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.]