- The Washington Times - Friday, May 16, 2003

A tired worker comes home from the plant, and between fixing supper and seeing to the kids and putting the bills aside for later, she tries to be a good citizen and catch up on the day’s news. The headlines are about tax cuts and an argument over them in Washington, but she figures the politicians will reach their usual compromise. They always do.

It would be nice to keep some more of her paycheck, and she may even wonder what the talk about not taxing corporate dividends would mean for her 401(K), but that’s about the end of it. She’s too busy doing real work — holding down a job, raising a family, volunteering — to spend much time following the ins and outs of tax legislation. Anyway, the final bill will come with loopholes galore for special interests, many of which won’t be discovered for months, if ever. That much she knows.

Meanwhile, the debate in Congress slogs on through committee hearings, floor votes, separate but equally partisan speeches, and lots and lots of great big numbers. At last report, the House of Representatives had passed a 10-year, $550 billion tax cut by a party-line vote of 222 to 203. That is $176 million less than the cut the president had first proposed.

Nor does the House bill completely adopt the centerpiece of the president’s original plan — a proposal to end the double taxation of corporate profits. Now the government taxes both the corporation when the profit is made and then the shareholder when it’s passed on in the form of dividends. If this bill passes, the top tax rate on both dividends and capital gains would drop to the same 15 percent.

Meanwhile, back in the Senate, the Finance Committee has voted out a more modest proposal, making only the first $500 in dividends exempt from taxes. Above that, a total of 20 percent of dividend income would become tax-free after five years. The capital gains tax wouldn’t be cut at all.

But what difference will it all make — besides giving Republicans and Democrats another reason to call each other names? (“Anti-growth,” “trickle-down economics”) To listen to the commentators, you would think the only thing that mattered about this debate over taxes is the maneuvering for next year’s elections.

Actually there’s an important difference between the president’s plan and the opposition’s. By eliminating the individual income tax on dividends, the administration would discourage the kind of speculative boom that marked the American economy in the ‘90s (followed by the predictable bust) and restore a measure of reality to economic decision-making. How? As a businessman friend explained it to me:

“Years ago, dividend income was much more important to investors and therefore to the companies that wanted to attract them. But by the 1990s, many companies realized there was another way to reward shareholders other than paying dividends, and that was to use the same amount of money that might have gone for dividends to purchase company stock and then retire it. That way, there would be fewer shares outstanding, which would increase earnings per share, and so drive up the value of their stock — since stock is traded as a multiple of earnings. Shareholders were rewarded with higher stock prices, and when they sold the stock, they paid only a 20 percent capital-gains tax instead of the close to 40 percent they’d have to pay on dividend income, or almost double the capital gains tax. Which suited management just fine, since it could devise stock option plans and, as the value of the stock went up, management would benefit, too.

“The upshot is that, even if a company made the same profit every year, the stock would go up if management used some of the corporation’s cash flow or other funds to retire stocks. So you had the anomaly of management being rewarded just by retiring shares — not by increasing the overall profit and productivity of the company.”

And that’s just one of the ways in which the country’s vague and almost incomprehensible tax code (now at 45,662 pages and about to be expanded again) distorts economic decision-making.

Economic sense is the first casualty when the issue of taxing dividends becomes just a political football. The Senate’s approach lacks the basic appeal to justice of the president’s case against double taxation. Nor does it give corporations and investors enough of an incentive to concentrate on increasing profits, creating jobs and generally growing — instead of just inflating the value of their stock.

The president’s plan promises to change corporate governance and decisionmaking in basic — and wholesome — ways. It could also change the way investors choose to invest — on the basis of dividend income rather than stock appreciation. Both would be changes for the decidedly better. In short, this president means business in more ways than one.

Paul Greenberg is a nationally syndicated columnist.


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