the double taxation issue - 1.8.03
Tax free dividends, follow-up
After writing How to fluff the market, part II I've read several articles about the subject. There is one somewhat valid argument supporting the proposal that I missed. It goes like this: taxing corporate dividends is bad because it typically results in double taxation. The corporation pays corporate income tax on profits, pays stockholders dividends out of what's left after tax, and then the individual recipient of the dividend has to pay taxes again. According to proponents of making dividends tax-exempt, this double taxation distorts the economy because it discourages corporations from paying dividends.
The double taxation issue is the primary reason for the distinction between Subchapter C corporations (which includes all publicly traded corporations) and Subchapter S corporations. Most closely held corporations (say, a family business for example) operate under Subchapter S, which treats the corporation the same as a partnership for tax purposes. That means the corporation files informational returns with the IRS, but doesn't pay taxes, thus avoiding double taxation. There are, however, limits on how much profit a Sub-S corp can retain, as well as a list of other restrictions too complex to discuss here.
Of course, many big corporations find ways (including using off-shore tax havens) to finagle their way around paying any corporate tax anyway, so this double taxation issue may lack substance. Finding ways to discourage domestic companies from using (essentially phoney) offshore subsidiaries - now there's a worthy goal, Mr. Bush.
I reference the situation with Sub-S corps for a reason. There's a simpler, better, cure for the double taxation issue, if that' really the problem. Make the payment of dividends to shareholders a tax deductible expense to the corporation. Payment of dividends really is an expense, basically. It's the cost of having investors. Simultaneously, raise corporate taxes to offset the loss in revenues. This way we're pushing corporations to pay dividends instead of pumping stock prices, and stimulating productive investments, not speculation all without unduly increasing the deficit. It would also (albeit indirectly) discourage corporate tax tricks like use of offshore subsidiaries for tax haven benefits.
Raise taxes? Yes, raise taxes. Remember when the Republicans were hell-bent on a constitutional amendment to balance the budget? That was before they got control of the government and started spending like drunken sailors and simultaneously cutting taxes - especially corporate and estate taxes. In a deficit environment, it's irresponsible to keep cutting taxes while waging war with and ever growing list of far-flung nations. Who ever heard of cutting taxes during a war?
Economic theory aside, the biggest fault with the Bush administration's proposal is that it favors the wealthy, who are doing fine anyway. A recent New York Times article says that "according to the Urban-Brookings Tax Policy Center, a nonprofit research group in Washington that has also analyzes tax changes, 64 percent of the benefit from eliminating dividend taxes would flow mostly to the wealthiest five percent of taxpayers"
In short, it's either class warfare, or trickle down economics. Neither are good things, and neither work.
