Why are bonds taxed more than stocks?

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kosomoto
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Why are bonds taxed more than stocks?

Post by kosomoto » Wed Aug 10, 2016 10:25 am

Tried googling this several times but never found an answer. Why would dividends have a lower tax rate? Bonds are important for businesses too I would think.

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Re: Why are bonds taxed more than stocks?

Post by grog » Wed Aug 10, 2016 10:34 am

I believe the thinking is that with bonds you're getting a pretty steady stream of payments so it's taxed as regular income. Meanwhile capital gains from stocks are often realized over time and some amount of the "gain" is merely inflation. For dividends it's often argued that they are double taxed because the corporation pays corporate tax and then pays out that after-tax amount to stockholders who are then taxed again. This supposedly creates some incentive to prefer debt to equity in a company's capital structure which many economists would argue is distortionary. A lower personal dividend rate could offset some of that.

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Re: Why are bonds taxed more than stocks?

Post by David Jay » Wed Aug 10, 2016 10:37 am

I tend to agree with grog that long term capital gains are taxed at a lower rate because of the inflation risk.

Also, tax law is written by politicians and they choose what to tax based on many factors, not all of them purely economic (i.e. what would be best for the economy).
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Re: Why are bonds taxed more than stocks?

Post by randomguy » Wed Aug 10, 2016 10:41 am

kosomoto wrote:Tried googling this several times but never found an answer. Why would dividends have a lower tax rate? Bonds are important for businesses too I would think.

Because it is what the people buying the tax code wanted:) You can google for the arguments both for and against different taxation of LTGC&Divs and decide which side you prefer. It should be pointed out that the difference between OI and LTGC taxation has changed (and probably will change) over the years depending on political climate.

As far as some being inflation: when you get 2% from a bond and inflation is 2%, what percentage of your gain is just inflation?:)

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Re: Why are bonds taxed more than stocks?

Post by Atgard » Wed Aug 10, 2016 11:00 am

I agree. There are after-the-fact rationalizations and justifications, but the driving force is that very wealthy people (who donate to campaigns & have lobbyists) make most of their money from investments (capital gains & dividends) vs. wages & bank interest (which is what most regular Joes get by on).

This is one of the reasons why we at Bogleheads try to do as the rich do, and plunk our relative pennies into the stock market to achieve that same beneficial taxation. But taxing wages at higher rates than cap gains & dividends certainly is not helping the middle class, most of whom have zero or very few stocks (especially outside retirement accounts).

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Re: Why are bonds taxed more than stocks?

Post by rmelvey » Wed Aug 10, 2016 11:43 am

Because the wealthy earn more of their income from stocks :twisted:

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Re: Why are bonds taxed more than stocks?

Post by whodidntante » Wed Aug 10, 2016 12:08 pm

Favorable tax treatment of qualified dividends and of capital gains is regressive and may well end someday.

dkturner
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Re: Why are bonds taxed more than stocks?

Post by dkturner » Wed Aug 10, 2016 12:29 pm

No need to delve into conspiracy theories on this one. Dividends are taxed at a lower rate than bond interest because corporations can't deduct the dividends they pay to their shareholders but they are allowed to deduct the interest they pay to their bondholders. Sort of a stab at minimizing the specter of double taxation of dividends.

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Re: Why are bonds taxed more than stocks?

Post by garlandwhizzer » Wed Aug 10, 2016 1:16 pm

The justification for different treatment is that dividends are double taxed, at the corporate level by firms paying them out and at the personal level by those receiving them. Bonds are single taxed, only to those who receive payments. It is also argued that such preferential tax treatment increases investment in corporations and thereby stimulates the economy. So goes the argument but in reality politics may be the driving force behind such a policy. Tax policy, like most things in government, is driven by politics. I suspect there are other loopholes in tax policy that have less justification and benefit well organized and well financed political lobbies.

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Re: Why are bonds taxed more than stocks?

Post by Doc » Wed Aug 10, 2016 2:05 pm

dkturner wrote:No need to delve into conspiracy theories on this one. Dividends are taxed at a lower rate than bond interest because corporations can't deduct the dividends they pay to their shareholders but they are allowed to deduct the interest they pay to their bondholders. Sort of a stab at minimizing the specter of double taxation of dividends.
Another way to say this is that the corporations have already paid taxes on the dividends. The dividends are from after tax profits of the corporation. Taxing the recipient of the dividends at ordinary tax rates would be taxing the profits twice.

There is no double taxation of the interest payments. It's only taxed on the recipient.
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Re: Why are bonds taxed more than stocks?

Post by Engineer250 » Wed Aug 10, 2016 3:32 pm

Atgard wrote:I agree. There are after-the-fact rationalizations and justifications, but the driving force is that very wealthy people (who donate to campaigns & have lobbyists) make most of their money from investments (capital gains & dividends) vs. wages & bank interest (which is what most regular Joes get by on).

This is one of the reasons why we at Bogleheads try to do as the rich do, and plunk our relative pennies into the stock market to achieve that same beneficial taxation. But taxing wages at higher rates than cap gains & dividends certainly is not helping the middle class, most of whom have zero or very few stocks (especially outside retirement accounts).
This is definitely my strategy as well. I act like the people with the most power because I feel like those people will protect their own interests as much as possible, and so our interests are aligned in the ways that I act like them.
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House Blend
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Re: Why are bonds taxed more than stocks?

Post by House Blend » Wed Aug 10, 2016 4:32 pm

Whether there is a good reason or a political reason, it has only been true since 2003.

Before that, dividends from stocks were taxed at the same rate as interest from bonds.

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Re: Why are bonds taxed more than stocks?

Post by LadyGeek » Thu Aug 11, 2016 8:00 pm

House Blend wrote:Whether there is a good reason or a political reason, it has only been true since 2003.

Before that, dividends from stocks were taxed at the same rate as interest from bonds.
Thanks for the clue! The wiki page Capital gains distribution has an excellent reference: Federal Capital Gains Tax Rates, 1988-2013, from taxfoundation.org.

Download either the PDF or Excel versions to find that the capital gains rates changed on May 6, 2003.

For those who wish to understand how tax rates get implemented:

The tax code is based on Title 26 of the United States Code, which is US law. (The Office of the Law Revision Counsel is the official source of US law.)

The wiki has a detailed explanation: Tax basics (Hierarchy of tax authority)
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Re: Why are bonds taxed more than stocks?

Post by NOVACPA » Fri Aug 12, 2016 10:05 am

Doc wrote:
dkturner wrote:No need to delve into conspiracy theories on this one. Dividends are taxed at a lower rate than bond interest because corporations can't deduct the dividends they pay to their shareholders but they are allowed to deduct the interest they pay to their bondholders. Sort of a stab at minimizing the specter of double taxation of dividends.
Another way to say this is that the corporations have already paid taxes on the dividends. The dividends are from after tax profits of the corporation. Taxing the recipient of the dividends at ordinary tax rates would be taxing the profits twice.

There is no double taxation of the interest payments. It's only taxed on the recipient.
The above is true.

Also, no one has mentioned the economics of the two securities.

There is greater risk in holding stock. One can lose their whole investment and are last in line during a bankruptcy. Thus, as a society, we have subsidized risk taking via lower taxation.

With a bond, time deposits, or demand deposits, your risk is lower than that of stock. You are first in line during a bankruptcy and likely have some protective covenants while holding the instrument. Cetrus paribus, taxes are higher compared to dividends.

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Re: Why are bonds taxed more than stocks?

Post by Doc » Fri Aug 12, 2016 10:20 am

NOVACPA wrote:There is greater risk in holding stock. One can lose their whole investment and are last in line during a bankruptcy. Thus, as a society, we have subsidized risk taking via lower taxation.
If the corporation pays 35% tax on its profits and the investor pays 15% taxes on the dividends from those profits the total tax rate on the corporate profits is just under 45%. And the tax on interest is less that that.

Tax on $100 profits 100*.35+100*(1-.35)*.15
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Re: Why are bonds taxed more than stocks?

Post by Karamatsu » Sun Aug 14, 2016 9:48 pm

It's purely a political decision, which strictly speaking means it is not a valid topic of conversation here, but you can see that quite clearly by looking at changes in the tax code over time, or by comparing the tax regimes in different countries. There are always rationales but it seems to come down to a balance between government tax revenues, ready availability of capital, and profits for the finance industry. In Japan, for example, interest, dividends, and capital gains are taxed at the same rate, and no distinction is recognized between short-term and long-term gains.

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Re: Why are bonds taxed more than stocks?

Post by Valuethinker » Mon Aug 15, 2016 3:22 am

kosomoto wrote:Tried googling this several times but never found an answer. Why would dividends have a lower tax rate? Bonds are important for businesses too I would think.
Interest is a tax deductible expense at the corporate level. Therefore the government is already giving a concession at that level-- bond interest is not double taxed.

Share dividends *are* double taxed, because most tax systems don't give a credit for the corporation tax already paid on the money, before it gets into the hands of the shareholder.

That is the logic for a lower rate for dividends. Note for long periods in the USA, and in many countries, this was/ is not true.

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Re: Why are bonds taxed more than stocks?

Post by KyleAAA » Mon Aug 15, 2016 8:24 am

soboggled wrote:For example, you pay federal and state income tax and payroll taxes on wages and earnings, then you pay sales tax and excise taxes when you spend the same money.
But those are all different entities doing the taxing. The income is not taxed twice by any given entity. Double taxation is a big topic in tax circles.

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Re: Why are bonds taxed more than stocks?

Post by dabblingeconomist » Mon Aug 15, 2016 5:41 pm

Note that there has been a big shift toward "pass-through" entities like S corporations, which pay individual income tax on their earnings. See, for instance, the graph at http://www.cbo.gov/publication/43750, which shows a fall from about 86% to 64% in the percentage of business receipts subject to corporate taxation.

What this tells us is that businesses are actively choosing not to have the "special" tax treatment afforded to dividends, and instead are simply subjecting themselves to individual income tax rates. Clearly the lower tax rates on dividends can't be that great a deal if most firms are moving to avoid them!

The reason for this, of course, has been mentioned many times here already: the combined tax rate on corporate earnings and dividends is well above typical individual income tax rates.

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Re: Why are bonds taxed more than stocks?

Post by soboggled » Mon Aug 15, 2016 5:53 pm

KyleAAA wrote:
soboggled wrote:For example, you pay federal and state income tax and payroll taxes on wages and earnings, then you pay sales tax and excise taxes when you spend the same money.
But those are all different entities doing the taxing. The income is not taxed twice by any given entity. Double taxation is a big topic in tax circles.
Who cares? Besides, you cherry-picked my post - see state sales/income taxes and federal income/excise taxes.
"Double taxation" is a big topic in rich people's circles and the propaganda they sponsor to lobby for lower taxes on them. That's why the argument is very targeted and selective.

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Re: Why are bonds taxed more than stocks?

Post by randomguy » Mon Aug 15, 2016 6:15 pm

KyleAAA wrote:
soboggled wrote:For example, you pay federal and state income tax and payroll taxes on wages and earnings, then you pay sales tax and excise taxes when you spend the same money.
But those are all different entities doing the taxing. The income is not taxed twice by any given entity. Double taxation is a big topic in tax circles.
Not always. Payroll and income are both federal. Capital gains and net investment tax are also taxed on the same income. Sales tax in my area has both a state and local component and the state also taxes out income taxes before that.

And the tax on dividends is a lot more complex than adding in the corporate rate and the individual rate. That might work small C corps but for large multinationals, you get all sorts of games like borrowing money to pay dividends so that you don't have to recognize the income you have from foreign sources. Tax law is hard given everyone who pays it trys to find ways not to pay.

Reality is that we ended up with a Dividend cut because it is what the republicans writing the laws wanted and they could "afford" through the congressional budgeting process. Sometime another group will change it up a bit more and we will get slightly different results. Look back 30 years and compare the tax law to today. Odds are over the next 30 years we will see similiar levels of change.

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Re: Why are bonds taxed more than stocks?

Post by Gill » Mon Aug 15, 2016 6:40 pm

House Blend wrote:Whether there is a good reason or a political reason, it has only been true since 2003.

Before that, dividends from stocks were taxed at the same rate as interest from bonds.
That's not entirely true. For many years, I believe as early as the 1940's, taxpayers were able to exclude $200 of dividends, $400 on a joint return. My parents held stock in each of their names for this reason and I did also. $200 was significant at that time.
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Re: Why are bonds taxed more than stocks?

Post by KyleAAA » Mon Aug 15, 2016 9:07 pm

soboggled wrote: Who cares?
Economists and taxation experts care. I care, because I care about the economy and about helping the poor and middle class thrive.
soboggled wrote: Besides, you cherry-picked my post - see state sales/income taxes and federal income/excise taxes.
Apples and oranges. One is a tax on income, the other a tax on consumption. What you propose is double taxation on income.
soboggled wrote: "Double taxation" is a big topic in rich people's circles and the propaganda they sponsor to lobby for lower taxes on them. That's why the argument is very targeted and selective.
By targeted and selective do you mean that virtually everyone knowledgable on the topic acknowledges the problems with double taxation?

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Re: Why are bonds taxed more than stocks?

Post by Atgard » Tue Aug 16, 2016 4:03 pm

"Double taxation" of dividends is no different than multiple forms of double, triple, etc. taxation, at all levels of federal, state, and local.

When you earn money, you pay income taxes. You use what's left to pay your gardener, and once it changes hands, he pays taxes on that money that's already been taxed. He uses what's left to buy a pizza, and the pizza shop gets taxed on their profit. Etc. Why should corporations be exempt from this? They avail themselves of lots of benefits and protections precisely because they want to be separate legal entities... until it is not convenient.

Not to mention that you are taxed on your income, then taxed when you buy a car, for which the materials used to make each component have been taxed when purchased, the driver who brought it to the dealership paid tax on the gas used, the trucking company paid tax, the salesman pays income tax on the commission he earns, the dealer is taxed on its profit, GM pays tax (well, unless they HQ themselves in Ireland), etc., etc.

Slightly different, but if you buy a car, you pay sales tax on the full amount. When you trade it in, the dealer re-sells it and the next guy pays sales taxes on the current purchase price, even though you already paid on the full value of the car. Then he trades it in and it gets taxed again on the next sale. Etc.

I take it back, there is one important way that dividend payments are different from all the other double-taxed transactions I mentioned: the vast majority are earned by people wealthy enough to use that money to influence the tax laws.

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Re: Why are bonds taxed more than stocks?

Post by Atgard » Tue Aug 16, 2016 4:05 pm

As a P.S., thanks to Bogleheadish investing, hard work, luck, etc. I am now in a position to benefit from the favorable tax treatment of capital gains and dividends. But that doesn't mean I think it's the best thing for the "poor and middle class to thrive," or for the economy or nation as a whole.

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Re: Why are bonds taxed more than stocks?

Post by bhsince87 » Tue Aug 16, 2016 4:20 pm

Bond (and bank, money market, etc) interest is income that's essentially guaranteed, and protected by law. Yes, there may be credit risk, but again, the bond or or account holder has a right to sue and use the US court system to attempt to recover principal and interest.

Dividends, however, are not guaranteed or protected by law. As an income stream, they can shrink or stop at any time. And there are no guarantees that your principle will appreciate or even be returned.

Dividends can actually considered as a return of capital (there are dozens of discussions on this subject), so it makes sense to tax them at the same rate as capital gains.

Also note that capital gains on bonds are taxed at the same rate as capital gains on stocks. It's only the interest that is taxed as income.
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Re: Why are bonds taxed more than stocks?

Post by Atgard » Wed Aug 17, 2016 8:28 am

But that just begs the question: why should income from capital gains (and dividends) be taxed less than income from labor?

There is a part of me that thinks maybe it should be the other way around: give the guy working 40+ hours a week a break, and the people earning passive income can afford to pay a bit more.

As for guaranteed vs. risky income, my small business income is taxed up to 39.6% + 15.3% self-employment tax (up to the SET limit), and it is far from guaranteed. I'd say Apple paying their next dividend is more guaranteed than my next quarter's income, so by that logic I should be paying less than 15%. :wink:

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Re: Why are bonds taxed more than stocks?

Post by Doc » Wed Aug 17, 2016 8:51 am

Atgard wrote:But that just begs the question: why should income from capital gains (and dividends) be taxed less than income from labor?
They are not taxed less. Once you add the tax the corporation has already paid on its profit to the tax the individual pays on the distribution/sale of those profits the combined tax on those profits is higher than the tax from labor.
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Re: Why are bonds taxed more than stocks?

Post by MathWizard » Wed Aug 17, 2016 9:59 am

I've long given up on determining logical reasons for the tax code.

There are justifications, but what is done is what a majority of house and senate members
decided which did not get vetoed by the sitting president.

If you want to know, I'd ask your representatives in Congress.

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Re: Why are bonds taxed more than stocks?

Post by expat » Wed Aug 17, 2016 11:29 am

Municipal bonds are not taxed more than stocks.

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