced in 2007 (H.R. 3970, Tax Reduction and Reform Act of 2007), which would have denied current interest deductions allocated to foreign earnings that are not subject to US tax.

Sen. Dean Heller (R-NV) asked the witnesses about global competitiveness. Buckley suggested the best approach is comprehensive business tax reform financed by elimination of distortive tax incentives and a revision of international rules to make US companies more competitive overseas and in the United States.

Member statements and witness testimony from the hearing are attached.

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ATTACHMENTS

Buckley statement

Hatch statement

Lurie statement

McDonald statement

Warren statement

Wyden statement