Are Taxes on Dividends Really "Double Taxation," As President Bush Claims?
Why the Answer Is No- And Why That is the Wrong Question to Ask, Anyway

By NEIL H. BUCHANAN

Thursday, Feb. 20, 2003

In speeches including last month's State of the Union address, President Bush has stressed his agenda to eliminate taxes on unearned income. In particular, Bush has emphasized his proposal to reduce taxes paid by the holders of certain corporate stocks.

Why should these taxes be reduced? Because, according to the President, these shares are currently subject to "double taxation": Corporations' incomes are taxed, and then shareholders pay taxes on dividends that once were part of those corporate incomes.

While the term "double taxation" might sound troubling, on closer examination it actually doesn't mean anything at all. (In this way, it's a bit like another tax-related re-dubbing the Bush Administration favors, calling the inheritance tax "the death tax.")

Of course, it sounds awful to be taxed double, since most people think being taxed once is more than enough. But the truth is, it doesn't matter how many times you're taxed, but rather how much you pay. The double-taxation slogan, however powerful, is simply empty. That may be why at least one business reporter in The New York Times had the good sense to refer to it recently as "the so-called double taxation of dividends."

There are, of course, plenty of substantive policy arguments to be made against Bush's proposal to cut dividend taxes. As many commentators have noted, it would predominantly help the very rich, and it would do next to nothing to help our sagging economy. What I want to focus on in this column, though, is simply the inaccuracy of the powerful label "double taxation."

Total Tax Is What Counts, Not the Number of Times Tax Is Imposed

Let's be blunt: Would you rather pay 10% income tax twice a year, or 50% income tax once a year? If you oppose "double taxation," then apparently you'd be happier paying the larger tax once. Obviously, though, no sensible person would make such a choice. We care how much money we have left to spend after we pay our taxes.

And on that score, the United States is still among the lowest-taxed industrialized countries in the world (by a large margin, compared to most countries). Moreover, the total U.S. tax rate on capital income, according to reasonable estimates, is quite competitive.

This is not, of course the first attempt to scare people with the term "double taxation." In 1996, for example, Jack Kemp chaired a private commission that complained that Americans must pay individual income tax, corporate income tax, dividend tax, capital gains tax, and inheritance tax. As a result, every dollar is taxed multiple times.

It's also possible, of course, to describe Americans as being "multiply taxed" on their wage income. There's federal income tax, state income taxes, and Social Security/Medicare tax. Once those taxes are paid, we then pay sales taxes on many goods and services as well. Does the Bush Administration refer to this as double taxation? Of course not. Reducing taxes on labor income is decidedly not on their agenda.

Quite simply, complaining that double taxation is bad because the "same dollars" are taxed twice makes no sense. People pay taxes. Dollars don't.

Do Dividend and Corporate Income Taxes Draw From the Same Tax Base Twice?

What about the idea, though, that the problem with dividend taxes is not that the same dollar is taxed multiple times, but that the same "tax base" is?

In the terminology of tax law, the "tax base" is the money generated by the activity or transaction-"the thing," if you will-that is being taxed. Thus, the money generated by sales of goods and services in a given city is that city's tax base for its sales tax. Similarly, the value of the estates of the deceased is the tax base for the estate tax.

But with dividends, it gets tricky. The tax base for the corporate income tax includes corporate income that will be paid out in dividends. Then, once that income is paid out to individuals, it becomes part of the tax base for the individual income tax. Based on these facts, the Bush Administration would contend that dividend taxes tax the same tax base twice.

To see why this is not so, it's necessary to delve deeper into what makes two different pools of money count as "the same tax base." Previously, we saw that a tax base was defined by the underlying activity or transaction. Is the activity or transaction really the same here?

The answer is no. The "thing" that is taxed when corporate income is paid is corporate income-earning (and hence corporate power). The "thing" that is taxed when dividend income is paid is individual income-earning. Different things; different tax bases.

And the difference matters. The tax on corporate income varies with the type and (broadly speaking) the size of the company generating the profits. Meanwhile, the tax on individual income - including dividend income - varies with the recipients' taxable incomes.

Moreover, both of these variations in tax liability make sense: It makes sense that different companies pay different amounts of taxes, and it makes sense that the rich pay more in personal income taxes, while the poor pay less (at least, it does to those of us outside the Bush Administration).

The Administration's proposal to reduce individual taxes would mean that one of these variations in our tax obligations - the one based on individual income - would no longer be as great. And that benefits only the rich.

Consider the current situation: A poor person who gets a tiny bit of dividend income doesn't pay tax on it; his or her income is too low. But a rich person who gets a huge dividend does pay. If you believe in progressive taxation, as I do, that's only fair.

Under the Bush Administration's proposal, the poor person still wouldn't pay, but the rich person would pay much less. For the poor person, there would be no change; for the rich person, a big, unjust change. And remember, even though the rich pay a high proportion of federal income taxes (as we are constantly reminded), the overall U.S. tax system is not progressive. The rich in this country are already getting a good deal.

What's Wrong With Taxing Both Corporations and Shareholders?

The argument I just made shows why the corporate income tax and individual income tax (including the dividend tax) do not really draw from the same tax base. But what if they did? It's not necessarily a bad thing.

While it's a nuisance that two sets of paperwork have to be done, having two entities each separately accountable may, in the end, reduce tax cheating: The individual takes a greater risk in lying about the dividend he got, because the corporation has a record; the corporation is also likely to be more careful in disclosing the income it's paid out in dividends, because individual shareholders' returns will disclose the amount. Attempts to evade both taxes will inevitably be more difficult to pull off.

In the end, though, these are fine points. Overwhelmingly, the most important point is that quibbles about "double taxation" are meaningless. What matters is the total tax that individuals and corporations must pay. (And although the focus of this article is on taxation, it also matters what the government buys with our money!)

Again, a good analogy with the Administration's arguments about the "death tax" holds: Don't look at how much tax you pay at the end of your life, but at how much you paid over your whole lifetime (including its end), as a percentage of income. And when people make claims of "double taxation," don't look at how many times you're taxed - just how much tax the government takes, total. Then compare it to the tax on those richer and poorer, and see if you think it's fair. We might disagree on that, but at least we're asking the right question.


Neil H. Buchanan, J.D., Ph. D., will be teaching tax law at Rutgers School of Law - Newark, starting in the Fall semester of 2003.

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