Do Rich Folks Get a Tax Break on Dividends?

Over the past several years, I've heard a lot of demagoguery thrown around by liberal politicians regarding the tax rates that rich people pay.  A lot of it centers around the fact that most rich people don't receive their high annual income through wages.  Generally they are owners of a corporation or, at least, they own a lot of stock in a very large, public corporation, and their income is largely in the form of dividends from this stock.

This issue came to light during the presidential primaries when Mitt Romney made his tax return public and timidly pointed out that he paid a low tax rate on his income because it was almost all dividend income.  Then, President Obama used some comments from the famous rich guy, Warren Buffet, to fuel the flames.  Mr. Buffet had said that his secretary paid a bigger percentage of her income in taxes than him, and it wasn't fair.  After all, he is a billionaire, and she is a lowly secretary (that earns a six figure income, by the way).  I don't think this was stated quite as clearly as I have stated it here, because it almost sounded like she paid more tax dollars than her billionaire boss.  In reality, she was paying a higher percentage of her income in taxes.

Warren Buffet chose to take his income from the company he owns, Berkshire Hathaway, as dividends.  He could have accepted a much larger salary instead of dividends, but he didn't.  If Mr. Buffet really felt he wasn't paying enough taxes, why not just avoid taking advantage of the tax breaks that our elected officials offered him?  In fact, you can pay extra taxes if you are so inclined to help out America.  The IRS will accept tax donations any time.  As long as you pay at least what you owe according to the tax code, you can pay as much extra as you desire.

Now that I have that off of my chest, here's something else to consider.  Why do dividends get taxed at a lower rate than regular salary and wages?  I believe Congress chose to allow the lower rate, because the corporate earnings were already taxed at the corporate rate before paying out the dividends.  The dividends are then taxed again at the recipient's personal tax rate.  I also remember hearing a professor in an accounting or finance class mention that a corporation can reinvest the earnings in the business rather than paying a dividend, and this prevents having to pay the personal tax.  This encourages businesses to reinvest the earnings in the corporation rather than paying dividends.  The desired result is to create growth, new jobs, etc.  I'm not sure that government should be in the habit of telling corporations how to run their business, but that is a lot different than the spin our politicians have put on these tax rates.

So, would the federal government receive a lot less in tax revenues if the tax payer gets paid income in the form of dividends?  Since this subject is always brought up with regard to rich guys, let's assume we're talking about a tax payer in the top tax bracket.  Here's their federal income tax rate:

• Single Tax Payer with Annual Taxable Income Over $400,000:  39.6%
• Married Filing Jointly with Annual Taxable Income Over $450,000:  39.6%
• Married Filing Separately with Annual Taxable Income Over $225,000:  39.6%
• Head of Household with Annual Taxable Income Over $425,000:  39.6%
• For Federal Income Tax Brackets of 25% or higher
• Capital Gains are Taxed at 15%
• Qualified Dividends are Taxed at 15%

The federal tax rate for the traditional large "C" corporation ranges from 15% for companies with profits of $50,000 or less to 35% for the ones with profits above $18,333,333 annually.  That is an extremely high tax rate when you consider that the owners of the stock will also pay tax on the dividends they receive after the corporation already paid federal tax.  If the corporation is only in the 15% bracket, here is a calculation of how much tax would be paid on the earnings paid out as a dividend to the stockholder:

• $100 of Corporate Profit --> $100 x 15% = $15 of Federal Corporate Tax
• $100 - $15 = $85 Left Over to Pay as Dividend
• $85 x 15% = $12.75 of Federal Personal Income Tax on Dividend Income
• $85.00 - $12.75 = $72.25 of After Tax Income to Stock Holder
• Total Federal Tax Collected $15.00 + $12.75 = $27.75
• Total Tax Rate on The Profits = $27.75/$100 = 27.75%

Hey, that's a lot more than the 15% that president Obama and Warren Buffet are talking about.  What if the dividend is being paid by a corporation with a modest profit of $10,000,000.  (That would be modest compared to Warren Buffet's Berkshire Hathaway.)  These companies pay a 34% federal corporate tax.

• $100 of Corporate Profit --> $100 x 34% = $34 of Federal Corporate Tax
• $100 - $34 = $66 Left Over to Pay as Dividend
• $66 x 15% = $9.90 of Federal Personal Income Tax on Dividend Income
• $66.00 - $9.90 = $56.10 of After Tax Income to Stock Holder
• Total Federal Tax Collected $34.00 + $9.90 = $43.90
• Total Tax Rate on The Profits = $43.90/$100 = 43.90%

That's a lot more than 15% and even more than 39.6%.  Do you still think that rich guys don't pay high enough taxes?  Do you still believe that Warren Buffet's secretary pays a higher tax rate than he does?  By the way, do you think Warren Buffet's secretary pays more tax dollars than Warren Buffet?  You know, that discussion certainly made it sound as though she paid more tax dollars than Mr. Buffet.  I'm really sick of the politicians phrasing things to purposely blur the lines between taxes and tax rates.

This is a MessAPolitico where the politician's main goal is to confuse and mislead.  I'm waiting with baited breath for the next debt ceiling debate, and I fully expect the Democrats to again say that rich guys aren't paying their fair share of taxes.  I'm not a rich guy by any means, so don't think that I'm writing this to help out myself or my buddies.  I'm just trying to shed a little light on the realities and the MessAPolitico here.

If you happen to be wondering how it hurts those of us in the middle class or below, consider this.  When money is paid in taxes, whether by individuals or corporations, that money can't be spent on other stuff.  If a rich guy owns a corporation that pays a bunch of taxes, he can't spend it building new manufacturing facilities or buying machines or computers or whatever it takes to grow his business.  If regular consumers, rich or middle class or poor, have less money after paying taxes, they won't buy as many dinners at a restaurant, as many new cars, as many new houses, as many new chairs for the living room, etc.  That gives us fewer jobs making, delivering, or selling this stuff.

Do you still think that high tax rates for the rich are a great thing?  Is all of that government stuff really free?  No.  Will Obamacare make your medical care free of charge?  No.  Obama will tell you that he is getting the rich folks to pay for it on your behalf.  Don't believe it.  All of the income of all of the rich people in America won't pay for it.  You can look forward to becoming rich if Obama gets his way.  No, your income won't go up.  Everyone will either be rich enough to pay high taxes, or poor enough to get a free ride.  The middle class will disappear.

This is my prediction for the coming MessAPolitico if we don't stop it now.