sad to say this is quite revealing, (of how little I know)

from mark thoma here:

September 07, 2008

On Dividend Taxes…

Greg Mankiw says that if your goal is to keep dividend taxes low, you should vote for Obama:

On Dividend Taxes, It’s a Post-Partisan Race, by N, Gregory Mankiw, Economic View, NY Times: …Before 2003, when a person received dividends from his stock holdings, this income was taxed at ordinary income tax rates. That is, a dollar of dividends generated the same individual income tax liability as did a dollar of wages.

But many economists have long argued against taxing dividends this way. Dividends are a stockholder’s payment from corporate profits, and these profits have already been subject to the corporate income tax. Any tax on dividends represents a second tax on essentially the same income.

One can question whether this double taxation of income from corporate capital is fair. But fairness aside, there is also the problem of incentives. Taxing dividends twice substantially raises the overall tax burden … and distorts various decisions. Whenever taxes, rather than true costs and benefits, drive the allocation of resources, the economy shrinks below its potential. …

Policy wonks like me have long hoped for changes in the tax code that would eliminate, or at least mitigate, these problems. In 2003, President Bush proposed that all dividends paid out of income that had already been taxed at the corporate level should be exempt from tax at the personal level. …

Although Congress did not give the president exactly what he sought, it gave him a large chunk of it. The top tax rate for dividends was cut to 15 percent, less than half the top rate for ordinary income. The adverse incentives of the tax … became much smaller. …

Senator Obama … has not been coy about wanting to use the tax code to redistribute income… But for dividend income, Senator Obama has proposed only a modest increase in the top tax rate, to 20 percent from 15 percent. …

In light of Senator Obama’s stand, the politics of dividend taxation may take some surprising twists. Senator John McCain wants to maintain the current tax rate of 15 percent on dividends…, but it is a good bet that if Senator McCain is elected president, while Congress remains Democratic, Congress won’t give the Republican president what he wants. They would instead let the Bush tax cuts expire, returning the dividend tax for high-income taxpayers to about 40 percent.

By contrast, if Mr. Obama is elected, Congressional Democrats will be less likely to balk at his proposed 20 percent dividend tax rate… On the issue of dividend taxation, Barack Obama may be the candidate with the best chance of preserving George Bush’s legacy.

Update from Dean Baker:

Greg Mankiw Promotes the Myth of Double Taxation, Dean Baker: There is an old myth developed by rich people at some point in the distant past that paying taxes on dividends amounts to “double-taxation.” The argument is that profits are already taxed at the corporate level, so taxing money when it is paid out as dividends to shareholders is taxing the same profit a second time. Gregory Mankiw, a Harvard University professor and former top economist in the Bush administration, pushes this line in a column in the NYT.

The trick in this argument is that it ignores the enormous benefits that the government is granting by allowing a corporation to exist as a free standing legal entity. The most important of these advantages is limited liability. If a corporation produces dangerous products or emits dangerous substances that result in thousands of deaths, shareholders in the corporation cannot be held personally responsible for the damage. The corporation can go bankrupt, but beyond that point, all the shareholders are off the hook, the victims of the damage are just out of luck.

By granting corporate status, the government has allowed investors to shift risk to society as a whole. In exchange for this and other privileges of corporate status, the corporation must pay income tax on its earnings. We know that investors consider the benefits of corporate status to be worth the price in the form of the corporate income tax, because they voluntarily choose to form corporations. If investors did not consider the benefits of corporate status to outweigh the cost of the income tax, then they are free to form partnerships which are not subject to corporate income tax. In this way, the corporate income tax is a completely voluntary tax. Anyone can avoid the tax by investing in a partnership, or alternatively, any corporation can be restructured as a partnership.

The complaint about double taxation is an effort to get the benefits of corporate status for free. It is understandable that rich people would want to get benefits from the government at no cost, just like most of us would prefer not to pay our mortgage or electric bill. But, there is no reason for government to be handing out something of great value (corporate status) for free. If rich people don’t like the corporate income tax, they have a very simple way to avoid it — don’t invest in corporations. The problem is that the rich are just a bunch of whiners.

Posted by Mark Thoma on Sunday, September 7, 2008 at 12:24 AM in Economics, Politics, Taxes