Fred Foldvary wrote: > If there are zero taxes on corporate profits, but taxes on dividends, then the incentive is to retain earnings rather than pay dividends, and the shareholders get the profits tax-free until the shares are sold for capital gains. The shares might never be sold, but passed on to heirs. > > For tax fairness, given the income tax, all income should be taxed equally, and for efficiency, the tax system should minimize the impact on decisions. > So it is better to tax corporate profits and then credit that against tax liabilities of dividend income. To achieve neutrality, unrealized gains should be taxed annually, and then we can forget about capital gains. > > That being said, the income tax is inherently unjust, complex, and > burdensome, but that is another story.
I disagree (not with your last point of course ˇV and it is partly because I agree with you on this point, I disagree with you on the rest) Below is an extract (rather lengthy, sorry) from my publication "Simpler Taxes - A guide to the simplification of the british tax system" (the whole publication may be downloaded free of charge here: http://www.adamsmith.org/policy/publications/pdf-files/simpler- taxes.pdf) ˇ§The first problem when taxing personal income is determining what it is, most importantly distinguishing it from capital gains. Some will find such a distinction impossible and even unwanted, believing that any capital gain should be taxed as income. To those it could be argued that: „h There is a big difference between income and capital gains, and „h While the former is easily identified and taxed, the latter is not. The difference between income and capital gains is, in theory, clear enough: an income is a certain payment at a certain date, subject to a formal or informal contract, while a capital gain is uncertain and not guaranteed to be positive. Thus work wages or interests on bank deposits are clearly incomes, while increases in house prices or shares are clearly capital gains. The former are certain and guarantied by contracts, while the latter are uncertain and could just as well be negative. Dr. Barry Bracewell-Milnes described the difference thus : ˇ§It is rather like the difference between night and day. Certainly there is a dusky time in the evening where it is difficult to say confidently whether night has fallen or not. But at most moments within any 24-hour period, everyone is perfectly well aware whether it is night or dayˇK If the otherwise insignificant boundary becomes important in some context, then we set an arbitrary cut-off point ˇV as we do with ˇ§lighting up timeˇ¨, a convention to prevent people driving unsafely while the night is still deepeningˇ¨ But what about these borderline cases? Clearly the problem of separating income from capital gains, and the possibility of transforming the first to the latter, have been the main driving forces behind treating capital gains as personal incomes subject to taxation. The problem overlooked by those who find the border between the two hard to police is, however, that the inclusion of capital gains as an income opens up a host of other boundaries to be policed. To what extent should capital losses be deductible, if at all? Should all capital losses in oneˇ¦s entire lifetime be deductible from any capital gains, or only those from within the same year as any gains? What about inflation in that period? To what extent should running investments in physical capital, or the opposite as the case might be, be included in calculations of capital gains? If a house is sold after 20 years of decay for the same price as it was bought, indexed for inflation, then surely some capital gain must have been materialised along the way by the owner. Should this gain be taxed? How is it calculated? If the same house is sold for twice the original price after being vigorously kept and refurbished, should this investment not be deductible? What if the bottom has gone out of the housing market and the house, despite investments, is still only worth the original price? Should the investments still be deductible? The list of questions is never-ending, and I shall not attempt to answer any of them. Neither shall I attempt to answer the other question faced when including capital gains as taxable incomes: which capital gains should be taxed and which should not. If policing the boundary between income and capital gains is difficult, this new boundary is even more so. As interns or trainees, many young people work for low wages in the anticipation that their value as workers will rise from the experience, and other young people spend years in universities hoping the same. Clearly these increases in ˇ§personalˇ¨ values are capital gains, but neither are taxed. Only the part of personal values actually materialised as income (if any) is being taxed. The capital gain itself is not, and trainees and interns are free to leave the country with it ˇV even students are free to leave with the capital gains from an education largely paid for by other taxpayers. Only if they choose to stay and earn an income from their gains will they be taxed ˇV on their incomes. The same clear and logical distinction is easily applied to other capital gains. In fact, most capital investments can be compared with the above examples, where young people choose between materialising some of their future value now, as trainees, or risking it all for an even higher value in the future, as students. Likewise with bonds and shares where you can have little or none of any gains materialised as dividend or interest, and the rest as a possible capital gain . Here again we see the clear distinction between the certainty of income and the uncertainty of gains. The first should be taxed, the latter not. Jacob Braestrup Danish Taxpayers association
