investment but also its composition. Although there may be social benefits of housing construction, as a result of the tax system’ s bias, approximately one-third of net private investment goes into owner-occupied housing, penalizing more productive corporate investment (Jorgenson and Yun, 1990; Poterba, 1992). To the extent international debt markets are integrated, reduced residential investment would not translate directly into increased investment in plant and equipment. Nevertheless, at least half of the value of residential real estate in the United States is equity financed, and a substantial part of the equity freed by reduced residential investment would be available for other investments, including plant and equipment. Moreover, given the tax system, investment in residential real estate has a highly favorable bias and plant and equipment are relatively disadvantaged. Reducing this disparity would eventually tilt the nation’s overall investment portfolio more in favor of the corporate sector.

Reducing the maximum mortgage principal eligible for interest deductions to $300,000 would yield additional revenues, estimated at $4 billion to $5 billion per year according to the Joint Tax Committee and the Congressional Budget Office (1994). The board believes that, pending conversion to a consumption tax system, some of the revenues generated by this measure should be used to lower the taxes on the returns from corporate investment, thereby lowering the cost of capital. We favor two proposals. The first is elimination of the double taxation of corporate/divided income flows.

Relative to other countries, the United States, through its double taxation policy, penalizes equity investment and increases the wedge between the cost of funds and the cost of capital, a condition that has prevailed for some time but attracted considerably more notice with the emergence of aggressive foreign competition and the decline in the growth rate of productivity.20 This double taxation is mitigated by three factors: corporations retain income, thus deferring the tax; financial investors can defer taxation of the capital gains portion of the return by holding the stock; and there is a class of tax-exempt or tax-deferred investors, primarily pension funds, that are in whole or in part relieved of the corporate income tax. Nevertheless, the double taxation penalty on taxable income flows at today’s higher marginal personal and corporate tax rates can be quite dramatic. Consider an individual investor who


This double taxation has led to an increase in corporate leveraging in buyouts (because interest is deductible but dividends are not) and hence to a reduction in government revenues. With the increase in marginal tax rates contained in the 1993 tax act, both at the corporate and individual levels, this double taxation became more of a hindrance to additional capital investment.

The National Academies | 500 Fifth St. N.W. | Washington, D.C. 20001
Copyright © National Academy of Sciences. All rights reserved.
Terms of Use and Privacy Statement