Note: This article originally appeared at National Review Online on August 17, 2012.
Let's say that you own a company that makes $100 in income. Let's say that It pays 80 percent tax on that, which leaves $20 that it can pay to you in dividends. Then let's say that you pay 5 percent in tax on that dividend income. That leaves $19. Some would say that you only paid a 5 percent tax! And yet the government has ended up with $81 of your income, and left you only $19. In what real-life sense is that a 5 percent tax?
Because this sort of multiple taxation on the same income stream hides the real rate of taxation, our current tax system amounts to a fraud on the public. Americans think that rich people and corporations pay lower taxes than they do. (And that is sometimes true, because of the exemptions, credits, and subsidies that you get if, say, the Obama administration likes your industry). But if you consider effective tax rates, it is usually false.
It's important to grasp that the fraud of double taxation applies as much with capital gains as it does to dividend income. A company's value increases as a result of past income and expected future income, and the company has paid or will have to pay tax on all of that. Some companies run losses for years and their value still increases because of high expectations for future income. But it is still income, whether in the past or in the future, that increases the value of a company, and the company has to pay tax on virtually all of that.
Think of it like this: Let's suppose you own a company that is worth
$100 dollars, and that company makes a $100 profit, taxed at, say, 40 percent to the company. Now the company has $60 that it can either pass on to you as dividend income, or hold as cash or investments. If the former, you now have to pay tax on the $60 of dividend income. If the latter, your company is now worth $160, and you now have "unrealized" capital gains in the amount of $60, which you will "realize" whenever you sell your stake, and at that point you will have to pay capital-gains tax.
In either case, you are going to have to pay taxes on an income stream that is subject to double taxation at an aggregate rate that would probably be politically impossible to impose as a single tax.
This matters because American companies are already subject to the developed world's most oppressive rates of business-income taxation, even before the taxes on capital gains and dividend income. Now the Obama administration wants to push the latter up to the same level as the former. Do Americans realize that Team Obama wants the government to take away such a substantial proportion of businesses' and individuals' income? No, they don't, thanks to the smokescreen of double taxation."