Taxes, government dependency and happiness

Two interesting things rolled across my desk today, interesting because they address the same topic — dependence on Big Government — but reach diametrically opposite conclusions.  The first is a Dennis Prager column that examines why American conservatives are happier than American liberals.  This isn’t just Dennis’ opinion, by the way.  Instead, several recent polls have shown that, on the whole, conservatives are happier people.

Dennis opines that the matter essentially boils down to a few key differences in outlook.  One is a sense of victimhood.  In America, those who turn to the government for succor are those who feel betrayed by the American system, whether because they’re blacks invested in the notion of racism, or people of any color feeling that they haven’t succeeded in the American system as they deserved.  Another is the notion of utopianism.  Liberals believe in perfectibility, and are constantly disappointed; conservatives recognize flaws, and are always thrilled to live in the society that best harnesses negative human traits and gives the most rein to positive traits.  Conservatives are also more generous — they give their money away to causes, rather than waiting for the government to take it.  That affects how they feel about their own contributions to societal good.

The other article that came to me, via a very Progressive facebook friend, is one by Thom Hartmann that argues in favor of huge taxes on the rich, with the assurance that, in Denmark, people are happy because they pay such high taxes, with the rich taking the greatest hit, but not feeling it, while everyone else gets cheap, high-quality government services.  It’s a very sophisticated argument, and often a correct one, about the differing effect taxes have on the rich and the poor.

As I understand it, Hartmann argument boils down to this.  The rich earn far more than they can ever spend.  This means that taxes affect only their non-discretionary income, not their discretionary income.  If they’re taxed more, they might save less, but it won’t affect the money they spend annually on both life’s necessities and its reasonable frivolities.  The non-rich, however, spend everything they earn after taxes.  If taxes are raised, they have less after-tax money to spend, which hurts them.  BUT (and this is the kicker), Hartmann contends that, invariably, the market adjusts so that, after a few years, the non-rich end up getting from their employers precisely the same amount in adjusted dollars to bring them to spending parity with their situation before the tax increase.

This means, says Hartmann that, if top marginal tax rates are increased, only the rich will suffer.  Everyone else will remain the same, except that the government will have hugely greater number of dollars at its disposal for free health care and education. Further, the less money the rich people have to throw around, the more stable the economy is, because it prevents bubbles.  This means that there is no great wealth creation, but there are no collapses either.

A large chunk of the article is concerned with trying to figure out why non-rich people are so stupid that they don’t want to tax the rich at a higher rate, considering that, in the long run, higher rates will leave non-rich people with pretty much the same amount of disposable income.  Scaife comes into all of this, of course, as does the Heritage Foundation, William Kristol, and the usual conservative suspects. I found that part of the article uninteresting.  When Hartmann got back to substance, he started making thought-provoking points again.

Thus, Hartmann asserts that, if you increase tax rates, government actually shrinks, which is what sensible conservatives should want.  I can’t summarize the argument adequately, so let me quote it here:

From 1985 until 2008, William A. Niskanen was the chairman of the Cato Institute, a libertarian think tank, and before 1985 he was chairman of Reagan’s Council of Economic Advisers and a key architect of Reaganomics. He figured out something that would explode Reagan’s head if he were still around. Looking at the 24-year period from 1981 to 2005, when the great experiment of cutting taxes (Reagan) then raising them (Bush Sr. and Clinton) then cutting them again (Bush Jr.) played out, Niskanen saw a clear trend: when taxes go up, government shrinks, and when taxes go down, government gets bigger.

Consider this: You have a clothing store and you offer a “50 percent off” sale on everything in the store. What happens? Sales go up. Do it for a few years and you’ll even need to hire more workers and move into a larger store because sales will continue to rise if you’re selling below cost. “But won’t the store go broke?” you may ask. Not if it’s able to borrow unlimited amounts of money and never—or at least not for 20 years or more—pay it back.

That’s what happens when we have unfunded tax cuts. Taxpayers get government services—from parks and schools to corporate welfare and crop subsidy payments—at a lower cost than they did before the tax cuts. And, like with anything else, lower cost translates into more demand.

This is why when Reagan cut taxes massively in the 1980s, he almost doubled the size of government: there was more demand for that “cheap government” because nobody was paying for it. And, of course, he ran up a massive debt in the process, but that was invisible because the Republican strategy, called “two Santa Clauses,” is to run up government debt when in office and spend the money to make the economy seem good, and then to scream about the debt and the deficit when Democrats come into office. So while Reagan and W were exploding our debt, there wasn’t a peep from the right or in the media; as soon as a Democrat was elected (Clinton and Obama), both the right-wingers and the corporate media became hysterical about the debt.

And when Clinton raised taxes so that people actually started paying the true cost of government (a balanced budget as in the years 1999 and 2000), they concluded that they didn’t need as many services, so government actually shrank—in terms of both cost and the number of federal employees.

As a non-economist, I have to admit that what Hartmann says makes a certain amount of superficial sense.  I suspect, though, that there’s more to it.  For example, Laffer’s curve may be involved.  That says that lower tax rates create greater wealth, which actually increases government revenue.  With greater government revenue, profligate politicians and greedy citizens have more to play with. The problem, then, isn’t the tax structure; it’s the boondoggles, and earmarks, and “other people’s money” syndrome that inevitably plagues an organization that lacks fiscal discipline.

My core problem with Hartmann’s whole premise, though, is that it works because his allusion to Denmark shows that what he really wants is a world in which the government is responsible for all income that’s not dedicated to life’s necessities.  Under the current American system, that “excess” money that the “rich” have floating around — the money that Hartmann thinks the government should take and redistribute — is money that goes to banks that lend it to future homeowners and entrepreneurs; it goes into businesses that hire people; and it goes into funding innovation that improves people’s lives.

Having wealth circulate in the marketplace increases the risks of a slap happy economy, but it also vastly increases the possibilities of life improvement.  It increases innovation and, yes, greed, which is a powerful motivator.  In the Scandinavian countries, which until recently had stunningly homogeneous populations, no defense budgets, and no sense of obligation to the rest of the world (which we, in the U.S., heavily fund), it’s easy to have a tight little loop of shiny, clean, teeny houses; lean, mean Danish modern furniture; health care for that homogeneous population; and an almost zero track record on innovations that improve life for most of the world’s population.

Hartmann envisions a world in which everyone is happy with a brightly colored Danish modern version of very little.  Hartmann also fails to take into account dynamic populations.  The Scandinavian countries worked so well for so long because they were populated by people with precisely the same values and precisely the same life habits, habits that happened to be particularly neat and self-disciplined.  The tremors are starting, though, as these same countries struggle to deal with newcomers who have nothing in common with this nice, neat, egalitarian very white world view.  The welfare scams, violence, polygamy, cultural incest, etc., that the Muslim populations are bringing to Denmark and Sweden, and other northern countries, are all going to place a very interesting burden on these happy little taxpayers who could always rely on each other for homogeneity and on Papa America for world stability.

Before being quite so smug, places such as Sweden and Denmark might want to cast a jaundiced eye on Holland and Britain and France, all of which started with less homogeneous populations than the northern countries; all of which have had a head start on the challenging task of incorporating Muslims into their closed world views; and two of which (Britain and France) actually had to set aside defense budgets.  Hartmann, too, might want to consider that America is Holland, Britain, France, etc., on speed when it comes to population diversity; constant immigration; and defense spending upon which the entire Western world has relied since 1942.

At bottom, I’d rather be a happy American iconoclast, living with a fairly low level of risk (heck, we’re not yet Argentina, Greece or Ireland) and wedded to the infinite possibilities of a dynamic economy that trusts the innovation and drive individuals, rather than coping with a government’s overarching static, inefficient bureaucracy.  I’d also rather be in a surging country that, better than any place in the world, incorporates incomers, even illegal ones, as opposed to a country that is, for the first time, has to deal with profound outsider disruptions to its cozy little system.  I’m happy here.  Not droned, not pacified, not opiated, but happy.

Cross-posted at Right Wing News

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  • Charles Martel

    Following Hartmann’s logic, I’m assuming that the high taxation levels in Denmark have led to a marked decrease in the size of the Danish government?

  • Ymarsakar

    What fools these mortals be.

  • David Foster

    I question the validity of happiness studies across cultures and especially across languages. Does the Danish word for “happiness” connote precisely the same meaning as the English word?

  • Ymarsakar

    Whether words have different connotations when you change the language or not, is something beyond the understanding capacity of the Left.


    I don’t want to be compared to Denmark, a danish pastry maybe. And I certainly don’t want to climb rafters and steps to sleep, eat and all the other necessities of life.

  • Danny Lemieux

    Wow! There are so many false premises here that I don’t really think I can cover it all. Where to start fisking? Here are some highlights:
    “The rich earn far more than they can ever spend.  This means that taxes affect only their non-discretionary income, not their discretionary income. ” —

    This isn’t only about what the rich spend, but also what they invest. As you point out, Book, The “rich” and many of the rest of us don’t keep their “excess” income in their mattresses, but instead put it into productive capital, such as CDs, investments, savings, etc…all  of which help pump the economy.

    “Hartmann contends that, invariably, the market adjusts so that, after a few years, the non-rich end up getting from their employers precisely the same amount in adjusted dollars to bring them to spending parity with their situation before the tax increase.”  —

    This assumes that employers have the ability to raise their employees’ salaries to spending parity at will, as if they were immune to competitive pressures. Business doesn’t work like that – they can’t simply increase costs and stay competitive. Ridiculous.
    “Further, the less money the rich people have to throw around, the more stable the economy is, because it prevents bubbles.  This means that there is no great wealth creation, but there are no collapses either.” —

    Yes…and no job “bubble” creation, because ultimately it is wealth creation that creates jobs, not government paying people to dig holes with spoons just to stay busy (a Milton Friedman metaphor, by the way). There won’t be any collapses only because everything will already be collapsed.

    “This is why when Reagan cut taxes massively in the 1980s, he almost doubled the size of government: there was more demand for that “cheap government” because nobody was paying for it.” —

    Uh, no…actually, Reagan expanded government because of a) defense expansion and b) he had to agree to it in exchange for tax cuts. That was the quid pro quo to the Democrat-controlled Congress for the tax cuts. The author suggests that whenever demand for government services goes up, the supply goes up as if there were no budgets for these services. It doesn’t work that way in real life. Services are rationed because there are budgets. I am not aware that the cost of government services to the individual has any bearing on tax schedules: you either qualify or you don’t.

    So while Reagan and W were exploding our debt, there wasn’t a peep from the right or in the media”

    Huh? In what alternate universe was that?

    I would also like to point out that the Scandinavian countries are not only homogenous but tiny: the population of Sweden is about that of the greater Chicago area, that of Denmark is about that of the Philadelphia metro area. Thus, they can live well of an export economy…for a while. However, to use Sweden as an example, Sweden has lost its capital and its wealth ever since the 1970s, when it adopted exactly the economic model that Hartman extols. This is non-sustainable, as they (and Denmark) have discovered, which is why they have been reversing course (reducing corporate and individual taxes). Hartmann describes an idealized “Stateopian” vision of these Scandinavian countries that cannot bear up to facts. As you point out in this post, Book, he is blind to all the problems in these societies that he extols. This is classic Stateopian Liberal argument: use just enough facts to provide a veneer of respectability onto false constructs.

    Finally, one final point about “happiness”. Happiness comes with being free. You cannot be free if you are dependent, against your will, upon an authority figure for your livelihood. People aren’t happy if, like vegetables, all they can do is stand erect in the sun and absorb rays while watered and fed at the will of the farmer. Ask any teenager. The form of unhappiness that comes with dependency and lack of purpose in life is one that I have observed both among the idle rich and the dependent poor.

  • Danny Lemieux

    Sorry about that…don’t know why the fonts were so messed up in that last response.

  • Bookworm

    Who cares about the fonts, Danny?  You’re a genius!  (And I’ll see if I can clean them up a little too.)

  • BrianE

    You may not be an economist, BW, but neither is Thom Hartmann. If this is an example of what’s in the book he’s touting, it’s swiss cheese wrapped in limburger. It is so full of assumptions, conclusions not based on facts, opinions masquerading as facts, in fact, the only consistent fact is that it’s nearly fact free. As an aside, Hartmann’s credentials include a degree from Hominion Herbal College in C.H. (chartered herbalist, a Master of Herbology from Emerson College of Herbology and a PhD in Homeopathic Medicine from Brantridge (a diploma mill). I don’t hold that against him, though I wasn’t aware that a Masters in Herbology existed! As to the website Hartmann was touting his book on, it is charitably, left leaning. It has been characterized thusly: “In the end, is nothing but a pro-Communistic/Marxist, French-adoring, anti-U.S., Bush-hating virtual gripe fest for U.S. traitors.  Those who visit are able to fuel their overt hatred for Bush and this country with anti-American propaganda.” That might be  slightly hyperbolic and was written in 2003 when the smears of President Bush had become a cottage industry. While it’s probably true that a few super rich types sock their profits away in a Swiss bank account as Hartmann claims, most put their money to work, providing capital for businesses to expand. Tax those profits and you’ve merely reduced the available capital in the market. As to the notion that increasing taxes reduces the size of government, I draw the conclusion that an increased tax bite does lead to lower tax revenues over time, though that does run counter to research by Richard Vedder and Lowell Gallaway that found that for every new dollar of taxes led to more than a dollar of increased spending. The research has been refined such that since WWII through 2009, that each dollar of new tax revenue was associated with $1.17 of new spending. As with all dueling statistics, may the better statistic win. To the idea that a business could run a 50% of sale forever, as long as they weren’t required to repay the loan, Hartmann leaves out a small calculation that would lead to the ruin of any business attempting such a strategy– interest payments. And that is one of the elephants in the budget room. We are living in a period of artifically low interest rates, (one that is killing seniors on fixed incomes by the way) which masks the true cost of our profligate deficit spending over the last few years, monumentally increased by the durrent administration. From the NY Times:
    “With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.
    In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.” We can’t tax our way out of this dilemna and we can’t realistically cut the budget enough either. The only way out is growing the economy. And this means “drill, baby drill”.  We need to aggressively exploit all our natural resources (not just oil), roll back excessive regulations on business and launch an era of home-grown growth.

  • BrianE

    I do kind of agree with Hartmann on one thing. OK, I don’t agree with him on anything, but I do think we should raise the tax rate on capital gains, but continue the lower rate on dividends.

    If we’re going to abuse the economy with tax policy, it’s time we got off the artifical growth bandwagon. Dividends mostly represent real sustainable profits. That’s the kind of business growth I think we should encourage.

    And to the notion of exploiting resources, hasn’t the last 30 years seen new tigers of industry in large measure by turning sand into gold? Which kind of goes against Hartmann’s thesis that the jack-booted monopolistic forces of corporatism kept the small entrepeneur strangled under the watchful eye of the evil Reagan. Tell that to Steve Jobs or Bill Gates. 

  • suek
  • Danny Lemieux

    BrianE, if you increase the tax on capital gains, what does that do for the attractiveness of investing in corporate stocks (ergo, equity investments in business)? Stocks are valued higher than bonds (whether treasury or corporate) because they represent higher risk. Capital gains are the reward for taking that risk. Take away the reward, people will not invest in those risks anymore.
    For example, if the company goes bankrupt, the bondholders get paid-off before the stockholders (unless the Obama regime nationalizes a company and unilaterally and illegally wipes out the bondholders).
    The U.S. economy depends on people willing to invest in capital markets.

  • DeweyfromDetroit

    “In 1930, the Republican-controlled House of Representatives, in an effort to alleviate the effects of the… Anyone? Anyone?… the Great Depression, passed the… Anyone? Anyone? The tariff bill? The Hawley-Smoot Tariff Act? Which, anyone? Raised or lowered?… raised tariffs, in an effort to collect more revenue for the federal government. Did it work? Anyone? Anyone know the effects? It did not work, and the United States sank deeper into the Great Depression. Today we have a similar debate over this. Anyone know what this is? Class? Anyone? Anyone? Anyone seen this before? The Laffer Curve. Anyone know what this says? It says that at this point on the revenue curve, you will get exactly the same amount of revenue as at this point. This is very controversial. Does anyone know what Vice President Bush called this in 1980? Anyone? Something-d-o-o economics. “Voodoo” economics.”  Ferris Buehler’s Day Off

    What’s the difference between a Master of Herbology and a Kenysian economist? Anyone? Beuhler?

    I am so sick of this sophmoric tax argument which perenially re-emerges as “genius” economic insight every time another ill-informed liberal discovers Keynes. Beware the perils of the superficially rational mind. I wonder if there’s an herbal treatment for that? Besides medical marijuana I mean.

  • DeweyfromDetroit

    I forgot: thanks, Danny Lemieux, for doing all the heavy lifting. Great job on the take down.

  • BrianE

    I’m going to pull a Hartmann, and claim causation of two possibly unrelated though connected facts.
    The capital gains rate was 12.5% from 1923-33. Capital gains rates were 15% from 2003-2008. The two greatest market crashes occurred when capital gains were taxed at the lowest rates.  Does low capital gains tax rates cause market crashes?
    My goal would be to take the one-arm bandit effect out of the stock market. The small investor would be better served by companies that paid dividends with the somewhat lower volatility. I would lower dividends tax rate back to 15% and keep the capital gains rate at 20%, possibly with an exclusion for holding it for a time period.
    It’s my contention that brick and mortar companies were forced to skew their business models (more short term strategies) to keep stock price growth high as they chased the returns the tech stocks were getting for producing vaporware in many cases. This did not have a positive effect on the economy. Companies off-shored to boost profits to chase capital appreciation, IMO. I realize this is a rather simplistic view as there were many causes, but I believe this was important.
    The trader is still going to trade since losses offset gains anyway. But the stock market, at this point, bears very little resembelence to the economy at large.
    I would also limit programmed trading. My expertise comes from staying at a Holiday Inn though.
    In an ideal world we wouldn’t be trying to use tax policy to affect behavior, but the greed principal is an unfortunate force. We’ve seen too much irrational exuberance.

  • nahab

    “in Denmark, people are happy because they pay such high taxes, with the rich taking the greatest hit, but not feeling it, while everyone else gets cheap, high-quality government services” – Somehow I find myself questioning this statement. People are happy BECAUSE they pay high taxes?! I don’t believe anyone likes paying high taxes “for high quality government services”, even if only because it’s inevitable that the distribution of those services are never going to be equal. Some people are always going to be paying more and getting less (and not only the “rich”), while others pay less and get more. You can’t tell me that the Danish people are so altruistic that they never resent those who take in more than they pay, especially those who defraud the system. I also doubt the rich don’t feel it – everyone feels the loss of investment capital, even if they don’t know it.
    “invariably, the market adjusts so that, after a few years, the non-rich end up getting from their employers precisely the same amount in adjusted dollars to bring them to spending parity with their situation before the tax increase” – isn’t this just a form of government induced inflation? Assuming his premise is correct, the “non-rich” suffer until the market “adjusts”.. what happens then? Do we assume that tax rates of all sort remain the same, or will the “non-rich” have to suffer just a little bit more until we get to the NEW equilibrium?
    Maybe in America the “non-rich” are too stupid to tax the heck out of the rich because they know that the definition of “rich” is an ever changing thing. Maybe we know that history has shown us that tax revenues go up when we unleash those excess “riches” to be put to work, creating new industries, new jobs and new opportunities. Perhaps we are smart enough to realize that by taxing the rich, we are putting obstacles in our way to becoming rich, since it’s invariably primarily income we tax, not wealth. As a result we’re not hurting the mega-rich Warren Buffets the politicians hope we’re thinking of, but rather we’re hurting everyone who wants to be the NEXT Warren Buffet (and all those who might have worked for him/her too).
    Maybe we know that the very idea of decreeing when a person’s income is “excess” is unfair and immoral. Who decides who qualifies as rich and who doesn’t – and how often do they redefine rich? Why is it assumed that politicians are perfectly moral creatures with no self interest in their decisions?
    Besides, how is it moral to take more of one person’s private property than another (as a percentage of income say), simply because we decided too do so based on an arbitrary criteria (income level). Would it be any more or less moral to change the criteria? How about we tax blonds more than brunettes? Is that really much different? Wouldn’t taxing everyone at the same rate with no exceptions or exemptions be more equitable?

  • Ymarsakar

    Suek, the Dems are working hard to make wage slaves so that they can live the high life. After all, don’t Progs say that the government can create real jobs?
    Real jobs for slaves. Just like the pyramid scheme of the Pharaohs. A lot of jobs were created in building those pyramids, ya know.

  • Ymarsakar

    “Does low capital gains tax rates cause market crashes?”
    Correlation is not causation. Didn’t you get that in 101 statistics.

  • Danny Lemieux

    “What’s the difference between a Master of Herbology and a Kenysian economist?”
    Kenysian economist! Too funny! We are really outdoing ourselves in the pun department. See what you started, Sadie?

    Personally, I think the only fair tax is a flat tax. The rich and poor should all pay at the same rate, no exceptions.

  • suek

    >>It’s my contention that brick and mortar companies were forced to skew their business models (more short term strategies) to keep stock price growth high>>
    Maybe you can explain something to me…
    About 20 years ago, I bought a book by the name of “Heads You Win, Tails You Win” (did a quick search, couldn’t find it to link to) which was a book discussing buying stock.  One of the basic criteria was the price/earning numbers.  At that time, his recommendations were for stocks that had PE ratios of about 4/1.  2/1 was great and above 6/1 was a no-no.  Today I see PE ratios of 18-20/1 and higher.  Why such a massive jump?  Somewhere along the line, I think there was a tax change that penalized the companies in such a way as to making it undesirable to pay dividends so that the only way to increase the value of your stock holdings was to sell them and take a capital gains profit at a reduced tax level.  The result is going to be an increase in churning – buying and selling on the basis of short term gains (I consider the long term capital gains period of 12 months to actually be a short term, in the investment sense) instead of long term investment in companies.  This is also a benefit to the investment brokers, since it increases buying and selling frequency.
    Was that the goal?  to benefit the stock brokers?  or was there some other reason to penalize companies for paying dividends?  You’d think it would be to the government’s benefit – dividends are taxed as ordinary income…so why change the laws to favor the long term capital gains category?

  • suek
  • Danny Lemieux

    Be careful in looking at Price/Earnings ratios, as they can be very misleading. Broad-market P/E ratios reflect the demand that exists for stocks.
    During times of high economic growth or at times when bonds are considered to be bad investments (e.g., when interest rates are super low), demand for stocks goes up, which drives up the broad-market average P/E (demand forces people to bid-up the price they are willing to pay). When broad-market P/E ratios go too high, it is often a sign of an impending crash. Off the top of my head, I seem to remember that P/E ratios at the time of the Yr-2000 Tech Boom crash, broad market P/E ratios were in the high-20s.
    I looking at individual companies, though, it gets confusing. A very large company with a high P/E ratio may reflect that its stock price is over-valued and due a correction. However, a start-up company with near zero-earnings may have an impossibly high P/E ratio. Stock prices are forward-looking, in that the “P” component looks at projected earnings, not current earnings, even though it is measured against current earnings.
    For the record, I am NOT giving you financial advice.

  • suek

    I understand, Danny…
    But you’re simply commenting on the inflation of the prices – which is valid – but I’m asking more about the other half of the ratio … the earnings.  There are certainly lots of things that can affect the PE ration, but over all, what is the market _average_ PE ratio?  What I’m asking about is why it was so low – in the 4/1 area – in the 60s-70s, and so high now.  The _average_ – not a particular one.  You could be right – that earnings per share are about the same, and it’s just the price of the stock that’s all kaflooey – but if that’s correct, isn’t that revealing as well?
    There are two factors here – one is taxing policy, the other is the market – inflation or bubble pricing.  You have to wonder about the one, and be scared as all heck at the other, I think.
    By the way, another basic principle of the book’s recommendations was that you invest in companies that were involved in something you actually know something about so that you can evaluate the practices of the company, the finances and the officers.  That would theoretically mean that you’d have an inkling of whether the prices for the stock were unrealistic.  His recommendations were based on long term ownership in the company, not buying and selling.  He recommended that if that was your goal…Las Vegas was also an option.
    Very interesting book.  Very worthwhile as a guide – even if the numbers are no longer valid.  It doesn’t seem to be available online anywhere.  One of my sons have my copy – or I could at least give you an author!


    Anyone care to take a stab at this (figuratively speaking).

    St. Petersburg, Russia – China and Russia have decided to renounce the US dollar and resort to using their own currencies for bilateral trade, Premier Wen Jiabao and his Russian counterpart Vladimir Putin announced late on Tuesday.

  • BrianE

    Suek, I’m not sure I understand what you were driving at, but dividends do suffer a double tax bite.  Corporations pay the tax on earnings and then when they return a portion of that to the shareholder as a dividend, the shareholder has to pay income tax on the dividend. Dividends were taxed at the same rate as capital gains during some of the Bush years, which have reset, I believe. As to P/E ratios, here’s a chart of the market PE ratios for the last 100 years. PE ratios are a function of demand (speculation)– money entering the market will drive prices up. These artificially low interest rates are driving investors into the market and equity income stocks will help. I think it would be beneficial tax policy to end the double taxation of dividends (assuming the dividends are paid from retained earnings). As to churning, that is illegal.

  • BrianE

    Anyone know why all by paragraph breaks disappear when I post. I’m putting three carriage returns between paragraphs.

  • suek

    I have a tickling memory of some function of taxation that discourages _companies_ from paying out dividends.  Something about retained earnings…which has resulted in lower dividends paid out, and more companies buying other companies in order to put their retained earnings to work.
    I’m not sure exactly – I guess I hoped it would trigger someone else’s knowledge of the general topic.
    PS.  We don’t _do_ carriage returns any more!  But I hit enter twice to put a space between one paragraph and the next!

  • David Foster

    If a company makes a profit, that profit is taxed at the corporate tax rate–it will vary depending on a company’s individual circumstances, but typically is around 35%. When dividends are paid out of the profits, they are also taxable to the shareholder—at one time, they were taxed at the ordinary income rate, but at the moment are taxed at a maximum rate of 15%, which is the same as the capital gains rate. Unless something is done by Congress, the dividend tax rate is about to reset to the ordinary income rate, and the cap gains rate will increase to 20%. So profit made and paid out to a shareholder would be taxed once at 35% and then taxed again at up to 39% of what is left.
    Tax considerations aside, many corporate managements are reluctant to pay out too high a % of their profits in dividends because of natural human reluctance to give up control of anything and a sincere belief that their wisdom will allow them to reinvest the money better than their shareholders could. There is little evidence for the latter belief.

  • Danny Lemieux

    David Foster, in all fairness to the corporate financial managers: paying out a dividend rate also becomes part of the expected return of investors. Thus, it becomes very difficult for companies to reduce dividends except as a signal that they are in trouble. So, if a company hits a period with very tough cash flow issues, a dividend expectation or obligation can be awkward, to say the least.

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