Double Taxation Double Speak:
Why Repealing Dividend Taxes
by John Miller
Dollars and Sense magazine,
Concerned that the most well off in our
society might be suffering a bout of the post-holiday blues, the
Wall Street Journal's day-after Christmas editorial urged the
Bush Administration to end the "double taxation'' of dividends-payments
of corporate profits to stockholders. Nothing lifts the spirits
of the wealthy like yet another tax giveaway.
But for the editors of the Journal, making
dividends tax exempt is not just psychotherapy for stock investors.
It's a matter of economic justice and sound economic policy. (See
excerpts.) In their hands, however, notions of a fair and effective
policy response to today's stagnant economy become "double
taxation" doublespeak. Let's try to set the record straight.
* The equity argument [for ending the
dividend tax is that it is unfair to tax anything twice, even
at the highest levels of income. Americans will favor repealing
the double tax on dividends because it offends their sense of
The "double taxation" of dividends
is the heart of their argument. But there is nothing about double
taxation that ought to offend Americans' sense of fair play. True
enough, the government collects income taxes on dividends paid
out of the profits of corporations that have already been taxed.
But being taxed more than once on the same income is a fact of
life for every taxpayer, not just dividends collectors. Most workers,
for instance, pay Social Security payroll taxes and income taxes
on their wages, and then sales taxes when they spend what remains
of their paycheck.
Beyond that, the claim that dividends
are "double" taxed is an exaggeration. To begin with,
in the year 2000 more than half of corporate dividends went to
tax-exempt pension funds, individual retirement accounts, and
non-profit foundations or to individuals who owed no income tax.
In addition, corporate income is hardly taxed the first time around.
Relative to GDP, U.S. corporate income taxes are no more than
half those of other wealthy industrial (OECD) countries. By our
own historical standards, corporate income taxes have fallen from
4.1% of GDP in 1960 to just 1.7% of GDP in 2001. In addition,
the average rate of taxation on corporate profits currently stands
at 15 %, far below the top corporate tax rate of 35%. Worse yet,
in 1998, twenty-four highly profitable major corporations, including
Pfizer, PepsiCo, MCI Worldcom, General Motors, and Texaco, paid
no corporate income taxes- and received a tax rebate. Robert McIntyre,
director of Citizens for Tax Justice, estimates that "barely
more than half of corporate profits are subject to tax at any
More importantly when it comes to fairness,
the issue is not how often we pay taxes, but how much we pay in
taxes. By that standard, eliminating taxes on dividends would
surely violate most people's sense of fair play. As even the Wall
Street Journal allows, the beneficiaries would be those "at
the highest levels of income.'' Some 42% of the benefits from
repealing taxes on dividends would go to the richest 1 % of taxpayers,
and three-quarters of the tax benefits would go the richest 10%,
reports the Tax Policy Center of the Urban Institute and the Brookings
Institution. The top 1 % of taxpayers, those with yearly incomes
greater than $373,000, also benefited most from the economic growth
of the last two decades. After adjusting for inflation, their
real average before-tax income more than doubled (a 138% increase)
from 1979 and 1997, according to the Congressional Budget Office,
while their tax burden, much like that of large corporations,
has declined. By 1997, the richest 1 % of U.S. families paid out
about 1/3 of their income in all federal taxes, far less than
the 215 they paid in 1977. These figures will only get worse due
to the 2001 Bush tax cut or the elimination of dividends taxation.
* [Taxing dividends] creates huge distortions
in both corporate and investor behavior... [Oln the corporate
side, taxation creates incentives for companies to finance themselves
via debt (interest on debt is tax deductible, dividend payouts
are not). Increased debt can of course result in increased financial
fragility for the company and risk for investors.
The Journal editors argue that repealing
the taxation of dividends might reduce corporations' reliance
on debt financing. Interest payments are currently tax-exempt.
By putting the taxation of interest payments and dividends on
an equal footing, the government would take away the incentive
for corporations to finance themselves through borrowing. But
so too would several other changes in the tax code that would
not result in a tax windfall for the super wealthy. For instance,
to eliminate the tax bias in favor of "growth stocks"
(which benefit investors by increasing in price), we could just
remove the 20% cap on income taxes on capital gains (the sale
of stocks and other assets). But the editors of the Wall Street
Journal are loathe to consider any proposal that would boost government
revenues and arrest the decline in the tax burden of the rich
or large corporations.
* The tax penalty also prompts companies
to retain earnings ... rather than paying profits to investors.
This can freeze capital-rather than allowing
investors to reinvest cash in other businesses where rates of
return might be higher, thus permitting capital to flow to more
Cutting taxes on dividends is surprisingly
less than popular with corporate managers. Both Carter and Reagan
administration proposals to reduce or eliminate the double taxation
found little support among business elites. Joel Slemrod, a former
Reagan administration White House aide and tax economist, told
the Wall Street Journal that business executives dismissed the
Reagan proposal to cut dividend taxes as "just for shareholders,"
saying that they preferred tax relief that comes directly to corporations.
While the Wall Street Journal editorial touts dividend paying
corporations as a good investment in today's bear market, some
economists are not convinced. Economist Alan Auerbach argues,
for instance, that with lower dividend taxes, investors would
expect corporations to pay out more of their earnings in the form
of dividends, reducing the cash available for new corporate investments.
Finally, repealing the tax on dividends
is unlikely to provide the stimulus necessary to counteract today's
economic stagnation. As Slemord's comments suggest, business investment
is unlikely to pick up in response to cutting dividend taxes,
especially in face of the overcapacity in today's economy. Even
if shareholders do pour new money into stocks paying dividends,
that will do little to spark new corporate investment. The vast
majority of stock sales are not new issues, but resales of existing
stock from one stock investor to another, which do not provide
corporations with new funds for investment. During the 1990s stock
boom, economists Robert Pollin, Dean Baker, and Marc Schaberg
put the ratio of stock resales to new stock sales at 113.8 to
If fairness and effectiveness are the
issues, then a cut in the Social Security payroll taxes will do
more to spread widely the benefit of cutting taxes and do far
more to get the economy going again than eliminating dividend
taxes. Today, three quarters of taxpayers pay more in payroll
taxes than income taxes. In addition, we can count on those middle-
and low-income households, many of them strapped for cash with
the economic slowdown, to spend more of their income than the
superrich who would make out with the repeal of taxes on dividends.
A one-year payroll-tax holiday on the
first $10,000 of wages would give workers a tax cut of up to $765,
with much of the benefit going to middle- and low-income taxpayers.
The AFL-CIO, the Business Roundtable, and the Economic Policy
Institute all support proposals similar to this one. The Tax Policy
Center estimates that 45.4% of the benefits of a Social Security
payroll-tax holiday would go to the bottom 60%, as opposed to
4.7% of the benefits from repealing dividend taxation.
A payroll tax holiday would do as much
to lift the spirits of most people as repealing dividends taxation
would do to buck up the super-rich. It's the right thing to do.
Don't let all the double taxation doublespeak make you doubt that
for one minute. D
John Miller is a member of the Dollars
& Sense collective, and teaches economics at Wheaton College.