There are obvious flaws to this scheme, but it's pretty hard to tax income in a fair way. Some places (notably the EU) favor using a consumption tax instead.
I don't really get this counterpoint; isn't everything in the economy a flow of money that has been taxed at a previous point in the flow? If I have $100,000 that I've already paid taxes on, I could invest it in external assets and hope to make capital gains on them; or I could plow it back into my own occupation and use it to generate income (say, by setting up an art studio). Why should I pay more taxes in the second case?
Consider two eBay-painting-seller scenarios. In the first, I buy painting materials, paint paintings, and then sell them on eBay. In the second, I buy existing paintings on eBay that I think are underpriced, and then resell them later for a profit. Why should I pay more taxes in the first case, just because I painted the paintings? In both cases my occupation is basically "selling paintings on eBay", but in one I'm creating new ones and selling them for an income, and in the other I'm flipping existing paintings, making a capital gain. In both cases the starting capital is money I've already paid taxes on. If anything, the first occupation seems like the one policy should encourage, rather than the second, but at the very least I don't see any reason to actively encourage the second version over the first.
By the way, in the first case, your outlays are tax-deductible.
(edit: I'm not an expert, so downvoters, please explain your disagreement.)
But in the second case, you're taxed at a lower rate, so the tax code appears to want to discourage you from investing your capital in your own work. If you ever find yourself in a situation where you could make a 10% return on capital by putting that capital to work yourself, or could make the same 10% by putting that capital into a passive investment, the tax code promotes the 2nd option.
I pay income tax. With the money left over, after paying the tax, I buy things. I pay tax on the things I buy even though the money has been taxed, so to speak. Suppose I buy something from the place I work at. The money I'm spending to buy the object has been taxed multiple times and part of that money ends up back in my hands. You just can't realistically distinguish between the myriad ways that money has been previously taxed.
Increases in equity on average, but not in the short term, coincide with accumulation of shareholders equity via retained earnings.
Otherwise what you get is that companies, in shareholder's interest, try not to give out so much dividends because they will be taxed twice. Instead they keep the cash to boost the share price so shareholders make capital gains.
You'd ask, what is really the point of buying stock in a company that will never pay dividend in its lifetime?
They can distribute profits via share buybacks. Instead of distributing 1% of the companies value as dividends, they can buy back 1% of shares. You then have the option of selling 1% of your shares back (equivalent to taking dividends) or keeping your shares (equivalent to reinvesting dividends).
This only works if you are a big shareholder - if you are a small time player on ETrade, transaction costs will kill this idea.
1% share buyback when you own 100 shares (price=$100) -> $100 cash in your hands + 99 shares valued at $100/share.
1% of corporate value distributed as dividends -> $100 cash in your hands + 100 sharesvalued at $99 (since 1% of corporate value was given away).
I was skeptical of this claim but Wikipedia confirms - that's an interesting scheme. It basically eliminates taxation as a decision factor in incorporating a company or not. That's interesting, I never heard of such a construct before, although it's quite obvious.
In most of Western Europe, there are different rates for dividend and income tax. So if you own a company, the company first pays e.g. 20% 'profit tax' on it, and then you pay 25% on the dividends; in the end, roughly coming out to the same marginal highest tax bracket for the income tax.