This article of which the following is criticism came to my attention via Nathan Smith's 23 July 2004 post on his
blog.
All of Daniel Clifton’s
arguments in favor of dividend tax cuts predicate on the idea that dividend income is somehow better than capital gains income or on the completely fatuous accusation that dividend taxes are somehow "double taxes." Let me examine the latter claim first, as it’s easier to dismiss.
I earned a dollar upon which I paid income taxes. I spent that dollar on a soft drink, paying sales tax. The store that sold it pays taxes on the profit it earns from the drink, then Coca Cola pays taxes on the profit
it earned from the drink. Then Coca-Cola decides to send that dollar to its shareholder, me, and I pay taxes on it again. Where is the double-tax there? The only clear example is that of me paying both sales tax and income tax on the dollar in the first leg. Now, people try to argue "well, the piece of the corporation that’s ‘paying’ you is really your own property so it’s a tax on what you pay yourself, and that’s not fair." This might be true except that ownership of stock is not like regular ownership - the legal fiction of the corporate person protects one from liability. The entire amount on the line is the price of the stock. If a corporation gets sued for a bajillion dollars, amounting to ten thousand dollars per stock, it doesn’t matter - you are not liable. Since you and the corporations are legally separate, you have to pay taxes on funds transferred from one to the other. There’s nothing "double" about it.
On the other hand, it may be that the large bias in favor of internal investment is a bad thing. That is the premise of Clifton’s primary argument.
His best claim under that rubric is that dividend tax rates in line with capital gains taxes will encourage corporate leadership to pay out funds to shareholders if there’s not an overwhelmingly attractive investment opportunity available. In other words, it discourages investment. Is that good for economic growth? Well, sometimes it is - sometimes it works best to increase consumer spending, sometimes it works best to increase investment. Essentially, the lower capital gains rate encourages saving/investment on the part of corporations and Clifton seems to think this is a bad thing.
Perhaps it
is a bad thing - I am biased by the belief that meddling in peoples’ economic choices frequently has unintended and counterproductive side-effects. If that was the case, then perhaps there’s no reason to give people a break on that portion of their income that comes from capital gains from stocks. In this case, however, I think I will break from my regular position. Right now, only established, low-growth companies generally pay dividends, meaning that only those companies who feel relatively certain they’ve encompassed about as much economic activity as they can reasonably expect are going to go ahead and pay out dividends. Everyone else just builds up their corporate assets or buys back stocks until such time as they have the cash for the next ambitious step or have to spend it to weather an economic storm. I also like this because it actually makes companies more accountable as well as more growth-oriented. What if Microsoft accidentally destroyed Lake Washington? Well, they have about $50billion in assets with which to pay for cleaning it - they have the resources to be held accountable. If they had already paid it out, then there would be no way to get that income back from all those liability-protected stockholders who didn’t put enough pressure on their company for accountability.
Clifton’s much weaker claim is that dividends require more honest accounting since the funds have to be paid out to everyone. He opposes this to stock buyback, however, which seems odd to me. With what does he mean to imply companies pay for the stocks? Corporate bonds? Those can pay for dividends just as easily. There are ways to trade holdings with institutional investors, but it’s not like those investors don’t have a strong interest in checking the books, plus resources to do it that individual stockholders can rarely match.
Clifton also says the dividend tax cut is good for stockholders. Brilliant observation. Perhaps the US government should lower taxes further, or even give people credits for buying stocks, plus a shiny medal with a blue ribbon. Or perhaps the interests of the United States encompass all its citizens, not just stockholders. And it’s just perhaps possible the executive director of the American Shareholder’s Association isn’t as concerned with the overall effects of tax policy as he is with the balance sheets of his group.
I find it very curious how much time he spends assuring the reader that dividend tax cuts do in fact encourage issuing dividends compared to how much justification he offers as to why this is a good thing. Overall, I think he’s done very little preaching to anyone but the choir, since he leaves all the most interesting pillars of the argument invoked rather than elaborated.
In conclusion I think it’s likely the capital gains tax advantage is too steep, but I like its existence somewhat. Therefore, I don’t think we need to remove it by treating it like all other income. Now, if one wants to cut income tax rates to spur the economy, then that's a different issue unaddressed by this article.