Whether I’m criticizing Warren Buffett’s innumeracy or explaining how to identify illegitimate loopholes, I frequently write about the perverse impact of double taxation.
By this, I mean the tendency of politicians to impose multiple layers of taxation on income that is saved and invested. Examples of this self-destructive practice include the death tax, the capital gains tax, and the second layer of tax of dividends.
Double taxation is particularly foolish since every economic theory – including socialism and Marxism – agrees that capital formation is necessary for long-run growth and higher living standards.
Yet even though this is a critically important issue, I’ve never been satisfied with the way I explain the topic. But perhaps this flowchart makes everything easier to understand (click it for better resolution).
There are a lot of boxes, so it’s not a simple flowchart, but the underlying message hopefully is very clear.
1. We earn income.
2. We then pay tax on that income.
3. We then either consume our after-tax income, or we save and invest it.
4. If we consume our after-tax income, the government largely leaves us alone.
5. If we save and invest our after-tax income, the government penalizes us with as many as four layers of taxation.
You don’t have to be a wild-eyed supply-side economist to conclude that this heavy bias against saving and investment is not a good idea for America’s long-run prosperity.
By the way, Hong Kong’s simple and fair flat tax eliminate all those extra layers of taxation.
That’s the benefit of real tax reform such as a flat tax. You get a low tax rate, but you also get rid of double taxation so that the IRS only gets one bit at the apple.
That is a revealing flow chart – simple and understandable. Now do one for where the taxes go – like entitlements to non-citizens, entitlements, defense etc.
We know we get taxed, but what is done with it. Clearly politicians take more money, power and influence at every possible opportunity. There is no downside to “buying” votes. In fact, that is the only, it seems, guideline, for the ssuccessful politician. WE must stop the taxes by stopping the entitlements. The bargaining bullshit has got to stop even though it is human nature. We hhave a good constitution, but supporting it takes a back seat to buying votes, power and influence to complete the circle. Stop the entitlements. Show us the flow chart of where it goes and to whom. If I ever acted this way while in the ARMY, this would be coming from Ft. Leavenworth.
Dan: do you really need to twist things as you do?
1 – the double tax only applies to investment income from C-corps. Investors and owners of LLCs and partnerships can reinvest profits without paying any form of double taxation.
2 – while you portray the death tax as being applicable to the person who earned the money, it should more correctly be viewed as a tax on the person receiving the inheritance. The person who leaves an estate (or who gives away more than the gift tax exclusion) is out 100% of the money, regardless of the tax rate.
3 – you fail to note that only the profits from investment income are taxed, the underlying principle is not taxed twice. The investor can always pull his money out and buy the big screen TV
Since no Corporation actually pays an income tax – it is all passed along to the consumers in form of increased prices – would it not make more sense to simply drop the Corporate rate to Zero and make all other income subject to the standard income tax?
Until you get to the death tax in that flowchart it is all additional income beyond the initial investment price so it is not a double “personal income tax” since the only double taxation starts at the Corporate level.
Hey Dan, Nice overview. (You should be on Kudlow more often instead of Jared “Unibrow” Bernstein, Robert “Econodwarf” Reich or Howard “Governor Aaargh” Dean.)
One area that needs more emphasis is the impact of inflation on tax revenue. Imagine an investor in a tangible asset (real estate, precious metals, etc.), the real value of which stays roughly constant over the long term but whose nominal value in USD terms goes up due to the debasement of the USD. The investor sells the tangible asset, realizes a nominal gain which is taxed at 35% and ends up with only 65% of the original real value.
Inflation and taxation on unindexed nominal gains is one of the most pernicious ways the state impoverishes its citizens. The only just solution is to index the original cost for a real measure of inflation.
Dan, Great way of highlighting the many layers of taxes that stifles investments in the US. What caught my eye though is the apparent simplicity of the left side of the chart. It couldn’t possibly be that simple.
When you decide to buy a TV, you’re not just paying for the parts and labor it took to build it. There are many layers of imbedded corporate income and employer taxes and government compliance costs tacked on to the price of that TV by every company that touches it throughout the supply chain. From raw material suppliers, to the contractor that built the factory, to the bank that holds the title, to the utilities that provide the energy, to the manufacturer itself, to the companies that produce the packing materials, to the freight companies that ship it, to the store you bought it from and all the other companies in between, they all bear a tremendous cost in taxes and government compliance in the US. These costs MUST be passed onto the end consumer and they ultimately bear these burdens. The idea of corporate taxes is sort of a myth. In the end the consumer will always pay them.
Oh, wait. Nevermind. The TV was made in China because no manufacturer could afford to build that TV here in the US under all of those imbedded costs. The Flat Tax will not fix that problem. In addition to removing all the layers you highlighted above, we must repeal all corporate and individual income taxes as and move to a national retail sales tax on all goods and services in order to level the playing field with imported goods, which do not have our ever-thickening layer of corporate taxes and government compliance costs. True prosperity for the US would require a tax system more along the lines of the Fair Tax. A bonus would be the liberty that comes from complete transparency and putting the consumer in charge of how much in taxes they are willing to pay. Don’t want to pay taxes? Don’t buy the TV – invest that money. You won’t have to pay taxes when you sell those shares. Cheers!
And this doesn’t even deal with the sales taxes on the items you buy or the hundred other taxes that come with getting that product to you (or in the case of some products like a phone or a car the new fees and taxes that come with that product).
[...] Explaining the Perverse Impact of Double Taxation with a Chart [...]
crisap444 reblogged this on The Conservative New Ager and commented: And keep in mind the rich, those who invest, are not paying enough taxes.
Sigh. “Death tax” is double taxation. On who, exactly? That’s like saying my employer who pays taxes and pays me after he pays taxes is being double taxed because I have to pay taxes, too. And my poor gardener, that poor dude is party to TRIPLE taxation then it appears.
What a joke. This guy calls himself an economist?
[...] because Herman Cain’s 9-9-9 tax plan has low tax rates, it eliminates double taxation, and it wipes out loopholes, and those are three very big and very good [...]
[...] because Herman Cain’s 9-9-9 tax plan has low tax rates, it eliminates double taxation, and it wipes out loopholes, and those are three very big and very good [...]
As a consumer we pay a sales tax ( it goes to government isn’t it?)
Does the author assume that we are all fools, or is he just sure that we all hate taxes so much we are willing to believe this fairytale.
[...] reduce the discriminatory and punitive treatment of income that is saved and invested (see this chart to understand why this is a serious problem in the current tax code). Since all economic theories – even [...]
Let me give an example to better illustrate what the author wants done:
Let us say that a rich billionaire leaves a 20 billion dollars in fortune that he earned to his son. That son, according to the author’s viewpoint, doesn’t get taxed because the author doesn’t like the death tax. Let’s say the son then invests his money in stocks and bonds, he doesn’t pay a penny in taxes since the author opposes capital gains. He then starts a company with his huge wealth, that company doesn’t pay a single penny of tax on its profits since the author opposes corporate taxes. Meanwhile, this guy goes on chartered flights on “business trips”, rents hookers for “business meetings” and shows them as expenses in his accounts while his employees continue to pay taxes on all their salaries.
Exciting isn’t it? Hey, once he is done, maybe he can pass this money along to his heir and let him repeat the cycle too…
What i read throw this post and the comments is the fact that maths are of no concern when it’s a tax question !
Tax is a question of ideology and not of serious maths.
Yes. What’s wrong with our economy is that people are buying consumer products instead of investing.
Everyone I know who is saving for retirement is investing less because s/he figures that the income they receive from speculation (capital gains) or investment (dividends and interest) is going to be taxed.
Seriously?
The chart is cute, but it implies that the same invested dollar gets taxed many many times, which is not even remotely true. Taxes only apply to the new income that flowed to the individual as a result of the investment of that dollar.
You know perfectly well that this is true. Why are you engaging in such deception? Why publish and sign your name to something that shows so little integrity?
Ah right. Self interest. Political ideology.
You exploit the ignorance of wide swaths of the populace to get them to believe that a policy that will harm them is a good idea.
Hey, can I buy you breakfast, lunch, and dinner every day for the next 20 years? Seriously. My treat.
I hope you like McDonalds. Oh, I won’t be eating with you.
At best, disingenuous spin; at worst, outright distortion and falsehood.
Please define the GAINS portion of capital gains. Investment is taxed in its increase, not the full capital.
A dollar made is a dollar made, whether in a fireman’s salary or a banker’s portfolio. Why should the fireman have his dollar taxed, and not the banker?
Can’t the fireman then invest what’s left of his dollar, too? Why is that dollar less important as investment capital than the bankers dollar?
You would have us create a tax-exempt ‘investor class’ benefiting from the market that flourishes in a stable society created by government and the rule of law, but not contributing to the cost of that stability.
How can you call this a double tax when you are only being taxed on each type of income once. Example:
you earn wages and pay your tax on them.
you use your after tax earning to buy stock. $1000 worth
The stock gains value, Now worth $1500(you dont pay any tax until you cash it in)
You cash in the stock and get $1500
You only pay tax on $500 since you already paid tax on the $1000 previously earned, and to top it all off, you pay capital gains tax on that $500 which in may cases is lower then the tax rate you paid on the initial $1000.
As long as you are smart about your investments, why is this bad? I would rather pay 15% on $1000 and 0% on $500 then 20% on $1500 and loose $150.
Just a thought.
Oh, and not to mention the step up in basis on stock that people get on death. This can sometimes be a MASSIVE amount in tax savings.
If the value of the stock goes down and you sell it for a loss, you get to write it off against your ordinary income. Therefore, the government subsidizes your losses. Hence I see no problem with the government participating in your gains. However, I do not think there needs to be a separate definition for this income. Income is income – it should all be treated the same. And I agree with other posts – corporate income is truly double taxation, and should be lowered to zero. Finally – estate taxes are a problem for me. I think people should be allowed to bequeath a significant amount of wealth tax-free; however, I also think there should be a limit before taxation kicks in and provides incentive for philanthropy. Perpetual inherited advantage builds an entitlement class and can inhibit the social mobility of others.
Haha. That’s pretty good. You make it look like the income is taxed over and over when it’s invested. The last tax isn’t even on the same “individual” who originally earned the money.
Clever enough to fool most people, probably.
Move to Canada…for every $1 you earn pay .50 in taxes.
Get free health care and education!
There’s nothing inherently wrong about double taxation; it’s just annoying because simpleminded readers and writers get the wrong idea that saving is more expensive than spending. A plumber charges tax to his customer and buys a restaurant meal with the rest. The restauranteur charges tax on his meal and spends the remaining money on a haircut. The hairdresser charges tax on their cut and spends the rest… you see where this is going: the hairdresser’s cut has had tax taken out by the plumber and restauranteur as well, but the double-taxation obsessivists don’t count that as double taxation. Because if they did, then they would realize that all taxes are a form of double taxation and their heads would explode.
This author has no clue how to make a cogent chart… not to mention the false logic behind what he characterizes as double taxation.
[...] world are capital-gains an example of double-taxation? Fortunately, they provide a handy link to a blog that explains the “double [...]
[...] because Herman Cain’s 9-9-9 tax plan has low tax rates, it eliminates double taxation, and it wipes out loopholes, and those are three very big and very good [...]
[...] revoke a discriminatory and punitive diagnosis of income that is saved and invested (see this draft to understand given this is a critical problem in a stream taxation code). Since all mercantile theories – even [...]
[...] in September, I posted a flowchart showing how the current tax system is biased against saving and [...]
[...] in September, I posted a flowchart showing how the current tax system is biased against saving and [...]
[...] Back in September, I posted a flowchart showing how the current tax system is biased against saving and [...]
[...] in September, I posted a flowchart showing how the current tax system is biased against saving and [...]
“1 – the double tax only applies to investment income from C-corps. Investors and owners of LLCs and partnerships can reinvest profits without paying any form of double taxation. ”
Wrong. LLCs and S Corps pay tax on profits, not withdrawals. If you leave the money in the company, it is taxed as income whether you take it out or not. If it’s less than about $105,000, you pay self-employment tax to boot.
[...] with me – at least implicitly – about “trickle-down economics” and the deleterious impact of double taxation. Rate this: Share this:PrintEmailFacebookTwitterMoredeliciousDiggFarkLinkedInRedditStumbleUponLike [...]
I could write a small book on your article but basically, you have no idea what you are talking about. For example:
Give me one example of how the capital gains tax is a double tax. You cannot do it.
[...] tax code is punitive and corrupt, but the economic damage caused by a bad revenue system is just part of the [...]
[...] tax code is punitive and corrupt, but the economic damage caused by a bad revenue system is just part of the [...]
The Declaration of Independence states that “all men are created equal”. The Constitution acknowledges this all important tenet by only granting the federal gov’t jurisdiction over foreign commerce, interstate commerce, and trade with the Indians. Since “all men are created equal” there can be no intrastate commerce jurisdiction and no such thing as a “taxpayer”.
Great Britain lost the Revolution on the battlefield, but immediately sent in its bankers to destroy American sovereignty. In the War of 1812, Great Britain was impressing our Merchant Marine into service for its Navy. The bankers bankrupted the federal gov’t in 1933 (title 11 USC, “Bankruptcy”, is implemented by title 11 CFR, “Federal elections” – we are only electing a bankruptcy “administration”.
The final nail in American sovereignty was the creation of Social Security. The Form SS-5 that one uses to apply for a S.S.# is actually a federal employment form – you become a “taxpayer”. A “taxpayer” is a member of the Merchant Marine – see 26 CFR 2.1-1(a)(5) for the definition. 26 CFR 2.1-1(b) states that this is the term used for all calculation of taxes. So now all Americans are being impressed into service for Great Britain’s bankers. Go to http://wp.me/pCW6e-7h to see “The Bankers’ Blueprint to Destroy American Sovereignty” with all the statutes and regulations.
[...] tax code is punitive and corrupt, but the economic damage caused by a bad revenue system is just part of the [...]
[...] because of bad tax law. If the United States had a simple and fair flat tax, there would be no double taxation of income that is saved and invested. As such, the IRS wouldn’t have any reason to care whether Americans had bank accounts and/or [...]
[...] because of bad tax law. If the United States had a simple and fair flat tax, there would be no double taxation of income that is saved and invested. As such, the IRS wouldn’t have any reason to care whether Americans had bank accounts and/or [...]
[...] bad taxation law. If a United States had a simple and satisfactory prosaic tax, there would be no double taxation of income that is saved and invested. As such, a IRS wouldn’t have any reason to caring either Americans had bank accounts and/or [...]
[...] bad taxation law. If a United States had a simple and satisfactory prosaic tax, there would be no double taxation of income that is saved and invested. As such, a IRS wouldn’t have any reason to caring either Americans had bank accounts and/or [...]
[...] bad taxation law. If a United States had a simple and satisfactory prosaic tax, there would be no double taxation of income that is saved and invested. As such, a IRS wouldn’t have any reason to caring either Americans had bank accounts and/or [...]
[...] bad taxation law. If a United States had a simple and satisfactory prosaic tax, there would be no double taxation of income that is saved and invested. As such, a IRS wouldn’t have any reason to caring either Americans had bank accounts and/or [...]
[...] and portfolios are expanding at 15 percent, the tax rate is still 20 percent. And keep in mind all the other layers of tax that would still exist, so the effective marginal tax rate will still be [...]
[...] As illustrated by this chart, double taxation is a serious self-inflicted barrier to American growth and competitiveness. Too bad Republicans are too short-sighted to address this issue intelligently. Rate this: Share this:PrintEmailFacebookTwitterMoredeliciousDiggFarkLinkedInRedditStumbleUponLike this:LikeBe the first to like this post. [...]
[...] As illustrated by this chart, double taxation is a serious self-inflicted barrier to American growth and competitiveness. Too bad Republicans are too short-sighted to address this issue intelligently. Advertisement GA_googleAddAttr("AdOpt", "1"); GA_googleAddAttr("Origin", "other"); GA_googleAddAttr("theme_bg", "fafcff"); GA_googleAddAttr("theme_border", "f0f1f3"); GA_googleAddAttr("theme_text", "2a2a2a"); GA_googleAddAttr("theme_link", "c0090e"); GA_googleAddAttr("theme_url", "808080"); GA_googleAddAttr("LangId", "1"); GA_googleAddAttr("Autotag", "politics"); GA_googleAddAttr("Autotag", "business"); GA_googleAddAttr("Autotag", "money"); GA_googleFillSlot("wpcom_sharethrough"); Rate this: Share this:EmailPrintFacebookTwitterMoreDiggStumbleUponReddit [...]
[...] Here’s the double taxation chart. [...]
[...] But my job is to do the right thing and bring truth to the economic heathens, so I said yes. And I’m glad I did, because it gave me a chance to try out a new argument that I hope will educate more people about the perverse impact of double taxation. [...]
[...] But my job is to do the right thing and bring truth to the economic heathens, so I agreed to participate. And I’m glad I did, because it gave me a chance to try out a new argument that I hope will educate more people about the perverse impact of double taxation. [...]
[...] which exists when the government cycles some income through the tax code more than one time. As this chart illustrates, this means a much higher tax burden on income that is saved and [...]
[...] which exists when the government cycles some income through the tax code more than one time. As this chart illustrates, this means a much higher tax burden on income that is saved and [...]