The myth of double taxation

As a rule I’m content to trust that my small band of readers will follow the excellent Dean Baker on their own (he’s the Beat the Press link on my Links list). But from time to time, I can’t resist reposting. This post recapitulates one of Baker’s themes, that the notion that corporate dividends are “double taxed” is fundamentally mistaken—or worse.

There is an old myth developed by rich people at some point in the distant past that paying taxes on dividends amounts to “double-taxation.” The argument is that profits are already taxed at the corporate level, so taxing money when it is paid out as dividends to shareholders is taxing the same profit a second time. Gregory Mankiw, a Harvard University professor and former top economist in the Bush administration, pushes this line in a column in the NYT.

The trick in this argument is that it ignores the enormous benefits that the government is granting by allowing a corporation to exist as a free standing legal entity. The most important of these advantages is limited liability. If a corporation produces dangerous products or emits dangerous substances that result in thousands of deaths, shareholders in the corporation cannot be held personally responsible for the damage. The corporation can go bankrupt, but beyond that point, all the shareholders are off the hook, the victims of the damage are just out of luck.

By granting corporate status, the government has allowed investors to shift risk to society as a whole. In exchange for this and other privileges of corporate status, the corporation must pay income tax on its earnings. We know that investors consider the benefits of corporate status to be worth the price in the form of the corporate income tax, because they voluntarily choose to form corporations. If investors did not consider the benefits of corporate status to outweigh the cost of the income tax, then they are free to form partnerships which are not subject to corporate income tax. In this way, the corporate income tax is a completely voluntary tax. Anyone can avoid the tax by investing in a partnership, or alternatively, any corporation can be restructured as a partnership.

The complaint about double taxation is an effort to get the benefits of corporate status for free. It is understandable that rich people would want to get benefits from the government at no cost, just like most of us would prefer not to pay our mortgage or electric bill. But, there is no reason for government to be handing out something of great value (corporate status) for free. If rich people don’t like the corporate income tax, they have a very simple way to avoid it — don’t invest in corporations. The problem is that the rich are just a bunch of whiners.

–Dean Baker

2 thoughts on “The myth of double taxation”

  1. The Baker argument is a bit rough at the edges but I don’t know enough about the subject to form my own response. I will say that incorporation laws should be refined and maybe Baker is the way to do that. What about the new idea of a corporation as an individual; doesn’t make sense to me especially in light of limited liability. This is a timely thread for the 2012 presidential election process.

  2. I don’t know how old his comments are, but I found it to be a little bit silly… If you want the liability protection, you don’t necessarily need the C corporation. There’s LLCs and S corporations for that matter. The main idea behind the stupidity of criticising the suppose “double taxation” is that C corporations within a certain income range pay LESS TAXES on its income than its shareholders on their personal tax returns. That’s actually why “C” is better. For privately owned corps, it’s very easy to avoid any type of double taxation by paying a decent salary to shareholders and accumulate earnings. But even when profit is distributed, the fact that most corporations pay only 15% tax already makes it worth it, because most shareholders fall into higher tax brackets.

Leave a Reply

Your email address will not be published. Required fields are marked *