Double Taxation, Warren Buffett and Mitt Romney’s tax rates

According to information taken from www.huffingtonpost.com, it was reported that Buffet made about $63 million and his taxable income was about $40 million in 2010—all 2 figures rounded up to million.

And according to Reuters, Buffet paid about 6.9 million in Federal income taxes—an effective rate of about 17.4%.  This is probably due to most of his income came from either qualified dividend payout or long-term capital gains which are both taxed at a rate of about 15%. No one knows for sure since his returns were not made public even though he was challenged to release them.

Similarly, Mitt Romney’s tax return showed that he paid an effective tax rate of 13.9% in 2010 and estimated rate of 15.4% in 2011. We know that Romney’s income came from investments—none came from salary compensation. He would pay 15% on qualified dividends and long-term capital gains. His effective rate was lower than 15% because he donated millions to charities which lowered his taxable income.

What are dividends? And why do they consider taxing dividend a double taxation of income?

When a company makes a profit, it will need to pay a corporate tax on this profit amount. After that, it can choose to retain all or part of the remaining profit to grow its business. It can also distribute all or part of the remaining profit to its shareowners in the form of dividend payout. Shareowners then will need to pay tax on these dividend payouts when they file their annual tax return. Therefore, taxes are collected twice on dividends, hence the theory of double taxation.

So just how much investors like Warren Buffett and Mitt Romney paid on their dividend income? Let’s work out an example.

Example: John Doe and Mike Doe each invested $2 billion in XYZ Corporation. XYZ generated revenue of $400 million, and a gross profit of $200 million.  Its earnings before taxes were $100 mil, after deduction of expenses.

Let’s look at XYZ’s simplified income statement:

XYZ Corporation  

(in thousands)

Revenue  

400,000.00

Cost of Revenue  

-200,000.00

Gross Profit  

200,000.00

Operating Expenses

 

-50,000.00

Operating Income  

150,000.00

All Other Expenses

 

-50,000.00

Earnings Before Taxes (1)

 

     100,000.00

Corporate Income Tax Expense (20%) (2)  

-20,000.00

Net Income

 

80,000.00

Notes:  (1) This amount 100 million are earnings for the owners (shareowners)

               (2) So when this is taxed 20% corporate tax, this is the first tax placed on the owners’ money

(I used 20% corporate tax rate in this example for ease of calculations. This rate is quite low. For 2011, Wal-mart paid corporate tax of 32% as an example.)

XYZ distributed the whole net income of $40 million to each of its owners in the form of dividend.

When John Doe filed his personal income tax return, he paid another 15% on his dividend income of $40 million, i.e. paying a tax amount of $6 million. This is in effect the second tax placed on the John Doe’s money—the first is on notes item (2) above.

John Doe’s total effective taxes paid: 

$10 mill (1/2 of $20 mil corporate tax) + $6 mil (individual tax) = $16 mil

John Doe’s real tax rate: 

$16 mil/$50 mil = 32%

Effectively, billionaire John Doe did not pay just 15% on his total earnings from his investment. Rather, John Doe paid a real tax rate of $32%.

Thus, Warren Buffet did not just pay tax rate of 17.4%.  Neither did Mitt Romney just pay 13.9%. They both paid much higher rates.

On May 28, 2003 President George W. Bush signed into law the Jobs and Growth Tax Relief Reconciliation Act of 2003 that was passed by Congress. Under this new law, qualified dividends are taxed at the lower rate of 15% for most individual taxpayers. This was set to expire on December 31, 2008. However, the Tax Increase Prevention and Reconciliation Act of 2005 extended it to the end of 2010. On Dec 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 to extend the rate of 15% on dividend for two additional years. At this time, he still had control of both the Senate and the House of Representatives, so he could raise the rate if he chose to.

Why didn’t President Obama raise the tax on dividend? Most economists believe that raising the tax on dividend will discourage capital investments, and in turn would hurt the economy. Perhaps, President Obama knew and agreed with it.

Why is the talk about raising taxes on rich people like Buffett now? It’s really just his propaganda in an election year. He knew that it would not be passed by Congress.

Want tax change? Why not exclude dividend payouts from being taxed at the corporate level, but instead tax them fully as individual’s income tax rate—this in effect will remove the double taxation and makes it fairer to everyone.

Ch3 Nguyen

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s