The Double Taxation of Corporate Profits and Other Fairy Tales

[WildNovember]

The usually insightful Steven Pearlstein swallowed a big one today in pushing the line that the taxation of corporate profits when they are paid out as dividends amounts to "double taxation." The problem with this story is that the corporation really is a distinct entity from the individual who receives dividends. In fact, according to the Supreme Court, they are actually distinct persons.

This is not a philosophical question; it is a very concrete economic one. No one is forced to organize a business as a corporation. Anyone can operate any business as a partnership. Partnerships do not pay a separate tax, the partners only pay tax on the profits as individuals.

In this sense, the corporate income tax is 100 percent a voluntary tax. It is paid only because people consider the benefits of corporate status to be worth more than the taxes that they must pay.

This removes any logical possibility of double taxation. The corporate income tax is effectively the fee that stockholders pay for the benefits of corporate status. By holding stock, they have voted with their feet to pay this tax. Their income, and the tax on it, should be treated as distinct from the corporate income. If individuals are not paying tax on their dividends and capital gains then it is not taxed.

http://www.cepr.net/index.php/blogs/beat-the-press/the-double-taxation-of-corporate-profits-and-other-fairy-tales#comments

[joeglow3]

1. I am guessing this person has not worked in taxes

Practically speaking, it would be near impossible for a large company to be an LLC. You have fun calculating the 704(c), 734(b), 743(b) & 754 adjustments for a large company every time a single share changed hands. I would agree with this if the IRC did not make it damn near impossible for a company over a certain size to elect subchapter K status.

[customerserviceguy]

3. That was my thought

I used to be enrolled to practice before the Internal Revenue Service, and the corporate form of ownership is the only practical one for those firms which want to have a broad base of ownership, including employees.

I do think that corporate profits are indeed taxed twice, but in most cases, I don't have a big problem with that. I have more of a problem with wages that are taxed once for FICA and Medicare, then taxed again for income tax purposes, with no deduction for the former payroll taxes.

[joeglow3]

4. Exactly. Not to mention all the technical terminations you would trigger

There is a VERY CLEAR double taxation, but I agree with you on both your points.

[Vincardog]

2. Consider the tax the fee they pay to escape liability for the corporate crimes

[aint_no_life_nowhere]

5. I've heard it argued that

a share of stock is also a device, like a taxi cab purchased by a taxi driver to earn income; a tool of the trade. At least I hope I'm expressing it correctly. Just because you make money with money instead of with a machine or tool doesn't mean you get off scott free from paying anything, whereas the manual worker pays on his revenue.

[joeglow3]

8. Yes and no.

Lets use a simple example. Suppose I invest $1,000 in a corporation. This corporation then takes this $1,000, buys a product and sells it for $1,200. The corporation makes $200 in profit and pays taxes on it. Lets assume it is taxed at 35% (yes, there are marginal corporate rates, but any decent sized corporation is in the 35% bracket). After paying taxes, the company now has $1,130 in cash. Now, assume I liquidate the corporation and distribute all the cash. I now have a $130 capital gain and pay 15% in taxes (about $20). The argument is that I paid $90 in Federal taxes (or a tax rate of 45%). Factor in both layers of state tax, and you end up paying about 55% in taxes.

Thus, I can see both sides of the argument when discussing this. It is not entirely honest to just look at the 15% tax rate by itself. That said, we should have a progressive tax structure and this is just a consequence of it.

[rgbecker]

6. Not to mention the tax break on Dividends and Capital Gains.

Maybe it's twice if you think the corporation is one in the same as the shareholders, but either way, the shareholder gets a huge break compared to the wage earning employee.

[Fool Count]

7. Even if it were a "double taxation", so what?

It's not like it is unconstitutional or otherwise illegal, is it? We can tax them once, twice, thrice or as many times as we want,
if I understand correctly how democratic system works. I'd say they should be grateful for being let off so easily - in many
countries dividends are taxed at the same rate as all other income, and honestly I don't understand why are they given
preferential treatment in the US.

[joeglow3]

9. Actually, most every country does it the same as the US

http://en.wikipedia.org/wiki/Dividend_tax

[Fool Count]

10. Here is the direct quotation from that Wikipedia article:

"Characterization of dividend income

In most jurisdictions worldwide, dividend payments are considered ordinary income and are taxed as such, the same as if the taxpayer had earned the income working at a job. Other jurisdictions separate dividend income and characterize it as something other than ordinary income subject to different tax rates if taxed at all."

Apparently, "most jurisdictions worldwide" do tax dividends as "ordinary income", which is clearly not "the same" as US.

[joeglow3]

11. Read on

While most of them tax it at an ordinary rate, they have credits that are generated from the corporation paying the tax that can be utilized to offset the tax. Using your logic, we cannot get mad at GE, because they were taxed at the ordinary rate (never mind the fact that they had enough credits to reduce the liability to zero).

[Fool Count]

12. I read on, and found only a handful of countries specifically mentioned by name

in this article in any context. Of those only two (Australia and New Zealand) are specifically mentioned as providing "franking credits" to offset part of
income tax on dividends. How does one conclude that "most of them" do it, I have no idea. Even if that was the case, it would still not in any way imply
that "most of them" do it "the same as US", but actually quite the opposite - that most of them do it differently from the US. What was the point of your
argument again?

[joeglow3]

14. My point is you really should do research BEFORE forming an opinion

You stopped at the top 2 (Canada & New Zealand). I will spell it out real simple for you:

Canada – Dividend tax credit
India – Complex system that provides reduced taxes
Australia – Franking credits
New Zealand – Franking credits
Austria – Taxes at 25%, half of their 50% tax rate
Belgium - Taxes at 25%, half of their 50% tax rate
Bulgaria - Taxes at 5%, half of their 10% tax rate
China – taxes half the dividend at 20%, while marginal rates top out at 45%
Czech Republic – Taxes at the marginal rate
Finland – taxes at 19.6%, while marginal tax rate is 30%
Japan – taxed between 10% & 20%, while marginal rates are 40%
Iran – No taxes on dividends
Ireland – taxes at marginal rate
Israel - taxes at 20%, while marginal tax rate is 45%
Italy - taxes at 12.5%, while marginal tax rate is 43%
Netherlands - taxes at 15%, while marginal tax rate is 52%
Pakistan – Taxed at marginal rate
Poland - taxes at 19%, while marginal tax rate is 32%
Romania - Taxed at marginal rate
Slovakia – no taxes on dividends, while marginal rate is 19%
Turkey - taxes at 15%, while marginal tax rate is 35%
United Kingdom - taxed between 10% & 32.5%, while marginal rates are 50%


Thus, my original point stands quite firmly.

[Fool Count]

15. It doesn't stand at all, leave alone "firmly".

There are 190 countries in the world. You listed 22. In what universe do they represent
"most of them"? The Wikipedia article you yourself cited clearly states that "most
jurisdictions" tax dividends as ordinary income. So your original point (just to remind,
you stated that "most other countries" tax dividends "the same as US") is clearly and
unambiguously wrong. So I suggest, you take your own advice and do some research before
posting obvious and easily disprovable crap.

[joeglow3]

16. I concede

I should have said the majority of major economies in the world (excluding the likes of Sierra Leone & Tuvalu).

[Fool Count]

17. Even that is questionable, depending on how one defines "major economies".

If one adopts the most common definition and looks only at members of the G-20 group, he would find only 8 countries from your list
among them (US, Canada, Australia, India, China, Japan, UK and Turkey). That is still not a majority. Even among those 8, only three
(China, Japan and Turkey) do it in a way that can, with some leeway, be called "the same as US". The other countries do it differently.
For instance, Australia taxes dividends at the same marginal rates as all other income. While it does provide "franking credits" against
the corporate income tax already paid, those credits also affect individual's net income (and can put him into a higher bracket) and
strict eligibility rules apply to them (i.e. only Australian residents who held the stock for more than 90 days are eligible). Also those
franking credit are limited to the actual profit shown on corporate tax return - dividends paid by a profitless company (not such
a rare thing really) will be "unfranked" and fully taxed. That is a complicated system which can hardly be called "the same as US".

[OccupySamizdat]

13. Corporate tax

Yeah, the reality is actually quite the opposite. See the first page for what's been happening with corporate taxes:

https://docs.google.com/viewer?a=v&pid=explorer&chrome=true&srcid=0B9AJGwr3upIFMzA1ZmJlYzctNDllZi00MDk4LWE2ZGMtMjFkOTFhN2NiMjE4&hl=en_US

[jmowreader]

18. There is NO requirement that a corporation pay dividends

Now, this is the thing: if the dividends were taxed to the recipient at the "ordinary income" rate rather than the "capital gains" rate I would be okay with not taxing them at the corporate level.

That's not what they want, though: they want dividends to be non-taxable at the corporate level, to be considered capital gains to the recipient, and for the capital gains rate to be abolished.