Pesky Bro-in-Law: Double Trouble on Taxes

October 21st, 2012 at 3:12 am

I haven’t tackled a pesky brother-in-law question for a while, naively hoping that earlier entries in this series were providing users with the ammo they needed to get through the holidays.  But with another Thanksgiving on the way, it’s none too soon to start gearing up.

A commenter told of a relative bugging her about how corporate earnings are taxed twice, once as profits by the corporate income tax and second as dividends when earnings are distributed to share holders.  Not fair, right?!

Actually, there’s very little double taxation of corporate income.  In fact, a dollar of earnings is probably more likely to be taxed multiple times.  And that’s all beside the point, anyway.

Let me explain.

First of all, thanks to all the loopholes and tax havens, far too much corporate income escapes taxation—it’s never taxed once!  The group Citizens for Tax Justice tracks this carefully, and it’s been the stuff of front page news, so ask Mr. Fairness what he thinks about that.

Second, most dividends pay outs are exempted from income taxes.  Back to CTJ:

…two-thirds of the dividends that are paid out by corporations to individuals (directly or indirectly) are paid to tax-exempt entities such as pension plans and other retirement vehicles. As a result…they are not  subject to personal income tax to begin with.

Third, to the extent that bro is whining about capital gains taxes on dividends that appreciated before he sold them, that’s not double taxation at all.  As CBPP points out, the capital gains tax is “…only on the appreciation in the asset’s value, not the owner’s “basis” (original investment) in the asset.  The appreciation in the value of the asset, above the amount initially invested, is new income that has not been taxed under the income tax.”

Finally, forget about corporate profits and think about your paycheck.  That’s subject to payroll taxes, income taxes, sales taxes, and in some states, state income taxes (though they can be deducted from your federal liability—or you can choose to deduct state sales taxes).

In other words, income of various forms is often taxed more than once.  That’s neither fair nor unfair—it’s a universal phenomenon in economies with taxation.  Fairness in the tax code can thus not be judged by citing instances of double taxation.  It has to be judged instead by a) how progressive is the code (are those with more asked to contribute more, a widely agreed upon fairness principle) and b) how progressive is the spending that the code supports?

On “a,” our federal tax code has gotten a lot less progressive over the years (see figure).  B is less well-documented, but while much spending pays for progressive social insurance (like Social Security and Medicare) and low-income programs like food stamps, a trillion a year pays for tax breaks that largely benefit the wealthy, like special rates for capital gains and deductibility of interest costs for housing and business deals.

And then there’s all the essential public goods that taxes support, many of which—infrastructure, education, enforcing the rule of law—are essential for businesses to earn profits in the first place.

In other words, the double-taxation claim is a canard that doesn’t withstand scrutiny.  It’s less likely to occur on corporate earnings than wage earnings, capital gains are new income that hasn’t undergone prior taxation, and fairness is a function of progressivity, not double taxation.

What your bro-in-law is doing here—and he’s not alone—is just engaging in the national pastime of complaining about taxes.  I’d urge him to stop for a second and think not just about the facts above, but about the benefits of taxation—the essential role it plays in the current WITT vs YOYO controversy.

Now wouldn’t that be a much more rewarding discussion to have around the Thanksgiving table?

Source: CBPP

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4 comments in reply to "Pesky Bro-in-Law: Double Trouble on Taxes"

  1. Jill SH says:

    Oh, thankyouthankyouthankyou.

  2. Auros says:

    A couple minor corrections…

    “Third, to the extent that bro is whining about capital gains taxes on dividends” I’m assuming you mean capital gains taxes on sales of assets that _yield_ dividends, like shares of common equity, mutual funds and ETFs, etc.

    “That’s subject to payroll taxes, income taxes, sales taxes, and in some states, state income taxes (though they can be deducted from your federal liability—or you can choose to deduct state sales taxes).” The state tax deduction on Schedule A gets deducted from your Adjusted Gross Income before determining your income tax liability; it’s not a dollar-for-dollar credit against the liability itself.

  3. dougfir says:

    You might also mention Social Security taxes are capped at $110,000. All income above that limit is not subject to payroll taxes, although I don’t know about Medicare tax. Some people (the Mitt Romneys of the world) enjoy an even lower rate of taxation on investment income than what us mere wage slaves pay on earned income.

    • Jared Bernstein says:

      Very nice point…there’s no wage limit, btw, to the Medicare 1.45% payroll tax.

      And because Soc Sec payroll tax is capped, it ends up being a) pretty flat: the effective rate for the middle income fifth is 8.4%, for the top income fifth, 7.2%, and for the top 1%, 2.5%. And of course, if you work, you not only pay this tax–it’s the biggest part of federal tax bill. Despite Mitt’s secret recording, among working households, almost 90% pay more in payroll than in income tax.