How a corporate tax rate cut could help small stockholders

Corporate tax reform is on the national agenda, with the House GOP hoping for a “border-adjusted" tax and President Trump threatening a "big border tax.” The President wants US companies to stay put, and he vows to remember the “forgotten people,” or working class Americans. Some of those Americans are corporate shareholders. 

Are there ways to reform the US corporate tax system that benefits them? Maybe. We just need to remember who pays corporate taxes and how. 

Thanks in large part to the financial market collapse of 2008, stock ownership has been declining. According to Federal Reserve data, about 49 percent of all adults owned stock in 2013 down, from 53 percent in 2007. For those in the middle of the income distribution, the stock ownership rate dropped from 14 percent in 2007 to 11.7 percent in 2010. 

Much of that stock equity is tax-exempt, held in individual retirement accounts or employer-based retirement plans. My TPC colleagues Steve Rosenthal and Lydia Austin estimate that only about one-quarter of US stocks are held in taxable accounts, down sharply over the past 50 years. 

Could corporate tax reform help those middle-income owners of taxable stock that remain? Perhaps. 

Take my own story: On June 19, 1987, my dad helped me invest my babysitting earnings in shares of four companies. Exactly four months later, on Black Monday, my dad said “The market crashed, but your stocks will come back. You’re young, you have time, don’t sell.” So I held my stocks for the long run, reinvested the dividends, and paid taxes on those distributions each year. 

Last year, one of those companies completed a corporate inversion. The company reduced its tax bill by changing its mailing address to a low-tax jurisdiction, and for long-term shareholders, tax bills skyrocketed. That’s because on paper, we sold stock in a US company and acquired shares in different, foreign, company. For me, that translated into an immediate tax bill for 30 years of capital gains. I’m not complaining about those gains, they’re great, but… ouch.

My dad didn’t warn me about this back in 1987, and he’s relieved I have the resources to pay the taxes I owe. But what about other small, long-term shareholders who might be feeling anything but great? What if stocks were taxed differently? 

My TPC colleague Eric Toder and Alan Viard of the American Enterprise Institute have a detailed plan to do it. They proposed an updated version last year, and just last month, Republican Senator Mike Lee of Utah said he likes the look of it.  

Eric and Alan would cut corporate tax rates from 35 percent to 15 percent. That would make US corporate tax rates competitive with the rest of the world and reduce a company’s incentive to invert. They'd also require shareholders to pay tax at ordinary income rates on dividends and on their “accrued,” capital gains each year. 

In other words, your broker would determine how much your investment increased in value over the year, and you’d pay tax on that profit (or report a loss)—even if you didn’t sell your shares. Taxable investors would get a credit against taxes already paid by the corporation. 

But wait—isn’t paying tax on unrealized gains a raw deal for shareholders, especially for those folks who don’t own a lot of shares and may not have the resources to pay the tax? 

Not to worry: Eric and Alan would not count the first $500 ($1,000 for couples) of annual growth (or loss) on a stock. In addition, they’d allow investors to smooth out big accrued gains over several years so they wouldn’t face tax sticker shock if an investment took off.

Would the small-investor exemption add to the deficit? Nope. While TPC estimates that about 90 percent of taxpayers have dividends and realized capital gains below $500/$1,000, their gains comprise only 3 percent of the projected tax revenue from shareholders. 

As a small stockholder, I like this plan. It could make US businesses more tax competitive and less likely to invert, reducing opportunities by US-based multinational firms to game the tax system, and protect small shareholders from taxes on their investments. Shareholders of all sizes would have less reason to hang on to stock just to avoid paying capital gains taxes. Or, they might not prematurely dump different stock at a loss just  to soften the tax pain of another stock’s gain. Larger investors would pay tax (or generate tax losses) in the year they occur. 

It’s fair. It’s understandable, even to a layperson like me. How often can you say that about corporate tax policy?

And maybe it’s just plain good. What if middle-income Americans knew that they could invest a little money in a US company and watch it grow over time—without a tax consequence when their holdings are small and  they may not have the resources to cover taxes owed? Maybe they'd be more likely to invest over the long-term and reap the rewards of their patience years, or even decades, later. 

That could be more than good. It could be great.

This story originally appeared on TaxVox.