Is the Double Taxation of Dividends in America Good for the Economy and Society - Coursework Example

Is the Double Taxation of Dividends in America Good for the Economy and Society? Introduction President George W. Bush has proposed the elimination of double taxation on dividend. Under the proposed plan, the corporate income tax would continue to exist but there will be no need for the individual stockholders to pay a tax for the second time on the profits distributed by the company as dividends. It is opined by economists that eliminating one layer of tax on this account would encourage the investors to invest more in corporate entities which is good for the economy. This in fact would reduce the tax bias on capital formation. According to the Council of Economic Advisors (2003) this move alone could increase the supply of machinery, tools and equipments and other capital items to the extent of almost one percent. No doubt such a move will result in the creation of more employment opportunities and higher living standards. As quoted by Federal Reserve Board Chairman Alan Greenspan “This particular program will be of net benefit to virtually everybody in the economy over the long run, and that is one of the reasons I strongly support it”. This paper argues that the double taxation of dividends in America is not good for the economy and society and the elimination of it would bring more economic prosperity to the country. Double Taxation is not Economically Beneficial to America One of the foremost reasons which go against any tax policy is that they are more self-destructive. Double taxation is no exception. It punishes the activity of investment which is absolutely good for the economic development of the nation. Double taxation of dividend has the effect of encouraging tax payers to consider only the present day instead of targeting the future. Double taxation has the adverse effect of retarding the economic growth by lowering the investment in corporate and other venues. It also promotes the debt to an excessive level. When the double taxation acts along with other mis-guided tax policies of United States it drastically reduces the competitive strength of the Americans in the context of global economy. Double Taxation is Biased against Capital Formation Any tax imposed on specific activities has the tendency of discouraging the respective activity. This is perhaps the reason that the politicians are keen in increasing the sin taxes every year. Adopting this basis it can be said that investing in corporate equity should represent an extreme overstepping on law. When the government taxes the dividend income both in the hands of the corporations and the individual investors, the effective tax rate can easily go up to 60 percent and in cases where the individual is in a higher income tax rate may even go up to 70 percent. These higher rates of taxation have the effect of discouraging the investments in the same way the sin taxes discourage the consumption of taxed products. By adopting double taxation policies on dividend the government acts to reduce the stock of productive capital. This happens by the investor using his disposable surplus on consumption items instead of investing. Further the higher tax burden makes the leading investors to allocate their investible funds in activities which are economically less efficient. The combined effect of these decisions to forego investments or to alternate the investment avenues is the lowering of wages and lowering of the economic growth of the nation. Additional Burden on Tax Payers It is observed that the double taxation affects certain specific class of taxpayers. It is the case with the senior citizens that they receive almost fifty percent of all dividends. The double taxation policy imposes a total tax burden of $ 936 million on all the senior citizens who number close to 10 million (Office of Tax Policy). The fact that since many of these senior citizens depend entirely on the dividends for income after their retirement the higher level of taxation due to double taxation deter the efforts of these citizens to lead a comfortable after retirement life. The plight of the shareholders is no different. They have to bear the brunt of double taxation directly with the effect that their investment income is taxed twice. Double taxation also acts to reduce the number of investment opportunities available to the investors. It is not out of place to mention that during the last four decades the number of dividend paying company has dwindled almost by 50 percent which may partly be due to the double taxation. The effect of double taxation seems to have its impact on the investment decisions of the investors. For instance an investor who is keen to invest his surplus funds in the ‘income stocks’ may have to pay a premium price which goes to reduce the rate of return. It may be noted that there is a sharp reduction in the dividend yields which was at 4 percent during the 1980s has fallen to less than 2 percent as of day (Council of Economic Advisor, 2003) Encourages Debt Making the dividend income subjected to tax, at an additional layer by way of double taxation would result in the creation of bias towards borrowed funds. This is so because the debt-financed investment is taxed only once whereas the equity investment is subjected to tax twice. This bias towards debt-funds created by the double taxation policy has provided very limited choice of corporate financial planners to over-utilize the debt financing option. While the debt financing is considered as the best option available to the corporate people, due to the perversity of double taxation, it has come with a huge of cost of debt burden on the companies. This adversely affects the financial position of the company during economic downturn when there is likely to be a decline in the revenue but there will not be any deduction in the interest burden on the funds borrowed. Investors often tend to buy bonds in order to reduce the overall risk in their portfolio and this they think will also substantially reduce their tax burden. (Rowe Price) It has been pointed out by the economists that a neutral tax code would have the impact of encouraging the corporations to consider a complete revamping of their financial structures and reconstruct their balance sheets. This in a way would reduce the number of companies going in the direction of bankruptcy. Although it may not precisely possible to estimate the number of bankruptcies the elimination of double taxation would have saved it can reasonably be assumed the shift in the policy to eliminate double taxation would result in a significant shift from debt to equity as the companies would no longer be pushed to resort to excessive debt financing. Impact on Wage Growth Investment becomes important from the point of view of growth in wages. There will be growth in wages only when there is an increase in the productivity. Increase in productivity is directly proportional to the increase in investments. Double taxation since hampers the growth in investment it indirectly affects the growth in wages by lowering the productivity due to lower level of investments. The other way to look at this point is that the productivity of workers will have a boost with better and efficient tools, equipment and technology which can be acquired by increased investment on capital account. Since double taxation has an adverse effect on capital investment decisions of the investors the workers are deprived of better tools and technology. This also leads to reduction in the productivity and as a consequence has an impact of lowering the wage levels. Other Tax Implications The reduction in investment on capital account is just a part of the problem. If an individual has amassed huge wealth and dies, the accumulated dividend income is subject to death tax. In addition such income may also be subjected to capital gains tax. The stock prices surge in the expectation of a higher future income. When the investors sell those stocks at higher prices they have to pay capital gains tax on the realized income. This implies that the investor is made to pay the tax on dividend even when the dividend income has not accrued. It is to be noted that under existing regulations, cash dividends are subjected to tax as regular income. However when certain companies offer dividend reinvestment plans, the stockholders are entitled to use their dividends to invest in more stocks of the same company. In this case the investors do not incur any brokerage charges. However according to the present taxation laws, the dividends along with the amount of brokerage paid by the company will be treated as taxable income. (Mitchell et al 2003) Benefits of Elimination of Double Taxation The proposal to eliminate double taxation on dividends will reduce the additional tax burden of tax payers and there will be a significant reduction in the effective tax rates even to the extent of more than 50 percent in some cases. The most important advantage of reform in the form of elimination of double taxation is that it removes a significant anomaly in the tax code whereby the investment decisions are drawn towards considering the economic aspects rather than pure tax-minimization policies. The following are some of the reasons for supporting the policy of eliminating the double taxation on dividends. Increase in Investments The decision to eliminate double taxation would result in a reduction of the effective tax rate on corporate investment from the present 32.2 percent to 21.7 percent. This gets translated into a lower amount of taxes on the investment income. As per the Council of Economic Advisors “By lowering the tax cost of corporate investment, a dividend exclusion could also lower the economy-wide average effective tax rate on capital income by as much as one-quarter (from 19.8 percent to 14.8 percent) and improve the overall incentive to save and invest”. It is also the estimate of the Council that the elimination of double taxation on dividends would result in lowering of cost of capital investments in plant and equipments to the extent of at least 10 percent. The Council has also estimated that there will be a reduction of tax burden on equity investment in structures to the extent of almost 33 percent. Efficient Use of Capital Resources The elimination of double taxation would lead to a level playing field. In this case there will be no tax preferences for non-corporate investments and owner occupied housing. To put it differently the available capital resources would be put to more productive uses which will result in maximization of economic growth. The investors will be induced to think of ways to make their investments contributing to more productivity. Attraction to Global Capital In the present day world economy it is important that any country should be able to attract capital inflow from investors in other nations. When the double taxation on dividends is eliminated it would be possible for the country to attract more investible funds from other nations which no doubt would improve the economic situation of America. In addition to the above benefits, there will be promotion of higher wage levels due to increased productivity. Of course this may happen in the long run. In the short run this policy would lead to positive economic growth. By resulting in enhanced level of corporate investment and capital accumulation the elimination of double taxation on dividend leads to higher productivity growth and thereby results in higher wage levels for workers. Increase in Competitive Strength By putting an end to the double taxation on dividends the competitiveness of United Stated in the global market can be greatly enhanced. It is the case with almost the rest of all nations except Switzerland and Ireland all the other nations provide some sort of relief from double taxation of dividend. Even in the case of Switzerland and Ireland the lower rate of corporate taxation offsets the impact of double taxation on dividends. This puts the country in an economically disadvantageous position affecting the competitiveness against other world nations. By eliminating the double taxation on dividends the country can significantly improve the competitive positions of the country in the global market. Conclusion By ending the double taxation on dividends the economic growth of United States is sure to get an accelerated phase. It will also promote the competitiveness of the country in the global arena. However it has to me taken in to consideration that these tangible benefits should not deter the objective of creating a tax code which is far simple and fair to all concerned. Thus it can reasonably be concluded that taxing any income only once is a sound economic policy towards reforming the tax structures and therefore the proposal to eliminate the double taxation of dividends can be considered as an important and necessary step towards achieving the fundamental tax reform objectives. References Council of Economic Advisers, "Eliminating the Double Tax on Corporate Income," January 7, 2003 Mitchell J. Daniel, Michel J. Norbert and John C. David ‘Pathway to Economic Growth and Tax Reform: Eliminating the Double Tax on Dividends Office of Tax Policy US Department of the Treasury February 27, 2003 T. Rowe Price, "T. Rowe Prices Views on the Presidents Tax Proposals," available online www.troweprice.com/common/index3/0,3011,lnp%3D10045%26cg%3D1350%26pgid%3D8816,00.html Read More