Date Posted: 2002
One of the most controversial aspects of the U.S. income tax system is the double taxation of corporate income. Such income is taxed both when it is earned by the corporation and when it is distributed to the shareholders. Most other kinds of income are taxed only once. It is generally thought that treating corporate income less advantageously than other income distorts investment incentives and reduces economic productivity. This article draws upon the fundamental insight that a properly structured income tax encourages investment in risky assets to argue that a second layer of tax on corporate income can be a very efficient way of raising revenue and can possibly improve economic productivity. The article also shows how this insight helps to justify the difference in tax treatment between debt and equity which is generally thought indefensible. It also analyzes how the U.S. income tax could be restructured to take advantage of this phenomenon.