I just moved from a no-income-tax state to one with 5% tax rate. The relocation allowance got a 35% tax bite, and although I might get some back after filing return, it still hurts. Meanwhile, media is speaking at length about Mitt Romney’s 15% tax rate for his income mostly from capital gains and dividends. Stories of $1-CEOs come to mind: the late Steve Jobs, Whole Foods’ founder John Mackey, Google’s co-founders Larry Page and Sergey Brin…. Aren’t they smart?
Gains on investments held for at least 1 year and qualified dividends are currently taxed at 15% while progressive tax brackets for wages go up to 35%. Arguments supporting this include “double taxation is bad for our economy and falls especially hard on retired people” as George W. Bush put it; and incentive for risk taking, entrepreneurship and job creation.
One can’t really avoid double taxation if not triple taxation: wages are taxed after payroll tax, dividends after corporate income, then comes sales tax. However, although the U.S corporate tax rate of 35% is among the highest in the rich world, over two-thirds of corporations pay no tax: Wells Fargo, Verizon, Boeing and General Electric (2008, 2009, 2010), Exxon Mobile (2009), Citigroup (2010)… So do partnerships, sole proprietors, and other non-taxable concerns. The average company pays only 18.3% in taxes.
Take a company with $100 profit. If it pays zero tax, passes to investors all $100 as dividend which is taxed at 15%, the government only gets $15. If it pays 35% in tax and investor pays no tax, or the company pays no tax and investor pays same tax rate as with wages, the double taxation is avoided and the government gets $35, $20 more in tax. Another option is equalizing tax rates for short-term investment income, dividends, and wages, while reducing corporate tax rates and removing loopholes. Say with 20% for the former and 20% for the latter, then the government would get $36. Equal tax rates would eliminate incentives for distortion behavior. After all, if one saves money to invest in a cotton candy machine and makes money off it at a state fair, why should he/she be taxed more than if he/she puts the same money to a dividend-earning investment? And as about “retired people”, perhaps Mr. Bush meant “non rich retired people”?
Risk taking is encouraged in America, and is the foundation for entrepreneurship. Investing in a troubled asset is risky and therefore deserves proportional reward when the bet plays out. However, this should be accounted for by the investment’s internal rate of return in relation to other alternatives and driven by market forces, not subsidized by lower tax rates. Tax on long-term investments should still be an exception.
And the truth is, investments and corporations are all about return and growth. Job creation, being a by-product, is rarely a business goal, if ever. Facebook, valued at $77 billions, is a private equity favorite but employs a mere 1200 employees. United Continental Holdings Inc., the world’s largest airlines with 87,000 employees and a profit margin of 6.2% in 2011, has a much smaller $7.56B market cap. Studies have shown that higher tax doesn’t affect the rich’s investment habit. As long as investing in businesses brings higher after-tax risk-adjusted return than savings accounts or Treasury notes, the well-heeled will surely put their money to work.
