The taxation of capital gains and dividends has been closely linked by Republican Presidential candidates during the 2012 Presidential primary campaign. While the argument presented earlier about the impact of eliminating taxes on capital gains also apply to eliminating taxes on dividends, there are some additional issues with dividends that need to be explored. Table 1 summarizes the income received from dividends for those taxpayers earning over $200,000 a year in 2008. Dividends accounted for only 2.65 percent of total income, but ovedr half of all dividends were reported by those earning over $200,000, and 42 percent of all dividends were earned by those taxpayers who reported over $500,000 in total income, the wealthiest 3 percent of the population. Further, over one-third of all dividends were earned by those making $1 million or more.
Table 1
Income Earned From Dividends--2008
Dividends accounted for 2.65 % of all income earned
Bracket Percent of Taxpayers Percent of Total Dividends
$200,000 or less 89 % 43 %
$200,000 or more 11 % 57 %
$500,000 or more 2.5 % 42 %
$1.0 million or more .95 % 37 %
$2.0 million or more .40 % 27 %
Source: Statistics of Income, 2008, IRS
Until the Bush tax cuts in 2001 and 2003, dividends tended to be taxed as ordinary income, so the maximum tax was the same as the maximum tax on wages and salaries. Taxes on dividends were reduced as ordinary tax rates were reduced in 1964, 1981, 1986, and 2001, but were increased in 1993. The Bush tax cuts of 2001 and 2003 reduced the maximum dividend tax rate to only 15 percent. But, as argued earlier, the reduction had only a limited impact on the growth in employment and output. Employment and output seem to respond more to general tax cuts or tax increases rather than being attributable to specific tax changes on individual income components.
There are two primary arguments being used by advocates of eliminating dividend taxation. The first is that dividends are taxed twice under U.S. tax law—once under the corporate profits tax, and a second time when profits are distributed as dividends and are then subject to personal income taxes. The second argument is that U.S. income taxes penalize U.S. multinational corporations who earn a substantial portion of their total profits from overseas operations. In order for U.S. corporations to remain competitive internationally, U.S. taxes must become more competitive with those nations that tax corporate profits and dividend distributions at rates as low as 10 to 15 percent.
The double taxation of dividends argument has been made for decades and has some credibility in taxation literature. Corporate stockholders are said to pay taxes on profits under both the corporate and the personal tax systems. If the personal tax on dividends was eliminated the tax system would be more equitable and simpler. There are at least two arguments against this position. First, the impact of the corporate profits tax may or may not actually fall on stockholders. Some studies show that the tax is shifted backward to employees in the form of lower wages or forward onto customers in the form of higher prices. If either argument is even partially correct, the burden of corporate taxes is not borne entirely by stockholders, but by other parties.
The second argument against the double taxation of dividends is “so what”. Wages and salaries are subject to multiple levels of taxation, not just “double” taxation. Workers pay Social Security taxes on all wages and salaries up to $110,100 in 2012, and then also pay personal income taxes on total wages and salaries as well. They then pay sales taxes on expenditures and property taxes on real estate, both of which must be paid out of wages and salaries earned. The double taxation argument is a problem only for those taxpayers who earn dividend income, which, again, is only a small fraction of total income earned. If politicians really want to eliminate double taxation on income they should propose to deduct Social Security taxes from total income before calculating income taxes on those same wages and salaries, and to make sales taxes also deductible again.
The second argument of equity between U.S. and foreign tax systems is more real and more difficult to deal with. This argument deals as much with corporate profits taxation as it does with personal taxes on dividends. The current maximum tax on corporate profits is 35 percent, but virtually no multinational corporation actually pays a 35 percent tax. In fact, every year news media reports dozens of major corporations who paid zero corporate taxes in the prior year. The corporate tax is riddled with loopholes, deductions, and exclusions that allow corporations to legally reduce or eliminate their actual tax burden. Income tax paid on foreign operations to foreign governments is deductible for U.S. tax purposes. Further, if income is earned on foreign operations and not repatriated, it is not subject to U.S. taxes.
From 2004 to 2006 Congress approved a temporary measure to allow U.S. corporations to repatriate foreign income to the U.S. and pay only 5.25 percent tax. The reason used was to allow corporation to bring back billions of dollars in foreign profits that could then be used to create U.S. jobs and stimulate the economy. While hundreds of billions were repatriated by the largest U.S. corporations, billions were used to repurchase their own stock and to pay millions in bonuses to corporate executives. Since corporations were not required to report what they actually used the funds for there is no reliable evidence that the program was successful or not. However, a Senate study published in 2011 argued that the largest 15 firms that brought funds home accounted for over half of all the funds repatriated. The study found that those 15 firms actually employed 21,000 fewer people in 2007 than in 2004. Pfizer, which repatriated the most ($35 billion), reduced employment by over 11,700 workers. A similar proposal was circulated in 2011 for another temporary tax reduction to 5.25 percent in an effort to stimulate the economy and create more jobs.
It is clear, however, that U.S. multinational firms do have an incentive to leave profits outside the U.S. if repatriation would subject those profits to taxes of up to 35 percent. What is not clear is whether they would use any potential repatriated funds to increase employment and capital investment within the U.S. Additional after-tax profits could also be used to repurchase corporate stock, pay bonuses, or to pay increased dividends to stockholders, which would only have an indirect impact on employment and total spending. But whatever direct or indirect benefits may result, it is clear that the U.S. would be better off if those profits could be brought back into the country. But an incentive needs to be provided for using the funds to increase employment rather than paying dividends or bonuses.
I propose a sliding scale tying corporate profits taxes and dividend taxes to corporate total worldwide employment. Table 2 summarizes this proposal. A reduction in corporate tax rates and corresponding dividend rates would be tied to the ratio of total U.S. employment to total worldwide employment. In addition, current loopholes and exclusions would be eliminated.
Table 2
Proposed U.S. Corporate/Dividend Taxes and Employment
U.S Employment as a % Maximum U.S. Maximum U.S.
Of Worldwide Employment Corporate Tax Rate Tax on Dividends
Less than 50 % 35 % 35 %
50 -60 % 30 % 30 %
60 – 70 % 25 % 25 %
70 – 80 % 20 % 20 %
More than 80% 15 % 15%
Such a system should encourage corporations to repatriate profits as well as provide incentives to repatriate jobs outsourced during the past decade. A decrease in corporate tax rates or personal tax rates on dividends not tied to the level of new employment will likely lead to actions by corporate officers that maximize their own and their stockholders interests rather than the interests of the entire country. Tying the corporate and dividend tax rates to the levels of U.S. employment would encourage corporations to repatriate foreign income while shifting overall employment back to the U.S.
Stockholders would also have an incentive to demand that corporate officers increase domestic employment rather than repurchase stock or pay executive bonuses so their overall taxes on dividends paid would be as low as possible. Even if officers used the funds to pay higher dividends without increasing domestic employment, taxes on those dividends would remain high. Since the current rate on dividends is only 15 percent, such a new system would result in additional taxes only for those companies that continue to shift employment from the U.S. to foreign operations. It would also allow corporations with substantial U.S. employment to remain competitive with foreign corporations in low tax nations.
An example can illustrate this process. In 2010 General Electric was widely reported to have earned over $14 billion in profits but paid zero U.S. corporate income taxes. In fact, they received a refund of over $1 billion. Would elimination of the tax on dividends or a reduction in the current corporate tax rate be expected to result in the creation of thousands of new U.S. jobs as argued by Republican candidates?
According to the 2010 GE Annual Report, in 2001 GE employed 158,000 workers in the U.S. and an additional 152,000 worldwide, a total of 310,000 employees. U.S. employment reached a high in 2004 when GE employed 165,000 in the U.S. and 142,000 outside the U.S. Total employment reached a high in 2007 when they employed 155,000 in the U.S. and 172,000 outside the U.S, a total of 327,000. By 2010 total U.S. employment had fallen to 133,000 and employment outside the U.S. had fallen to 154,000
GE’s total U.S. employment as a percentage of worldwide employment was highest in 2001 at 51 percent, before the Bush reductions in dividend taxes. It declined throughout the decade, reaching a low of 46 percent in 2010. Total U.S. employment decreased by 32,000 workers between 2004 and 2010, but it had decreased by 10,000 before the 2007-2009 recession. Meanwhile corporate profits ranged from $13 billion to $17 billion a year during the same period. Under the proposed system GE would pay a maximum corporate rate of 25 to 30 percent until they increased U.S. employment as a percentage of total worldwide employment. Since they currently pay zero corporate taxes, any system that eliminates current loopholes would result in increased taxes for GE.
It seems clear that job creation and increased production and output depend on numerous factors, of which tax rates appear to be only a minor cause. There is little or no evidence to suggest that the most successful anti-recession economic policy is likely to be a reduction in corporate tax rates and/or an elimination of personal taxes on capital gains and dividends.
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