What's the economic argument (if any) for taxing dividends as ordinary income?

Question

My (limited) understanding is that dividends and share repurchases are economically very similar: while share repurchases are slightly less direct, both transactions are effectively ways for publicly traded companies to transfer wealth to their shareholders.
From what I can tell, the only real difference between these two transactions is the way that the tax code treats them: (non-qualified) dividends are taxed as ordinary income, while the gains resulting from share repurchases are taxed as capital gains. Companies often prefer to make share repurchases because they are effectively taxed at lower rates.
It seems to me that there's a likely inefficiency whenever effectively equivalent transactions are taxed at different rates. Is there some important difference between dividends and share repurchases that I'm missing that justifies the tax code's differential treatment?

Brian Romanchuk · Answer

Dividends have to be taxed as income, as otherwise people can incorporate, have their wages taxed as revenue for the corporation, and then pay themselves a dividend. (Canada adjusts taxes on dividends in an attempt to make these two approaches equivalent for taxes purposes.)
Capital gains are at a lower rate for reasons that are debatable. However, in order for a gain to qualify as a capital gain, the principle is that there has to be a possibility of a loss. (To what extent that principle is achieved can be debated, since there is an incentive to exploit this lower tax rate.) In the case of share buybacks, even though the firm is purchasing shares, there is no guarantee that the sellers are selling at a profit.

I am a consultant in Canada, and one of the first things to decide is whether to form a corporation or not. The logic varies upon the tax code in each jurisdiction. The following article discusses the situation in the United States: link to small business advice website.

What's the economic argument (if any) for taxing dividends as ordinary income?

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