Double Taxation

Double taxation refers to situations in which the same financial assets or earnings are subject to taxation at two different levels. For instance, one form of double taxation occurs when income from foreign investments is taxed both by the country in which it is earned and by the country in which the investor resides. To prevent this type of double taxation, many double taxation treaties currently exist between countries that allow income recipients to offset the tax [Page 618]already paid on investment income in another country against their tax liability in their country of residence.

Another example of double taxation can occur with regard to the taxation of corporate earnings. This happens when corporate earnings are taxed at both the corporate level and again at the level of shareholder dividends. That is, the earnings of a corporation are first taxed as corporate income and then, when that income has been distributed to the shareholders of the corporation in the form of dividends, these earnings are taxed as the personal income of the shareholders. Since the shareholders are the owners of the corporation, they are effectively paying taxes twice on the same income, once as the owners and again as part of their personal income tax. In the United States, this type of taxation is widespread, because the tax on corporate profits and the personal dividend income tax are federal, and thus universal, taxes. Many states have personal income taxes that include the taxation of dividends as well.

This latter form of double taxation is particularly contentious and has been the subject of much debate, particularly in the United States where recent efforts to reduce or eliminate this form of double taxation have been widely disputed. Opponents of double taxation on corporate earnings contend that the practice is both unfair and inefficient. They claim that the practice is inherently unfair in treating this type of corporate income differently than other forms of income in subjecting it to taxation twice. Opponents also claim that the practice engenders economic inefficiency since it encourages companies to finance themselves with debt, which is tax deductible, and to retain profits rather than pass them on to investors. Opponents also argue that the elimination of dividend taxes would stimulate the economy by encouraging individual investment in corporations.

On the other hand, proponents argue that the economic effects of reducing or eliminating double taxation of this form are overstated and that such cuts would only benefit the wealthiest persons, whose earnings are substantially constituted by dividend income. Here, for example, proponents argue that eliminating dividend taxation could actually stifle capital reinvestment and thus discourage economic growth. Some proponents also question whether the taxation of dividends truly constitutes a form of double taxation. In this regard, they argue that there is a legal and conceptual distinction between a corporation and its shareholders because the former, as a unique legal entity, has rights, privileges, and obligations that are distinct from those of the latter. As such, they argue that there is nothing unfair in taxing the income of the corporation distinctly from the personal income of its shareholders.

...