John Edwards and dividend taxes

John Edwards at the debate last night stated that,

millionaires sitting by their swimming pool, collecting their statements to see how much money they’re making, make their money from dividends, pays a lower tax rate than the men and women who are receiving paychecks for serving on the
ground in Iraq.

This statement is wrong from all sorts of angles.

• First, Edwards is wrong on the facts. The Defense Department web site on military compensation states,

  Earnings received while in the combat zone are excluded from taxable income.

  Update: Even if there were no combat zone deduction, Edwards' statement would be false. As MSNBC reports, "President Bush last year cut the tax rate on dividends to 15 percent, whereas most soldiers would be in a 15 percent tax bracket — and pay an effective rate much less after taking deductions for children and mortgages. (The article does not however note the combat zone exclusion.)

• Second, it's not just the millionaires by their swimming pools who receive dividends; it's the middle class. According to the Heritage Foundation, in 1998 "70% of taxpay­ers directly receiving dividends earned less than $55,000 in wages and salary." (For more, read Who Really Benefits from Dividend Tax Relief?, from the Heritage Foundation's Center for Data Analysis.)

• Third, most millionaires pay a much higher tax rate than Edwards implies, because they have a good bit of earned, taxable income. And even for the subset of millionaires who are not working, their money was taxed when they did earn it. And if they inherited the money, it was taxed when their forbears earned it and again when they inherited it.

• A high tax rate on dividends is illogical and discourages productive, job-producing investments. Consider this example:

  You and some friends decide to take a risk. Despite your knowledge that many new companies fail, you invest your savings in starting a personal service company. You work hard, build up clients, and produce a good service. You expand the business, hire employees and incorporate. So far, so good. Because you were willing to risk your savings for later gain, you've been able to build a good company, provide a useful service and provide employment to others.

  After a few years of hard work, you are able to turn a profit. You are a bit unhappy that your company must pay 35% of its profits in federal taxes, but you figure you'll accept it.

  After some more time, despite the taxes, the company builds up some cash. You and your friends decide to pay yourselves some of the cash in dividends.

  But the powers that be have heeded the advice of people like John Edwards, so your dividends are taxed at your ordinary income tax rate of, say, 27%. But the money was already taxed at the 35% personal service corporation rate. So ultimately, you receive less than half of each dollar that you company earned through your investment in the company.

  On second thought, perhaps it wasn't such a good idea to risk your money in the first place...

Finally, for a bigger picture perspective, it is important to look at income taxes as well as dividend taxes. While the Democrats would have you believe that Bush pushed through a "tax cut for the wealthy," it is important to keep in mind that the wealthy pay a greater portion of the income tax pie under the Bush tax cut than they did beforehand. Hence the poor and middle classes pay a smaller portion. I do not know why the Republicans are not trumpeting the point, but they should be.

(Department of Defense link via Betsy's Page via PoliPundit.)