Wednesday, June 1, 2016

The Long-term Decline in Taxable Corporate Stock

Updated October 2017

When most of us think of American corporate taxes, we often recall Corporate America's whinging about the 35 percent headline tax rate and how punitive it is to their businesses.  Critics of the current corporate tax rate base much of their anti-35-percent argument on the fact that corporations are double-taxed; first paying the 35 percent rate and then, through their shareholders, paying up to 23.8 percent on both dividends and capital gains.   A recent study by Steve Rosenthal and Lydia Austin at the Tax Policy Center finds that this argument is not based on reality.

The study by Rosenthal and Austin suggest that the anticipated increase in revenue may not be as substantial as expected for one key reason; how America investors hold their equity investments compared to how they held equities in the past.  When just using Federal Reserve Flow of Funds data, it appears that households own a substantial portion of the outstanding shares issued by U.S. corporations; in 2015, households directly owned 37.3 percent of corporate equity and an additional 13 percent indirectly through mutual funds for a total of 50.3 percent.  Other sources suggest that household equity ownership ranges from 44 percent to 68 percent.  The authors suggest that the Federal Reserve's household share ownership measurement is too broad and greatly overestimates the ownership of U.S. stock in taxable accounts, a more meaningful measure.  To gain a more meaningful ownership level, the authors adjusted the Fed's data as follows:

1.) Excluded foreign equity held by U.S. residents.

2.) Measured only the stock of corporations that are separately taxable under subchapter C and ignored passthrough corporations like mutual funds, ETFs, CEFs and real estate investment trusts.

These two steps isolate the corporations that are subject to U.S. taxes and are potentially subjected to double taxation.

3.) Excluded stock held by non-profits.

4.) Excluded stocks held by IRAs.

5.) Added back stock that taxable individuals held beneficially through mutual funds, ETFs and CEFs (i.e. the underlying portfolios of these passthrough corporations).

Step 5 combines indirect ownership with direct ownership by taxable accounts.

Here is a table showing the end result of their calculations:

In 2015, the outstanding value of U.S. corporate stock was $22.8 trillion

Now, the authors calculate what portion of the $22.8 trillion in U.S. corporate stock was held inside and outside of taxable accounts as well as removing stock held by foreigners, pensions and non-profits as shown on this table:

In 2015, the total holdings of taxable corporate stock held by U.S. taxpayers was $5.525 trillion or 24.2 percent of the total outstanding value of U.S. corporate stock.

Now that we have the data for 2015, let's take a journey back in time.  Looking back to 1965, the authors found that the percentage of U.S. corporate stock held inside of retirement plans (both defined benefit and defined contribution pension plans as well as IRAs) has grown substantially from around 5 percent in 1965 to 37 percent in 2015 as shown on this graph:

In addition to growing stock ownership in tax-sheltered plans, ownership of U.S. corporate shares by foreigners in both portfolios and direct investments has risen from 5 to 6 percent in 1982 to 21 to 26 percent in 2015  as shown on this graph:

Putting all of the data together, the authors derived this graphic solution:

Over the last five decades, U.S. corporate stock held in individual taxable accounts has fallen  from 83.6 percent in 1965 to 24.2 percent in 2015. 

As you can see from this research, there has been a substantial erosion in the taxable shareholder base.  Individuals are simply increasingly choosing to hold their equity investments inside a tax-sheltered vehicle.  This means that any proposals to increase federal tax revenues by increasing taxes on both dividends and capital gains may well be moot.  It also means that any proposals to reduce the so-called double-taxation on corporate earnings must take into account the fact that a very substantial and increasing portion of U.S. stock is already outside the grasp of the Internal Revenue Service.  

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