>I understand why dividends aren't expensed. Can anyone >shed some light
>on why dividends are taxed in the first place?
>Just because they can?
Basically, because it's the easiest way to structure your tax system (a "classic" system). If you want to stop taxing dividends, then your proposal of treating them as a return of capital doesn't really work; for one thing it's theoretically unattractive, because dividends are the return earned on an investment, not part of the investment. And for another, it looks to me superficially as if your treatment would have massive potential for abuse; there are about a million and one clever things that it's possible to do if you can randomly shift things between capital gains and income, and a million more that you can do if you can shift a tax lliability indefinitely into the future. Finally, it discourages long term holdings; if you'd held your stock for twenty years, then you could quite possibly be in a position in which you were unable to ever sell it because the base had been lowered so far as to create a tax liability greater than the sale proceeds.
If you want to get rid of double taxation on a revenue-neutral basis (and it *is* double taxation; I don't think we do ourselves any favours by comparing it to wages --> sales tax. Dividends get taxed twice before they become income), then the way in which you do it is to move to an "imputation" system. Every time you get a dividend, it is counted as part of your taxable income, but with the dividend you get a tax credit reflecting the corporation tax that has already been paid on the earnings out of which the dividend comes.
Sounds simple and isn't. The troubles come in spades because companies have overseas earnings which are taxed overseas at different rates, so you don't necessarily want to give domestic shareholders a credit against tax paid on this income. Foreign shareholders can sometimes, but not always, use the tax credit, so there's a wedge between different classes of shareholders. You also want to ensure that a company can't defeat its entire tax liability by choosing the right dividend policy. And so on, and so on. A google search for "advance corporation tax" reveals how warped this code got in the UK before it was scrapped. The French still have an imputation system, which I am led to believe works quite well.
I also don't agree with Nomi that this measure is going to create bubbles. Scrapping double dividend taxation does encourage companies to pay their officers with stock, but siple ownership of stock does not create anything like the sort of incentives that ownership of stock options does. I'd also point out that ending double taxation removes a key advantage of debt finance over equity, and encourages a lower overall level of gearing.
The Bush dividend plan is quite possibly a giveaway to the rich, but the general idea of ending double taxation of dividends is a good one.
dd
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