Do Regular Wages Face "Double Taxation"?

Timothy Taylor ("The Conseravble Economist") has a very interesting post at his blog about Obama's proposed ideas for corporate tax reform (but there's too much good stuff to paraphrase here, so I'd suggest that you read his entire post.)

But I do have one specific gripe with his piece. Towards the end of his post, he writes: "Corporate income can often be taxed twice: for example, when a firm pays taxes on profits, and then distributes some of those profits as dividends that are taxed under the individual income tax."

This whole mis-characterization of corporate profits being unfairly subjected to "double taxation" really gets my goat, so I had to say a few words on the subject.

First, Mister Taylor doesn't mention anything at all about executive pay packages and the capital gains tax — even though this is all related to the corporate tax — such as when a corporation funnels corporate income to their executives in the form of stock-option grants and bonuses as "pay for performance". The executives, after one year, can cash in their vested options and pay a long-term capital gains tax rate of 23.8% on this personal income, as opposed to the statutory corporate tax rate of 35% (assuming the company doesn't pay a much lower "effective" corporate tax rate, which many times they do.)

Every financial traction (excluding Wall Street traders, and why we need a financial transaction tax) usually imposes some form of tax (e.g. sales, excise, capital gains, state, etc). When a corporation's lowly janitor receives his paycheck, he is automatically taxed for federal, state, (sometimes for county and city taxes), Medicare and Social Security taxes. But when he makes a financial transaction (e.g. when he purchases tires for his car, or if he pays a cable TV bill, or sells his house), then he too would also face this supposed "double taxation" travesty.

If a corporation was really a person — a living and breathing human being — then yes, it would be taxed twice. But because it is only a limited liability legal entity (that only exists on paper and usually sits in a file cabinet in the State of Delaware), a corporation is only a classification for a type of business — and a business is just a vehicle for generating revenues. And so, the corporation is only taxed once. It's only then that the managers and investors of this corporation are taxed for dividends and executive compensation packages (on their personal income, just like the janitor's) — and so therefore, they too are also subjected to other taxes when they purchase something (like a yacht) or when they sell something (like a beachfront mansion).

If I bought oil paints, canvas and brushes at the local art store, and was taxed on those purchases, then I painted a pretty picture and sold it for $500, should I be taxed for a "realized capital gain" (profit after expenses) on that sell? After all, I was already taxed on the components. And if someone bought my painting a year later for $1 million (it's called a SWAG investment) and then resold it after owning it for 20 years for $10 million, should they also be taxed for a capital gain — even though I was already taxed on the oil paints, canvas and brushes over two decades ago?

Any corporation (business) can always un-incorporate if they don't want to pay corporate taxes; but they usually don't because, not only do they get huge tax advantages, they also enjoy many other perks that most working people don't enjoy. There are too many to list here, but here's one example:

Billions of dollars in settlements, damages, penalties and fines for corporate wrong-doing are tax deductible. The tax loophole that permits this, the CEOs call a "business expense". Critics say that taxpayers are in effect subsidizing corporate misconduct. Not to mention, with "limited liability", the CEOs of these corporations can also avoid personal forfeitures and doing jail time for criminal offenses. (So, by all means, un-incorporate.)

* Here's a related post at the New York Times on Obama's proposal for corporate tax reform — about the repatriation of overseas corporate earnings, how some companies could benefit, and how it could affect the offshoring of jobs. Bruce Bartlett at the New York Times also has a lot of good articles about the corporate tax debate. And here's a recent post that I also did on the subject — featuring Rep. Paul Ryan ;)