A formula for success

The lower tax rates on dividends and long-term capital gains enacted in 2003 have already yielded tremendous economic results. Investors, businesses and the U.S. economy have just started to accrue the most significant benefits from the reduced rates, but those gains may be temporary if the rates are allowed to expire at the end of 2008 as provided in current law. Indeed, the beneficial effects may stop long before then because of increasing uncertainty among investors and businesses as 2009 approaches. Congress must act soon to turn temporary success into permanent gain.

President Bush is expected to seek to make these important tax changes permanent. That would keep the maximum tax rate on both dividends and long-term capital gains at 15 percent after 2008. If the changes are allowed to expire, the maximum tax rate for dividends will rise to 35 percent, while the top long-term capital gains tax rate will return to 20 percent.

Since enactment, more companies have begun offering dividend payments, and the size of those payments has jumped sharply. In 2003, 113 publicly tradedcompanies began paying dividends, compared to an average of 22 companies in prior years. Total dividend payments by American companies increased by $81 billion from 2002 to 2004. Significantly, after-tax dividend income just from S&P; 500 stocks was $56.6 billion in 2004, an increase of nearly 60 percent from 2002.

Nearly 60 percent of Americans who reported dividend income in 2002 had adjusted gross incomes of less than $75,000. The average dividend income reported by taxpayers in this category was more than $1,700. The increased dividends are especially important for millions of senior citizens who rely on this additional stable, long-term source of income to supplement their Social Security earnings and other retirement savings.

Businesses, too, have gained from the lower rates. Unlike dividends, retained earnings and debt financing are taxed more lightly, thereby discouraging the use of equity financing to raise capital. In turn, the tax-code bias in favor of debt encourages companies to become more highly leveraged, leaving them susceptible to failure when their revenues fall or interest rates rise. The 2003 tax cut has lessened that distortion.

Dividend payments also encourage firms to focus their attention on sustaining profitability to generate the cash to pay dividends. Since dividends can be a more tangible, reliable measure of corporate profitability than an accounting statement, investors benefit from greater transparency and improved corporate governance. Management undertakes only the most productive investments that increase shareholder value. Returning profits to shareholders increases efficiency, capital raising, income growth and job growth.

Although the rate cuts do not expire until the end of 2008, Congress must act now so that investors can plan their savings for education, health costs or retirementwithabsolute confidence. Similarly, business investmentstake time to plan, implement and bring to maturity.Uncertainty in business hinders the planningprocess, breeds inaction and discourages firms from adjustingtheir long-term investment horizons as long as the rates are temporary.

Acting now to make the lower capital-gains and dividends tax rates permanent is a formula for success: more investors receiving greater dividend payments, businesses having more leeway in the type of financing they use to generate cash and be more accountable totheir shareholders and the U.S. economy continuing to grow at a healthy rate.

Marc E. Lackritz is president of the Securities Industry Association.