Is Taxing Dividends After Taxing Profits Wrong?

This question originally appeared on Quora.

Answer by Mark Rogowsky, internet entreprenuer, @maxrogo:

In theory.

In a world where corporations actually paid the corporate tax at anything near the statutory rate, taxing dividends again on distribution would be bizarre.

Fortunately, we don’t live in such a world. We live in a world where major corporations pay significantly less than the statutory rate of 35 percent. In fact, the United States collects less corporate tax relative to the overall economy than almost any other country in the world, 1.7 percent of GDP vs. 2.8 percent on average globally.

Look, our tax code is ridiculous. An innovative young company like Facebook is paying close to a 40 percent effective tax rate. A giant multinational like GE has averaged 2.3 over the past decade!

This is dumb.

But it also means GE’s dividend is not “double taxed,” OK? And Facebook? Well, they don’t pay any dividends, and really the tax code has nothing to do with that.

I’m a pretty big advocate that corporations ought to hand the cash back to shareholders in the form of dividends. Stock buybacks are a very obtuse way of “returning money to shareholders” and are often used to mask options and RSU-based dilution that are occurring anyway. So if you ask me (and you didn’t, but I’m telling you anyway), the correct way to fix this is to largely get rid of the corporate tax such that you can fire the 500-plus tax accountants at GE. Make it some low, flat rate that is free of deductions, affects profits here and abroad, and is basically easy to comply with and well-understood and nominally among the lowest of OECD countries. That will end the insane political nonsense that comes from people claiming “we have the highest corporate tax rate in the world” when that simply isn’t true. (Except on a piece of paper that affects one Facebook out of every few hundred companies. The average corporate tax paid by U.S. companies is lower below the global average. This is a fact.)

Let’s figure this rate should be something around 15 percent to 20 percent. By also affecting foreign earnings, it will discourage the process of multinationals off-shoring increasingly endless amounts of cash (Yes, you, Apple and Google.)

Then, you should tax dividends like ordinary income. This means you will have to also tax capital gains like ordinary income. This means you will also have to cut marginal rates. OK, we’ve gotten all that out of the way. I know, I know, you’re sure you need a favorable capital-gains rate to stimulate investment, right? Except there is no data to back that up. When you find the data, I’ll reconsider this hypothesis. Until then, we’re going to put that myth in the same circular file we keep the myth about the U.S. having the highest corporate taxes.

That dividend/capital gains/ordinary income rate will cap at about 30 percent and will be lower for nearly everyone else. Today, ostensibly, you can get “hit” with a 35 percent corporate tax and 15 percent on dividends (although that increases next year). So together, the max is 50 percent, right? In the new, cleaner system, the max will almost certainly be below 50 percent, but I’m not the CBO, so I’m guessing here. Probably like this: Corporate tax, flat at 15 percent. Personal tax, 25 percent for incomes from $250,000 to $1 million, 30 percent for $1 million and up (the so-called “Buffett rule”).

It appears I wind up with lower tax rates than Mitt Romney’s plan, except for those in the $1  million and up bracket, where Romney goes to 28 percent. But he wishes to maintain differential treatment for different types of income (i.e. lower capital-gains taxes). I recognize many of you are sure this is a good thing, so I’ll leave persuading you why it isn’t for another day. Whatever small effectiveness of it may exist, incidentally, is reduced by every reduction in marginal rates. It’s likely rates could be lowered further if more deductions/preferences were removed across the board, and especially from those higher up the income chain. This would also free up accountants from tax scheming to potentially productive work. Who knows what kind of boom that might unleash?

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