Hiking Dividend Taxes to Pay for a Corporate Rate Cut

Finland’s government recently announced a broad fiscal reform package that cuts corporate tax rates—financed in part by higher taxes on corporate dividends. The plan makes sense for Finland and is worth considering here at home.

Finland will lower the corporate rate to 20 percent in 2014, down from the current rate of 24.5 percent (and 26.0 percent in 2011). The move follows rate cuts in competing European nations, including the UK and Sweden, and a planned rate cut in Denmark. Finland’s current corporate rate is at about the median in the OECD; dropping the rate to 20 percent will put Finland’s rate close to the bottom for European OECD countries.

Finland plans to pay for part of the rate cut by boosting the effective investor tax rate on dividends paid by companies listed on the Finnish stock exchange. (The reform is not a statutory rate hike, but rather a reduction in preferences for dividends.) Effective taxes will increase only on dividends, not on capital gains.

The swap makes sense.  A lower corporate tax rate should help attract new business to Finland, which maintains an extremely open and competitive economy. As in other countries, a lower corporate rate will reduce distortions—such as the type and financing of business investment—that become more severe with higher rates. Moreover, the swap is likely progressive, and will help mitigate Finland’s rise in income inequality over the past decade.

The plan is not without drawbacks. One chief concern is that taxing only dividends of companies listed on the Finnish exchange will push firms off the bourse. Still, the reform’s benefits appear to outweigh the costs.

A similar reform would make sense in the United States. There is widespread agreement that the U.S. corporate tax rate is too high. Both President Obama and House Budget Committee Chairman Paul Ryan—a pair rarely in agreement—have called for a lower corporate rate. Despite a jump in tax rates in 2013 relative to last year—the top rate on dividends rose from 15 percent to 23.8 percent—tax rates on investment returns remain at historic lows for most taxpayers.

Moreover, trading a lower corporate tax for higher taxes on investors in the U.S. would be progressive. My TPC colleagues and I analyzed a revenue-neutral plan to tax capital gains and dividends as ordinary income while simultaneously lowering the corporate tax rate from 35 percent to about 26 percent; we found the plan would lower the average tax burden for the bottom 99 percent of taxpayers. (Implementing Finland’s plan today would pay for a smaller drop in the corporate tax rate because of the higher rates in 2013 and the fact that the reform would only raise taxes on dividends, not capital gains.)

Corporate tax reform in the U.S. seems to be inevitable, but questions remain over how to pay for it. Finland may have the answer.