Briefly describe the rationale for the reduced tax rate on dividends for individual taxpayers

The double tax on dividends creates a number of distortions in the economy, including (1) an incentive to invest in noncorporate taxpayers rather than corporate taxpayers, (2) a preference by corporations to finance operations with debt rather than equity, and (3) a motivation for corporations to retain earnings and to structure distributions to avoid the double tax. Taken together, these distortions raise the cost of capital for corporate investments by causing reliance on debt financing. This increases the vulnerability of corporations during economic downturns. By taxing dividends at a lower rate, policy makers argue that the negative impacts of the double tax are mitigated. As a result, capital formation in the corporate sector should increase, stimulating the economy. Reducing the double tax through a lower tax rate on dividends should also make the United States more competitive internationally.