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Home Publications Blogs Beat the Press The Double Taxation of Corporate Profits and Other Fairy Tales

The Double Taxation of Corporate Profits and Other Fairy Tales

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Sunday, 27 November 2011 10:17

The usually insightful Steven Pearlstein swallowed a big one today in pushing the line that the taxation of corporate profits when they are paid out as dividends amounts to "double taxation." The problem with this story is that the corporation really is a distinct entity from the individual who receives dividends. In fact, according to the Supreme Court, they are actually distinct persons.

This is not a philosophical question; it is a very concrete economic one. No one is forced to organize a business as a corporation. Anyone can operate any business as a partnership. Partnerships do not pay a separate tax, the partners only pay tax on the profits as individuals.

In this sense, the corporate income tax is 100 percent a voluntary tax. It is paid only because people consider the benefits of corporate status to be worth more than the taxes that they must pay.

This removes any logical possibility of double taxation. The corporate income tax is effectively the fee that stockholders pay for the benefits of corporate status. By holding stock, they have voted with their feet to pay this tax. Their income, and the tax on it, should be treated as distinct from the corporate income. If individuals are not paying tax on their dividends and capital gains then it is not taxed.  

[Stuart Levine offers well-taken correction below. Only closely held partnerships avoid taxation. Any partnership that had publicly traded share would be subject to taxation. Of course, this is still a choice made by owners of the partnership.]

Comments (9)Add Comment
Technical Foul
written by Stuart Levine, November 27, 2011 11:23
Dean--I have to call a technical foul here. You say that: "No one is forced to organize a business as a corporation. Anyone can operate any business as a partnership. Partnerships do not pay a separate tax, the partners only pay tax on the profits as individuals."

That statement is only true with respect to closely-held entities, "closely-held entities" being defined as businesses the interests of which are not publicly traded. The IRS defines a "publicly traded partnership [as] any partnership an interest in which is regularly traded on an established securities market regardless of the number of its partners." See here: http://1.usa.gov/v6emHk

However, I generally agree with your conclusion insofar as it should read: "The corporate income tax is effectively the fee that stockholders pay for the benefits of having ownership in a business that has interests that are regularly traded on an established securities market. By holding interests in such a business, they have voted with their feet to pay this tax."
hmm
written by David, November 27, 2011 11:49
Why should you/we endorse the "corporation as citizen" distortion of Citizens United? Instead, flow-through taxation for all corporate net earnings whether distributed or not (a la S-corps, last discussed comprehensively by Lester Thurow in The Zero Sum Society) would make the opposite and salutary point: that corporations are mere extensions of natural persons. It would also have the added benefit of eliminating the bias against debt financing (interests costs are deductible against the corporate income tax) versus equity financing (dividends are not deductible). This debate not just about effective tax rates or incidence. The corporate tax creates substantial distortions that would be worth eliminating.
correction
written by David, November 27, 2011 11:56
sorry .. in previous comment, make that eliminating bias *toward* debt financing.
Corporate Taxation
written by Douglas Hopkins, November 27, 2011 1:54
I must agree with David - the "corporation as citizen" is an illogical construct with grotesquely detrimental consequences. But the double taxation argument itself is a red herring - since corporate taxes are subject to far more avoidance (and Congressional influence peddling) than compliance.

It may seem at first counter-intuitive, but I advocate repealing corporate income taxes and restructuring all tax obligations to be personal in nature - assessed against holders of the capital structure, both debt and equity. see www.2pctsolution.com

Our current methodology for taxing investment income is riddled through with misincentives that distort investment decisions.
We're all double taxed all the time
written by Anon, November 27, 2011 4:27
Aren't we all double taxed all the time? I earn income and pay taxes on it and I use that income to pay a gardener who then also must pay taxes on it. Why don't I get to deduct the cost of paying my gardener -- and for that matter of buying groceries at the grocery store before paying taxes.

The underlying complaint isn't that corporations are taxed twice, it's that rentiers aren't getting as many deductions as they want.
New Stimulus Plan - Wages No Longer Taxed as Double Taxation
written by izzatzo, November 27, 2011 5:24
In a blinding flash of humble recognition Corporate America now agrees double taxation of wages is equivalent to double taxation of dividends since both are paid out as income.

Correspondingly wage income for employees working for corporations will no longer be taxed since it's already taxed once from the corporation.

A spokesperson noted this will not reduce total tax revenue to the government since the tax elimination will pay for itself as part of a stimulus plan.

Stupid liberals.
Corporations as people
written by Charlie, November 27, 2011 10:00
I think conservatives used to argue that corporations are not people, so shouldn't be taxed. Supreme court ruled they were, I think, in order to allow them the right of free speech, if they want to buy political inflewence.
...
written by PJM, November 27, 2011 11:19
Slight clarification/question. In point of fact, "double taxation" is voluntary choice for those seeking income producing stock (aka those with dividends) as opposed to hoping rely on capital gains. Corporations, for their part, decide to issue dividend bearing stock (and hasn't this type of stock declined historically) in order to sell more shares(ie decrease their borrowing costs).
Investors do not get a free lunch
written by LSTB, November 28, 2011 9:00
The greatest benefit corporate status provides is limited liability.

If the shareholders don't want to pay the tax, they can be personally liable for entity's civil/criminal misconduct. There is no free lunch for investors.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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