15 December 2012

Comments from the MMM Forums Part 4: Invesment Income Taxes

Part 4 (part 1 was here)...This thread was not intended to be political at all.  But of course someone had to turn it that way.
Someone, meaning me…

By Guitarguy:
Did anyone's eyes pop out of their head when...
Romney said he'd completely get rid of all capital gains taxes for people earning less than $200,000 a year off of dividends ect... in the debate tonight? Is that really possible? And how does that affect a mustachian's situation of retirement?

By Bakari:

Re: Did anyone's eyes pop out of their head when...
« Reply #9 on: October 17, 2012, 05:49:14 PM »
Does anyone else see something morally wrong with taxing earned income at a higher rate than unearned income?

Set aside the personal benefit we are all looking forward to, once we can afford to live off passive income.

From a strictly objective viewpoint:
person A spends 40 hours or more (plus commute time) a week going to a job and working hard.  On top of the direct value their labor provides to society as a whole, they also contribute a percentage of the income they earn towards the general good in the form of taxes.

meanwhile, person B simply sits around at home (or travels, or has a hobby, or whatever, doesn't matter) and has positive income flow for no other reason than they had money to begin with.  Maybe they worked hard in the past and saved up, or maybe they inherited it, or maybe they laundered it after a crime, doesn't matter, point is they are not working hard now, and for that they are rewarded with not having to contribute to society.

Is there really any rationalization that makes this seem fair or reasonable?

Yes, I understand that investing can spur economic growth, I'm not arguing against the concept of capitalism, but actually doing work is much more vital than letting people borrow your money.  Simple thought experiment if there is any doubt:  imagine what a society would look like with all laborers and no investors.  Now imagine a society with all investors and no laborers.  We need people to do actual work.  We do not need investors. 

Furthermore, anyone who has enough capital to have a significant amount of passive income is obviously not hurting for money.  There are those who think progressive taxes aren't fair, and argue for a flat rate, but taxing earned income but not unearned is regressive, and I don't think any argument can be made for that.

What I really have trouble understanding is why enough of the middle class thinks this would be a good thing for Romney to be promoting it in public as a tactic to get elected: "I want to lower the taxes the rich pay, so that a few years from now you can make up the difference".  This resonates with the people?

By Bakari:

Quote from MooreBonds on October 17, 2012, 06:23:27 PM
2) Having said #1, you do have to keep in mind one important, critical fact: dividends issued by US companies have already been taxed before they were distributed to shareholders!!! Does it bother you that a company has a net income of $1, then pays (perhaps) 35%-40% in federal/state/local income taxes, leaving $.60, and then distributes $.20 of that $.60 to its owners....and that $.20 is then turned around and taxed yet again!

The concept of "double taxation" makes no sense.

Say I go to work, earn a dollar, and pay a dime of it in taxes.  Then I go out and hire someone to do a service for me, pay them with my dollar, and now he pays income tax.  Now he goes out and buys something... etc etc
The "same dollar" has been taxed 3 times!
But each individual has only been taxed once.

The corporation and the individual shareholder are not interchangeable entities.  Me having stock in PepsiCo does not make me PepsiCo, nor make PepsiCo me.  A corporation is considered its own legal entity, with its own rights and responsibilities, and as such, it pays taxes on its income.  The shareholder is paying taxes on their own income.  Totally independent transaction, for which any previous transactions are totally irrelevant. 

By Bakari:

Re: Did anyone's eyes pop out of their head when...
« Reply #13 on: October 17, 2012, 09:00:47 PM »
^The difference is you own a share of the corporation paying you a dividend. In your example the employee does not own a share of your company. The analogy is invalid.

What employee?  There is no employee is my analogy.  You hire a contractor or a masseuse or whatever, that doesn't make them your employee.  As I said, owning a share of a company does not make you interchangeable with the company.  The corporation is taxed.  That is one thing.  Whether that corporation pays 100%, 5% or 0% of their profits to you in dividends is entirely up to them.  Some corporations pay no dividends at all.  This does not change the corporate tax rate.  If they decide to give you some of their profit in the form of dividends, that is income for you.  So you should pay income tax on it.   

By Bakari:

Re: Did anyone's eyes pop out of their head when...
« Reply #21 on: October 18, 2012, 10:51:20 AM »
If, however, Bakari hands a masseuse $20 and says "give me a full Swedish Massage", then he is exchanging his $20 for a good or service. This exchange/trading between 2 people for goods and services is commerce, and is what creates a taxable event.
I'm not sure where you got the idea that only commerce can be taxed.
Alimony, found property, gambling income, prizes, awards, rewards, scholarships above the cost of tuition, unemployment, welfare, all count as income, even though they are not commerce, and all get taxed.

Most importantly to this example: if my friend deposits that $20 gift, and earns interest on it, that interest IS taxable.

In your example I buy $20 in stock for Pepsi.  (Ignoring for the moment capital gains and losses) that's what I own.  The $20 worth of shares.  If I withdraw those shares, then yes, this is just a transfer, not income.  And as such, it isn't taxed.  However the $60 in profit does not come out of my original $20 in shares that I bought.  Being paid a dividend does not reduce the amount of shares you hold, nor the value of them.  This is additional income.
If you have $100,000 and put it in the bank, and get $1,000 in interest, you can't say "its not fair that I have to include that $1000 as taxable income, because I already paid income tax when I earned the 100k".  This isn't that money.  This is new income.
because Pepsico is merely a representation for the sake of convenience and a limit of liability; a system of ownership and limitation of liability that has been one of the cornerstone foundations of capitalism.
yes, and that is an ENORMOUS difference that you are glossing over.  As a shareholder you get that convenience and limit of liability.  If what you want is a partnership, than you file as an S corporation.  Then the companies profits are your directly as a shareholder.  That also means that you are personally responsible for the companies losses.  Which means you can lose more than what you put it, if the company suffers loses.
If you want to invest in an S corporation, go right ahead.  If you want to limit your liability to the amount you paid in capital, then the C corporation becomes its own legal individual, and as an individual, it has to pay its taxes on its income.
If at some point you choose to withdraw your own shares, you get what you put in tax free, as that is just a transaction.  If you take out more than you put in (which includes dividends), then you pay taxes on your income.
If Bakari owned all of the shares of Pepsico, he could walk up to the bank teller where Pepsico's account is at, and tell the bank teller to hand over the $60, just like I could walk into the bank where Pizzas-R-Us has its checking account, and instruct the teller to hand over the pizza company's $60.
if one person owns the entire company, then it is a sole proprietorship.  However, if a sole proprietor chooses to incorporate in order to limit their liability, then the same situation is true - the corporation is its own individual, and as such pays its own taxes.  The owner gets what's left over, and if that includes income, then that is income, not a transfer.
A dividend paid out by a company to the shareholders is merely taking money out of the bank and transferring it to another account. The same people owned the same $ before the transfer as after the transfer. There is no exchanging of goods or services when companies pay dividends.
no, you did not own the dividend any more than you own the interest a bank will give you in the future if you leave your money in.  All you own is your shares.  The bank does not have to pay you interest, and the company does not have to pay you dividends.  Some don't.
Can you explain again why Bakari the individual should be allowed to keep the $60 Berkshire Hathaway profit that he owns 100% of.....but if there are many shareholders of Berkshire Hathaway, they must pay additional money to the government, even though no goods or services or transfer of legal ownership has occurred? Or do you offer a different definition of commerce, and what constitutes a taxable event?

Basically, buying shares does not make you the company.  That's why its different.  You are not entitled to the company's profit, just like you aren't obligated to pay its debts.  If you own your own business you are.  As an individual, whatever money you take in is income.  Whether that money was taxed before you got it has no bearing on whether or not it is income for you.

It sounds like your implied reasoning is: "if the corporation hadn't been taxed, I would have gotten all $100 in dividends" but that is flawed reasoning.  Maybe the rest would have gone to higher employee wages, or lower product prices, or increased internal infrastructure.  The employee could say "I shouldn't have to pay any income tax, because my employer was already taxed, and that money would have been mine".  Maybe.  Probably not.  Then the employee's landlord says "I shouldn't have to pay tax on the rent I get, cause the employee would be able to afford higher rent if the company didn't pay taxes and passed that money on to him".

That $100 profit was never yours as a shareholder.  The corporation chooses to give shareholders dividends as an incentive to let it borrow their money.  Its almost like points on a loan.  It is a commerce transaction, a payment for a loan.  Although, like I said in the first sentence, commerce is not actually a prerequisite for taxation.

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