Sunday, January 29, 2012

Double Taxation of Dividends

If you drive your car, I'll tax the street
If you try to sit, I'll tax your seat
If you get too cold, I'll tax the heat
If you take a walk, I'll tax your feet
--The Beatles

The Left is once again fixating on dividend income and its tax characteristics. Since 2003, ordinary dividends have been taxed at 15% for individuals in that marginal tax bracket or higher. Although set to expire in 2010, the 15% dividend tax rate was extended thru 2012 by legislation signed into law by the Obama administration.

Liberals detest the 15% dividend tax rate because wealthy individuals who receive dividend income often realize an effective tax rate significantly lower than the current 35% top bracket. This is the gist of Warren Buffett's absurd argument that his secretary pays less tax than he does. Although the reality is that wealthy people pay the lion's share of all taxes in the US, with nearly 50% of all people paying next to no income tax, those on the Left want...more.

In a back-and-forth Facebook thread on this issue that I was observing the other day, someone noted that, while the tax rate on dividends is 15%, dividends are double taxed--once at the corporate level and then a second time when shareholders receive dividend checks. If corporations pay a 35% rate, then total taxes paid on dividend income amount to a 50% rate.

A second contributor, obviously sympathetic to the notion that dividends are undertaxed, subsequently offered two arguments in attempt to refute the double taxation observation. One argument was along the lines of: 'all income is taxed multiple times, so double taxation of dividends is nothing special.' He suggested that a store owner, for instance, could not avoid paying taxes on dollars received from patrons even though the patrons had presumably already paid income taxes on dollars used to purchase goods or services in the store.

This argument is in error.

Income is defined as an individual's rightful share of output gained thru productive effort. Prior to the inception of money, income was measured in terms of tangible production. If I chopped wood for a living, then my income was a fraction of the cordage produced by me that I could rightfully claim as my own.

Although income is commonly measured in units of currency today, it still reflects production claimed as personal property. Since passage of the Sixteenth Amendment in 1913, government can legally tax a fraction of that production claimed as individual income.

The error of the second contributor's claim lies in viewing the transaction between store owner and patron as a one sided transfer of resources. If a patron purchases a box of ceral for $4, the patron plainly does not 'give' after tax income to the store owner. Instead, the patron exchanges his/her income for a quantity of product/services rendered by the store owner.

In addition to the cereal, the patron might pay for the convenience of the store's location, or for the selection that the store offers. Indeed, such service attributes is how retail establishments commonly add value.

The important point is that the store owner has generated new production, The proprietor has provided goods and services that were previously unavailable to the market. The $4 represents the price of the store owner's output in terms of the resources that the patron was willing to trade to get that output. After accounting for costs of business, the store owner hopes to generate a positive income--i.e., his own fraction of output to be claimed as personal property that, under our current system, will be subject to income tax.

As such, this situation describes already taxed resources owned by someone being traded for newly produced resources owned by someone else that have yet to be taxed. There is no double taxation here.

The second argument offered by the second contributor was that taxes on dividends do not constitute double taxation at all. Companies pay taxes, then individuals pay taxes when companies send them dividends. Two different owners, two different taxes.

This is argument is also misguided, as the owners are the same in both instances.

Shareholders are the owners of corporations. When dividends are declared, shareholders receive the payouts. Those payouts typically come from earnings realized from the company's activities. Corporate income is subject to tax when reported. Because shareholders have a rightful claim on corporate earnings streams, any corporate income tax paid is effectively taxing shareholders, because there is now less income available for subsequent distribution to the owners.

To further grasp the impact of corporate taxes on shareholders, suppose that the corporate tax rate was 100% . In this case, corporate shares would be worthless since no cash generating capacity would be available to owners.

Higher taxes reduce income available to shareholders.

Should the company declare a dividend subsequent to paying corporate taxes, then those earnings declared as dividends are once again subject to tax. Currently this is the 15% levied on dividend income.

Dividends are indeed double taxed, because shareholders have ownership claims on earnings taxed at corporate rates as well as dividend payouts taxed at individual rates.

Unfortunately, history suggests that reason is unlikely to sway the minds of liberals in pursuit of a cause. The cause in this case is a redistribution of resources among people using government force, a cause that is at odds with nature.

Taxation of dividends is but one of a litany of rationalizations recited by the Left seeking to legitimize the taking of life, liberty, and property at gunpoint.


dgeorge12358 said...
This comment has been removed by the author.
dgeorge12358 said...

Buffett paid $6,938,744 in federal taxes for 2010. Am guessing that his secretary Debbie and any politicians are not interested in swapping tax bills with him.