An OECD working paper written by M. Harding and M. Marten and issued on 15 February 2018 is entitled “Statutory tax rates on dividends, interest and capital gains: the debt equity bias at the personal level”.  The paper presents tax rates on various forms of income from capital, including integration between corporate and personal taxation on dividends and capital gains. The analysis looks at the debt/equity bias of the taxation system when personal tax rates are taken into account.

The paper notes that the tax system can distort choices at the corporate level as it favors debt over equity financing, with tax deductibility for the costs of debt finance but no comparable treatment for equity finance apart from certain regimes in Belgium, Italy and Turkey. In considering the whole picture on the debt/equity bias it is necessary to consider taxation also at the personal level. This involves consideration of personal tax rates on income from both forms of finance; integration between personal and corporate tax rates on dividend income; and the relevant tax rates.

If the whole picture is considered the return from corporate debt in the form of interest is deductible against corporate income and is also taxable as interest income on individuals. In the case of equity finance the return is taxed at the corporate level and is then taxed at the personal level when it is received as a dividend or capital gain. At the individual level the extent to which tax rates are higher depends on the tax rate for each type of income; the integration of personal and corporate taxation applicable to the return on equity investment; and the tax regime for personal income.

The paper presents a table showing combined tax rates on the return on equity compared to the top statutory tax rate on interest from corporate bonds. As the return on equity can be paid as dividends or capital gains the table shows weighted average tax rates using three different assumptions about the form of the return on equity. The three assumptions are firstly that equity is distributed as 25% dividends and 75% capital gains; the second assumes the equity is distributed 50% dividends and 50% capital gains; and the third that it is distributed 75% as equity and 25% as capital gains. To allow for the effect of deferral of tax on capital gains until they are realized the top personal tax rates on capital gains were reduced by 25%.

The average combined top statutory tax rates on equity are separated into the corporate tax on profits and the additional tax paid at the top individual level under each of the three assumptions. The difference between the combined top statutory rates on equity (assuming the return is distributed equally between dividends and capital gains) and the top statutory rates on bonds is then shown.

The resulting table indicates that when personal income tax rates on the return to equity and bond interest are taken into account there is still a bias towards debt financing but the bias is lower than it is at the corporate level alone.

The paper notes in its conclusion that countries apply different tax treatments to different types of capital income. Both interest income and capital gains on property are taxed on individuals only at the person level whereas dividends and capital gains on shares are taxed at both the corporate and the personal level. The integration of the corporate and personal levels of tax is therefore important in determining the overall tax rate on dividends and capital gains. In most countries tax rates are highest on dividends and lowest on capital gains on real property.