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Up Doubling of Taxation Isn't Limited to Dividends January 21, 2003 Doubling Up of Taxation Isn't Limited to Dividends By DANIEL ALTMAN ouble taxation," President Bush said in introducing his proposal to end the personal tax on dividends, "is bad for our economy. Double taxation is wrong." Corporate dividends, however, are not the only kind of income that is taxed twice. Other taxes create a double, triple or even quintuple burden. And unlike the double taxation of dividends, which mainly affects the wealthy, the burden of other forms of multiple taxation sales taxes, import taxes, payroll taxes, among others often falls most heavily on poorer Americans. These taxes may not be associated with inefficiencies in the capital markets, but can still take a hefty bite out of paychecks and reduce the incentive to work. Democrats and a few Republicans outside the White House have proposed cutting at least one of those taxes, but no one is talking about eliminating them altogether. The double tax on dividends is really a double tax on corporate profits. The federal government taxes companies' profits and then taxes the money again when it passes to shareholders as dividends. The double tax affects about 54 million Americans. Economists agree that it also gives companies an incentive to issue debt with the interest counting as a pretax cost rather than equity. Multiple taxes also affect the other 236 million Americans who would see no immediate benefits from elimination of the tax on dividends. For example, import tariffs, sales taxes and federal and state excise taxes can add to the price of a product. Nearly all such taxes are extremely regressive, said John S. Barry, the chief economist of the Tax Foundation, a nonprofit educational group. Low earners spend a larger share of their income on alcohol, gasoline and tobacco, as well as inexpensive imported textiles and manufactured goods, than high earners do. President Bush has said he is attacking the double tax on dividends in an attempt to help economic growth in the long term. Yet sales and excise taxes can also create distortions in the economy, said David F. Bradford, a professor of economics at Princeton. Even though these taxes are on purchases, not income, they can have the same effect as income taxes. "These are proportional taxes," Professor Bradford said. "If you do spend your money over your lifetime on taxed goods, then it's got to be a wage tax." Because taxes on goods and services can have the same effects as a tax on wages, they may reduce the incentive to work. Taxes on saving and wealth should also affect people's willingness to work, Professor Bradford said. "Suppose I have to pay a tax on my interest. That should affect how much I work today. I earn my wages, and then I save my money, and then I pay again." Those distortions can add up, even for low-income Americans. The Consumer Expenditure Survey, prepared by the Bureau of Labor Statistics, offers a window onto the tax burdens of families at different incomes. The total burden from nearly all forms of taxation income, sales, property and excise taxes, and the Social Security payroll tax was strikingly similar across the entire spectrum of incomes in 2001. For individuals and families in the lowest fifth, with an average income of $7,946 (including just $25 in dividends), the cumulative tax rate was 18 percent. For the top fifth, with an average income of $116,666 (including $1,188 in dividends), the rate was 19 percent. Property taxes, in addition to sales and excise taxes, make the overall system less progressive. "It's pretty well agreed upon that property taxes are passed through to renters," Mr. Barry said. "It is a disproportionate effect on low-income folks." Property taxes are also a form of double taxation. They affect assets bought with income that has already been taxed. The estate tax, whose burden falls mostly on the very rich, belongs in the same category of double taxation. The tax cut law passed by Congress in 2001 phases out the estate tax over a decade but then fully restores it in 2011. Republicans are expected to push to abolish it permanently, but doing so would widen the budget deficit. Social Security can also add a layer of multiple taxation. If workers do not perceive a concrete link between their contributions to the system and the benefits they will someday receive, then the payroll tax will decrease their incentive to work, just like any other income Even tax. those who do believe in the connection, as Martin S. Feldstein of Harvard and Andrew Samwick of Dartmouth wrote in 1992, can face high tax rates at the margin, because they may receive less than a dollar at retirement for every dollar they contributed. It depends on how much they earn, whether they are married and how old they are. The figures from the Consumer Expenditure Survey provide a rough estimate of tax burdens, since people do not always report incomes accurately. The survey also does not add the value of some entitlements, like Medicaid, to incomes. The figures also focus on just one year, which can be misleading, since people may have high incomes while they work and low incomes after they retire. A recent study by Laurence J. Kotlikoff, a professor of economics at Boston University, and his co-authors took these criticisms to heart. They calculated average tax rates for entire lifetimes. To encompass the government's role completely, they factored in virtually all entitlement programs, like Medicare and food stamps, in addition to taxes. For a couple who earn the minimum wage, Professor Kotlikoff calculated a lifetime negative tax rate, or subsidy, of 32 percent. The rate becomes positive quickly, though, rising to a tax of 30 percent for couples earning just three times the minimum wage. For the families with the highest incomes, the tax rate reaches about 50 percent. "It doesn't take a lot of income to start paying a lot of taxes," Professor Kotlikoff said. Over their lifetimes, "the superpoor don't pay taxes, but the poor do, and certainly the middle class does." The rates for the working poor and the rich are fairly close together, Professor Kotlikoff said, in part because of the disproportionate effect of multiple taxation on low-income families. "You can have quintuple or octuple layers of taxation quite easily." Nonetheless, "the real issue is not the number of layers, it's the high effective tax rates at the margin." At the margin, Professor Kotlikoff added, the poor suffer from yet another form of double taxation. Entitlement programs can create tax-like effects, since a worker may lose eligibility for them by earning more money. The implicit tax in addition to any explicit income taxes also detracts from the incentive to work. In fact, the tax rates for the poor and well-to-do may be even closer than the study found. Professor Kotlikoff and his co-authors did not include some tax breaks, like those for 401(k) and I.R.A. saving plans, employer-provided health insurance and capital gains on home sales, which upper-income taxpayers are far more likely to take advantage of. Just 43 percent of the lowest fifth of earners were homeowners, according to the expenditure survey, compared with 88 percent of the highest fifth. In last year's annual survey by the Census Bureau, 83 percent of people earning $75,000 or more reported having health insurance offered by their employers, compared with 26 percent of those earning $25,000 or less. Because they cannot take advantage of the tax breaks, the poor can end up paying what amounts to another extra tax. "If you have these exclusions that benefit certain behavior," Mr. Barry said, "that forces up the rate on all income." Though Democrats and a small number of Republicans in Congress have repeatedly suggested a reduction in the payroll tax that pays for Social Security as an economic stimulus, the idea has not gathered much steam. But two other types of measures, which are gaining political support, could reduce multiple tax burdens for virtually all households. Last month, the Economic Policy Institute, a left-wing policy group, proposed a subsidy of 3.5 percent to the first $15,000 of all workers' wages, and $75 billion worth of grants to the states, which would allow them to avoid harsh tax increases and spending cuts. Since then, Democrats in Congress and the Democratic Governors' Association have announced plans with similar measures of varying sizes. Yet the White House is unlikely to attack forms of double taxation besides the dividend tax, said Peter R. Fisher, the under secretary of the Treasury for domestic finance. "This is the one we want to go after now, so this is it," he said in an interview last week. Adding other "bells and whistles" to balance the proposal, he said, would "invite a level of complexity back at you that you don't necessarily want." Copyright 2003 The New York Times Company | Permissions | Privacy Policy

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