Commentary Magazine

Demagogy and the Corporate Income Tax

AP Photo/M. Spencer Green

Ben Steverman of Bloomberg News has an article up entitled, “Why American Workers Pay Twice as Much in Taxes as Wealthy Investors.” In it, he shows how an emergency room doctor with an income of $300,000 and an investor with the same income from capital gains and dividends would have tax rates respectively of 34 percent and 14 percent.

This is either sheer demagogy or Mr. Steverman thinks the corporate income tax is paid by the tooth fairy.

In fact, it is paid by some combination of higher prices for consumers, lower wages for workers, and lower dividends and stock prices for stockholders. The exact distribution between the three depends on the particular economic circumstances for each industry.

But let’s assume our investor is wholly invested in Amalgamated Widget and Congress decides to eliminate the corporate income tax (as it should, but won’t). The tax is currently at 35 percent, the highest rate in the world. Amalgamated Widget’s after-tax profit would instantly rise by 35 percent. This would translate almost instantly into both higher dividends and a greatly improved stock price.

Why are dividends taxed at a lower rate than wage income? Because they are paid out of after-tax profits. In other words, a tax of 35 percent has already been levied on that money. Bond interest, on the other hand, is considered a business expense, so bond interest is paid out of pretax income. That’s why interest on bonds is taxed at the full rate. Eliminate the corporate income tax and dividends would properly be taxed at the full rate as ordinary income as well.

Why are capital gains taxed at a lower rate than wage income? Again, stock prices (a function of perceived future profits) would be much higher if not for the corporate income tax, so taxing capital gains on stock at the full rate would, again, be double taxation. More, capital gains are not indexed for inflation (they certainly should be). So if our theoretical investor had bought 1000 shares of Amalgamated Widget in 1967 for $100,000 and sold them today for $1,000,000, he’d owe a capital gains tax on the “profit” of $900,000. But there’s been a cumulative inflation since 1967 of 635.1 percent. So his real profit is only $264,913.

The Supreme Court had struck down a personal income tax on the wealthy in 1895. In 1909, President William Howard Taft, a very gifted lawyer, devised the corporate income tax as a clever means of taxing the income of the rich anyway, as corporate stock at that time was almost all owned by the rich. But when the 16th Amendment was passed in 1913, and a personal income tax quickly levied, no attempt to merge the two income taxes was made.

The result has been 1) a century of ever-increasing tax complexity as tax lawyers and accountants played the two taxes off against each other to avoid taxation. And 2) a century of liberals screaming that the rich are not paying their fair share when that has often not been the case, as in the examples given by Ben Steverman.

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