Double Taxation

August 19, 1963

In spite of the growing seriousness of the balance-of-payments problem, and an already ominous prospective budget deficit, the Administration is renewing its pressure for tax reduction. Its argument is that such a tax cut will stimulate the economy. This argument might have some validity if taxes were reduced on investors and on productive enterprises. But these are the very groups on which taxes are to be increased—on the ground that more revenues must be raised to compensate for those lost by reducing taxes on those who are already, proportionately, being taxed least.

Specifically, the Administration has recommended not only that stockholders no longer be permitted to exclude from their taxable income $50 of the dividends they receive each year, but be disallowed the 4 percent credit they may now take on the rest. In June the House Ways and Means Committee tentatively rejected both recommendations. But now a compromise is being considered to increase the dividend exclusion to $100 a person and disallow the 4 percent credit entirely.

52 PERCENT TO START

This is precisely the opposite of what ought to be done. There is no more justification for the exclusion of the first $50 of dividend income from taxation than there would be for the exclusion (on top of existing exemptions and deductions) of the first $50 of wages or any other form of income. This exclusion ought no longer to be allowed. But the 4 percent dividend credit is an entirely different matter. It is not only justifiable; it is a mere token mitigation of a flagrantly oppressive double taxation.

Suppose a married man is a one-tenth partner in a business that earns $200,000. His share is $20,000. Assuming for simplicity that this is his total net taxable income above exemptions, he pays income tax on this amount of $5,280. Then he is through. He can keep the remaining $14,720 for his family (at least before state and other taxes).

But suppose he owns, instead, 2 percent of the shares of a corporation that earns $1 million. His share is again $20,000. But the corporation must pay about 52 percent of this in income taxes, or $10,290, before the taxpayer ever sees it. (This is no different in principle from a withholding tax paid at the source.) Suppose, now, the entire remaining $9,710 is paid to him in dividends. Though he already has been taxed much more heavily than the man who received $20,000 from a partnership, his taxes have only begun. His remaining $9,710 is considered his taxable income to start. Out of it, on the same assumption that this is his full taxable income, he would pay on this (with his 4 percent credit but without a $50 exclusion) a tax of $2,023, leaving him only $7,687—or just about half of what he would have had from a partnership. Disallowing the 4 percent credit would raise his tax to $2,124, leaving him only $7,586.

IN BRITAIN AND CANADA

Thus investment in corporations (upon which we mainly depend for industrial employment) is already heavily penalized. Our tax system reflects the delusion that a corporation’s income is something in addition to that of its individual stockholders. The tax on corporation income is, in fact, a tax on income of the individual stockholders. Other countries recognize this. Canada allows a 20 percent credit on dividends. The British levy two taxes on the net profits of corporations: a tax of 15 percent, and in addition an “income” tax of 38¾ percent, bringing the total to 53¾ percent. But when a shareholder receives dividends, he is credited with having already paid his “standard rate” (38¾ percent) of personal income tax on these dividends.

So in the interests of promoting investment and economic growth our income-tax credit on dividends should gradually be increased rather than diminished. To protect it against misunderstanding or demagogic attack, however, it might be changed in form. Instead of allowing the individual dividend receiver a tax credit, a differential tax might be placed on corporation income itself—say, for a start, a 52 percent tax on undistributed profits, but only a 50 percent tax on profits paid out as dividends.