Relevant and even prescient commentary on news, politics and the economy.

Dividend Taxes, Part I: A Primer; Double-Taxation

A primer (skip ahead if you know this):

Dividends are profits that are distributed to shareholders. If Angry-Bear-Tech (AB Tech) makes an after tax profit of $10m this year, the CEO and the board must decide what to do with that $10m. Some of it, say $1m, we may keep as cash, a rainy day fund. Some of it, say $3m, we spend on improving our infrastructure. We spend another $2m to acquire Honey Bees Inc.. That leaves us with $4m. One of the things we could do with this is distribute that $4m to the owners of the firms, the shareholders. Why would we do this? In principle, the Board represents the shareholders and will, acting in the shareholders’ interests, say give the shareholders that money! If there are 20 million shares of AB Tech outstanding, then that $4m has to be split $20 million ways, meaning each share has the right to $4,000,000/20,000,000=$.20. AB Tech will pay this out as a dividend of 20 cents per share. If you own 10,000 shares of AB Tech then you get a check for $2,000. Under current tax laws, that counts as income on your 1040, so you will have to pay taxes on that $2,000.

Of course, AB Tech’s pre-tax profits were above $10m, roughly $13m. So that $13m was taxed once and it brought the total down to $10m. Then it gets paid out as dividends, where it is taxed again as personal income. If the average tax rate of AB Tech shareholders is 25% then that $10m becomes $7.5m of after-tax income. At the end of the day, $13m in pre-tax corporate profits becomes $7.5m of after-tax profits in shareholders’ pockets. This is an overall tax rate of (13-7.5)/13=.423, a 42.3% effective tax rate on income received via corporate profits.

So is the problem really that dividends are taxed twice? All sorts of income are taxed twice. It’s taxed when I get my paycheck and then it’s taxed when I buy gasoline. It’s taxed when I get my paycheck and then taxed again when my landlord receives it as income. Should we really be counting the number of times something is taxed? What if it were taxed twice at very low rates? Is that better than taxing it once at a high rate? That part of the discussion is just silly.

Returning to the example above, do you really think the advocates of eliminating the dividend tax would be happy if the corporate income tax rate were increased to 42.3% (with no dividend tax)? Then the income would only be taxed once!

Another point rarely mentioned by the pro-cut side: if you own stocks in a 401(k) or Traditional IRA, then your dividends are not taxed when you receive them, but rather when you retire and draw upon the funds (this is tantamount to paying a lower rate. Paying taxes 10 to 30 years from now is a lot better than paying them right now). Dividend income from stocks held in a Roth IRA are never taxed. I’m not sure what proportion of stocks are held in these vehicles (, but it is a substantial amount, probably in the neighborhood of 10-20%.

One more point for the time being, but there’s more to come. If you make less than $85,000 per year, as 80% of all households do, then it’s a pretty safe bet that the vast majority of your dividend income is in retirement accounts. The same is true, though to a lesser extent, for the 95% of households that make under $150,500 per year (see Money Income in the United States, 2001, p. 19). So for the majority of the population, dividends are not taxed or are highly tax-advantaged, so there is not really much of a double taxing.

So of the myriad intricacies and oddities in the tax code, this is the one we have to fix right now? Because it’s the one that causes about 5% of the population to pay an overall tax rate around 42% on income received from corporate profits?

But there are legitimate reasons why the dividend tax is problematic, but they are more subtle than “double taxing bad”, andthus not widely invoked by the proponents of eliminating the tax.


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Just turned on the TV and, flipping through the channels, I come across Bush giving a speech on the economy (I believe he’s in Georgia). The first thing I heard of note was “There’s a blue chip forecasts by economists that predicts growth this year of 3.3%–and that’s positive.” I’ll give him the benefit of the doubt and assume he meant that in the “good news” sense rather than the “greater than zero” sense of the the word “positive”.

But then what do I hear from the President?

“”This [tax] plan is fair and it is balanced”

Hmm? Who is writing Bush’s speeches and where do they get their news? It’s not my place to say…I report, you decide.

Just about to sign-off when I heard this: “Ten million seniors rely on dividend income to make sure their quality of life is strong”. See my earilier post.

Most of the speech was on the need for immediate tax relief and a push for dividend tax cuts, then a section on Iraq. I’ve made references to an upcoming dividend tax post, and it’s still upcoming.


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The Much Ado About Nothing? Post

For many years, there was a third rail of politics: Social Security. Simply put, don’t f*** with the Grey Lobby. They vote and they have money (and they don’t like it when you try to take it away). The stock market boom of the late 90’s came close to changing the calculus—giving seniors 20% annual returns on their money would be giving them more, not less, money. Clinton flirted with, but never really jumped onto, the privatization train. Bush on the other hand was a strong advocate of privatization—remember his complaints of how bad a deal a 2% rate of return is for seniors? Of course he forgot to mention that that was, essentially, a risk-free rate of return.

Turn the clock ahead to 2002, by which time 2% looked pretty good, and Republicans are running away from claims that they ever favored privatization of Social Security. Josh Marshall was pretty good on this one. So I think it’s pretty reasonable to say that messing with Social Security recipients’ income is once again politically dangerous. Think also of the variety of more recent references to how eliminating the dividend tax would benefit seniors.

What does this have to do with Consumption Taxes?

Social Security benefits are subject to less income taxes than other sources of income. There’s a very concise summary at Brookings; here’s the important part:

“Benefits are only subject to tax if this expanded income measure exceeds $25,000 (single) or $32,000 (married filing jointly). Above these thresholds, up to 50 percent of benefits are included in taxable income if the income measure is below $34,000 for singles or $44,000 for joint filers. For those with higher incomes, legislation enacted in 1993 increased the maximum inclusion rate to 85 percent of benefits…By design, more beneficiaries will be subject to tax over time. The Congressional Budget Office estimates that only about one-third of beneficiaries were taxed on at least part of their Social Security benefits in 2000.”

Eliminating income taxes on seniors would generate less savings for them precisely because they pay so much less in income taxes than the under-65 population. They do, of course, consume—that’s half of what retirement is about, right? (Presents for the grandkids counts as consumption).

I just don’t think the political will or audacity exists to implement this. Add to this the black-market problems that would surely arise with a combined federal and state tax that, conservatively estimated, would have to exceed 25%, and it’s a no-go.

Yes, a carefully crafted set of tax exemptions could alleviate the disparate impact that a consumption tax would have on seniors. Similarly, a well-crafted set of exemptions could also make a consumption tax progressive (CalPundit makes this point correctly). But, a few points are in order:

  1. Almost nothing about using exemptions in the consumption tax made it into the Economic Report of the President (on page 196, the authors mention possibly retaining favorable tax treatment of nonprofits)
  2. The only compelling case for a consumption tax is its theoretical simplicity. As soon as you start talking about favoring seniors, nonprofits, making the rate increase with the value of the sale, exempting some goods and services, applying regional adjustments to adjust for regional price and income variation, continuing to encourage the social goal of home ownership, favoring families with children, the popular R&D credits… it starts to look a lot like the current tax code morass.


P.S. Is it really much ado about nothing? I don’t think so. It’s telling that this proposal made it as far as it did. Now if I could just figure out what it tells me.

P.P.S. The fonts appear to be under control!

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Calpundit has the heads up on this one, though he highlights a different quote.

“The White House team is saying that the Fed chairman has lost sight of the broader thrust of the president’s tax proposals. They claim that Bush has started a major revamp of the tax system, from one that taxes investment and savings, to one that taxes consumption [emphasis mine]. Rather than make one massive effort to achieve that goal, they say, Bush is chipping away at the problem, with the abolition of the double taxation of dividends and the institution of new tax-advantaged savings plans. They say that these are the first steps on what will be a long road. As the Financial Times perceptively notes, ‘Little by little, [the administration] has headed towards the distant dream of some Republicans: a tax system based on consumption.'”

Calpundit muses accurately “And on a related note, is it just my imagination or is the Standard really a more interesting, more unpredictable, and basically more honest conservative magazine than National Review? It seems that way to me.”


P.S. is not intended to be “consumption tax central”, I just happened to start this blog as the issue was picking up steam. Soon, I’ll have thoughts on dividend taxes and why they are bad (it’s not the intrinsic unfairness of double taxation)–and no, that statement doesn’t mean that I favor the Bush plan.

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Angry and Timely

New in

Meme Watch: Consumption Tax Gambit: Taxing the poor by stealth?

By Timothy Noah

Posted Monday, February 17, 2003, at 2:50 PM PT

Coincidental email from Angry Bear to Timothy Noah (twelve hours before the Slate story was posted):

Mon, 17 Feb 2003 02:52:54 -0800 (PST)

From: “Angry Bear”

Subject: taxes



Big fan of most of your articles, of late, particularly the “meme watches” on the tax the poor meme. In any event, you haven’t yet added coverage of chapter 5 of the most recent Economic Report of the President. There, the CEA argues explicitly for replacing the income tax with a consumption tax–with a consumption tax, of course, there would be no more “lucky duckies” not paying taxes. Well, I suppose that if you were poor enough to not consume anything at all, you would still be a lucky duck. See for more.


Slightly left of center comments on news, politics, and economics from an Economist.

Screenshot of the email here.


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How High Would a National Consumption Tax Need to Be?

Dave Neiwert interveiws Robert S. McIntyre, an economist at Citizens for Tax Justice. Neiwert, quoting McIntyre:

“It becomes pretty hard to run when you get up to a rate big enough to replace the income tax, because you’re going to have to have a 40 or 50 percent rate. That’s what scared Bill Archer [the chairman of the House Ways and Means Committee, a fierce advocate of a consumption-tax approach] from ever putting a bill in. He was for it, but he didn’t want anybody to know how high the rate would be. He asked his staff to analyze it, and they came back and they said, ‘Well, if you taxed everything, you could do it at 42 percent.’ He says, ’42? Come on, I was hoping for 10.’ And they said, ‘Well, you’ve gotta tax everything, you understand.’ And he said, ‘Like what?’ And they started going through this, you know, rents and everything. ‘Oh shit!’.”

Is 40%-50% really what you would need? I’ll admit that at first glance it seems implausibly high, but that doesn’t mean it’s wrong. So I went to the Bureau of Economic Analysis web page for some numbers and it turns out that if the goal is to finance the entire federal budget using only consumption taxes, then yes, 40% is reasonable and 50% is not out of the question. Click to see a table with annual GDP, Federal Revenue, and implied Consumption Tax Rates (sorry, my html skills are not yet up to inserting an inline table–it keeps messing up all the formatting in the rest of the blog.

The table shows that to finance the current level of government spending with only consumption tax revenue would require a national sales tax of 30%, assuming (incorrectly) that levying this tax on consumption does not reduce consumption.

Remember, adding a 30% sales tax to a $100 DVD player makes the price to the consumer equal $130, resulting in less DVD players being sold, reducing consumption tax revenue. The estimates in the table are “naive” because they do not factor in this effect. (Conservatives may reply, with some truth, that this also does not factor in the fact that eliminating income taxes increases disposable income, increasing consumption). With apologies to Vermont, add in state and local taxes and it’s really easy to get a total sales tax over 50%.

One more thought: with sales tax rates like these (heck–suppose I’m wrong and a 25% federal tax would do the trick), imagine the size of the black market in consumer goods likely to emerge. Think the IRS is full of jack-booted thugs now? Enforcing a consumption tax won’t probably won’t make the IRS any friendlier. Honest estimates of the requisite size of a conusmption tax must include projections of the size of the black market.


Still to come: why this may be much ado about nothing (hint: Untaxed Social Security Benefits).

P.S. I’m working on eliminating the apparently random font changes.

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This is worth skimming (I saw it on Atrios): Columbia Tape Shows Network Competition.

Here’s the fun part

NEW YORK – During coverage of the space shuttle Columbia’s disintegration, the folks in CNN’s control room thought the picture they saw on rival Fox News Channel looked familiar.

So they tried a little experiment.

The producers superimposed a tiny “CNN” logo on the upper left corner of the network’s screen as it showed the shuttle breaking into pieces. Blip! The same logo appeared on Fox News Channel.

Then they decided to abruptly switch cameras so a picture of correspondent Miles O’Brien appeared. For two seconds — until it was hurriedly replaced with a view of NASA (news – web sites)’s mission control — it looked like O’Brien was working for Fox, too.

I suppose it’s only fair, CNN cribbed Fox’s call of the winner in Florida and thus the nation in November 2000 (around 3:30 a.m. as I recall).


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Stuart Buck cites a editorial by Bruce Bartlett arguing that consumption taxes are not regressive. Bartlett essentially parrots the logic of chapter 5 of the Economic Report of the President:

Liberals also make the mistake of assuming that a consumption-based tax system is regressive — taking more out of the pockets of the poor than the rich. In fact, over one’s lifetime, consumption is roughly proportional to income, because over a lifetime we eventually consume all our income [emphasis mine]. Thus, a tax on consumption will also be roughly proportional — taking the same percentage from all taxpayers.

Of course it’s not true that all income is consumed over a lifetime. Those with estates to pass on when they die don’t consume all of their income. Not surprisingly, the advocates of the consumption tax are the same people who argue against estate taxes.


P.S. Stuart Buck also asks why we can’t create progressivity by making the sales tax an increasing function of the sales price. This is the logic of luxury taxes. But setting the tax rate as an increasing function of the sales price is a recipe for substantial economic distortions. For example, firms would simply unbundle sales to qualify for lower rates (but since firms currently do bundle sales–e.g., tires come with the car–we can infer that bundling is valued by consumers). More generally, this penalizes things in the economy that are intrinsically expensive, like housing, in favor of things that are intrinsically inexpensive, another distortion. Maybe we could make a different increasing tax rate for every good so that a Mercedes is taxed at 30% and a Ford at 18%, but housing is only taxed at 14% for the first $1000, but at 25% after $1000, except that has to be adjusted for regional differences (see State and County Consumption Tax Adjustment Factors in Appendix K-7). It gets complicated quickly, and simplicity is a major part of the case for the consumption tax.

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