Explaining the Perverse Impact of Double Taxation with a Chart

March 14, 2018 Addendum: Because of various changes in tax law, an updated version of the flowchart is attached at the end of this column.

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.

March 14, 2018 version of chart:

For a more detailed analysis of double taxation, click here.