The Perils of Double Taxation

We Americans believe we are overtaxed, as a Rasmussen poll revealed, as we focus on the accretion of direct taxes on income, payroll, products and services, and property.

Intimations of new taxes, like the value added tax (VAT), portend government’s scrambling to find ways to access a citizen’s wealth and income to fund its huge deficits.

It is the obscure double tax, though, that is insidiously harmful to the economy.

Adam Smith anticipated overreaching by government and proposed four maxims for equitable taxation in Wealth of Nations: 1) proportionality to income, 2) “certain, not arbitrary … clear and plain,” 3) “levied at the time, or in the manner … convenient for the contributor,” 4) “contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.” 

John Stuart Mill built on these in 1848 in Principles of Political Economy and added his argument against the progressive or redistributive tax: “To tax the larger incomes at a higher percentage than the smaller is to lay a tax on industry and economy; to impose a penalty on people for having worked harder and saved more than their neighbours.”

Perhaps Mill’s most significant contribution was his analysis demonstrating that tax should be imposed on only the interest on savings, and not the savings itself, in order to prevent double taxation of principal and an erosion of productive investment. 


Adopting Smith, the American Institute of Certified Public Accountants (AICPA) published A Framework for Evaluating Tax Proposals in 2001 adding six more maxims, including tax neutrality—a tax should influence neither behavior nor decision, and a “tax system should not impede or reduce the productive capacity of the economy.” 

A stand against double taxation on principle, therefore, derived from the Smith, Mill, and latter-day maxims, would yield enormous economic as well as political benefit.

It may be challenging, for example, to object to the VAT on the grounds that it expands government and thus reduces productive capacity or to object to the corporate tax on the basis that it violates the neutrality principle by favoring debt over equity financing.

Both arguments are impeccably valid, but perhaps not viscerally appealing to most. On the other hand, opposition to giving government the same dollar twice appeals for purely philosophical reasons.

A young family can then easily understand that paying VAT on purchases of diapers with after-tax dollars, or a paying a tax on dividends from their company after it first paid a tax on their share of profits, reduces baby’s college savings in grossly unfair ways. 

Standing against double taxation as a core principle would vitiate the argument that the VAT is a consumption tax and encourages saving. This logic would have merit were the VAT to replace all taxes on personal and business income permanently. That is the foundation of the “fair tax” recently proposed. Otherwise, as a supplemental tax, the VAT is simply double taxation and leaves less disposal income for savings.

Simply reducing the rates of taxation on dividends and capital gains, or on corporate income perpetuates double taxation although each would spur growth. Abolishing one or the other tax, however, would end double taxation and accelerate capital formation. Economists, conservative and liberal, have come out against the corporate tax because it also is ultimately paid by employees, consumers, or shareholders, and because it distorts capital markets by allowing a deduction for debt but a tax on capital. 

Milton Friedman first proposed “integrating” all business profit with shareholder income and taxing it once only at a flat rate. Thirty years later, the Treasury Department published a comprehensive study on this matter in Integration of the Individual and Corporate Tax Systems: Taxing Business Income Once, January 1992.  The mechanics are in place.

There are other supply-side arguments against the corporate tax. The top U.S. statutory rate of 35% is highest among OECD members, making American companies uncompetitive and encouraging flight of capital from our shores.

In a 2006 congressional testimony, David Walker, Comptroller General of the United States, observed, “The design of the current system of business taxation causes economic inefficiency and is complex. The complexity provides fertile ground for noncompliance and raises equity concerns.” Two years later, the GAO found that over 60% of U.S. and foreign corporations avoid paying income tax.

Standing against double taxation in all forms bolsters arguments for fairness, neutrality, economic growth, and transparency. It also recalls Mill’s warning, “Over-taxation, carried to a sufficient extent, is quite capable of ruining the most industrious community, especially when it is in any degree arbitrary, so that the payer is never certain how much or how little he shall be allowed to keep; or when it is so laid on as to render industry and economy a bad calculation.”

Cartoon courtesy of Brett Noel