The graduated corporate rate structure was publicly promoted as a tax on “bigness” when President Franklin D. Roosevelt first introduced it in 1935. In proposing the graduated rates, Roosevelt explained “[t]he advantages and the protections conferred upon corporations by Government increase in value as the size of the corporation increases . . . it seems only equitable, therefore, to adjust our tax system in accordance with economic capacity, advantage and fact. The smaller corporations should not carry burdens beyond their powers; the vast concentrations of capital should be ready to carry burdens commensurate with their powers and their advantages.” Given the relatively modest graduation in the original rates, however, this move is often portrayed as largely a political ploy rather than a serious tax measure. Paul Conkin noted that the 1935 tax bill in which the graduated rates were imposed “neither soaked the rich, penalized bigness, nor significantly helped balance the budget.” Even at the time its opponents called it a “legislative absurdity” enacted on the “whim” of the President. The conventional wisdom is that the graduated corporate income tax structure was designed to appeal to populist voters as part of the “rhetoric and psychological warfare” of New Deal-era politics, but was not designed to actually change the economics of operating businesses through large corporations. At best, it has been characterized as “an aid to small business.”

…continue reading: Taxing Bigness

In our paper, The Corporate Pyramid Fable, which was recently published on SSRN, we investigate the impact intercorporate taxation of dividends had on corporate pyramids. Intercorporate taxation of dividends became a permanent feature of the U.S. tax landscape in 1935. Correspondingly, to assess the impact of this change, we rely on a pioneering hand-collected dataset based on filings made between 1936 and 1938 with the Securities and Exchange Commission by investors owning 10% or more of shares of corporations registered with the Commission. To the extent that the received wisdom concerning tax and corporate pyramids is correct, the introduction of taxation on intercorporate dividends in 1935 should have prompted the rapid unwinding of corporate-held ownership blocks in public companies, thus causing the simplification of complex group structures, including pyramidal arrangements.

Our results indicate matters worked out much differently. Although politicians may have supported the intercorporate dividends tax because they believed that it would induce corporations to unwind stakes held in other publicly traded corporations, tax reform apparently did not have that effect. Corporations that owned large stakes in publicly traded firms rarely sought to exit in the years immediately following the introduction of intercorporate taxation of dividends, and many corporations even increased their ownership stakes in other corporations. A key reason the introduction of intercorporate taxation of dividends did not have the anticipated impact was that the tax burden was so modest. Although dividends by one corporation to another corporation were no longer completely tax-free, they remained largely exempt.

…continue reading: The Corporate Pyramid Fable