Do you remember those happy bygone boom days when the stock market was going to save us from a variety of ills? Rising stock prices would solve the problem of Social Security shortfalls; boost federal, state and local income tax revenue; and let us all retire young, rich and happy. It never happened, of course. And now that stocks have been in a three-year funk, we the taxpayers are being asked to bet around $500 billion on the dubious proposition that we can jack up stock prices by changing the way we tax dividends. And that higher stock prices will bring back the good times so many of us got used to in the late '90s.
What I'm talking about, of course, is the dividend tax cut that's the heart of the proposed economic stimulus package from President Bush, our MBA-in-chief.
The debate has focused largely on questions of fairness and affordability, which are certainly important. But lost amid the din are some important unanswered questions, such as whether a $33 billion-a-year dividend tax cut can really provide serious help for an ailing $10 trillion economy. And whether a dividend cut whose benefit is concentrated among a small number of high-income households is a better way to jump-start the economy than House Democrats' proposals to send out millions of one-time checks in the $300-to-$600 range. And, finally, whether we should even be trying to stimulate the economy with tax cuts, rather than letting it seek its own path.
Bush's proposal is designed to eliminate double taxation of dividends. That's when a corporation pays taxes on its profits, then pays out after-tax money as dividends to investors who pay tax on them.
Bush's plan, simple in sound-bite form but horribly complex in the real world, would make some cash dividends that companies pay tax-free. But a company's status depends on how much income tax it paid the IRS. So you wouldn't know what to count on from year to year.
The Treasury estimates that the dividend package will reduce tax revenue by $364 billion over 11 years -- my $33 billion-a-year number. But we'd have to pay years of interest on a larger national debt, hence my $500 billion cost estimate.
You've got to take several leaps of faith to believe a $33 billion cut can bring back the good times. The leaps look like this: Cutting dividend taxes jacks up stock prices. Higher stock prices make capital cheaper, encouraging companies to expand, adding jobs. Combine these jobs with the good feelings that higher stock prices would generate among the populace and people run out and spend, stimulating the economy big time. That's enough leaps to give you shin splints.
This is actually a simplified version of the thesis floated by economists including R. Glenn Hubbard, head of Bush's Council of Economic Advisers. At various times, Hubbard has said that eliminating dividend taxes would raise stock prices by 20 percent or 10 percent or 7.5 percent. He's co-written papers asserting that dividend taxes depress stock prices. But academic opinion is divided on the subject. Besides, who'd risk $500 billion on an academic theory? Not me.
When you enter the real world, you run into more problems with the dividend-cut-to-the-rescue plan. To wit: About half the dividends eligible for this break go to non-taxpayers, such as pension funds and retirement accounts, for whom tax cuts are irrelevant. Besides, the big players who drive stock prices -- professional traders, hedge funds, mutual funds -- are generally rated on their results without taking taxes into account.
Finally, the double-taxation problem is smaller than it used to be. That's because corporations pay less income tax (as a percent of profits) than they did before the advent of aggressive corporate tax shelters, and dividends are far lower, relative to stock prices, than in the pre-'90s days.
If we're going for quick stimulus through tax cuts -- which I'm not sure would work -- I'd take the Democrats' version. If we want to fix a long-term problem, I'd reform the hideous alternative minimum tax. The AMT, a complex trap designed three decades ago to keep richies from ducking taxes entirely, has morphed into a monster that threatens millions of middle- and upper-middle-income people.
The Bush tax package would mitigate the problem through 2005; Treasury types told me it would return in 2006. But the Bushies can produce happy tables showing middle-income people benefiting today. Apres moi, l'AMT.
Even though I think the idea of reducing dividend taxes to stimulate the economy is not likely to work and would be a terrible waste of public money, I love the way the Treasury tax types want to implement it. Instead of just making all dividend payments tax-free, which is what I thought would happen when I wrote about this last month, Treasury has come up with an elaborate plan to make sure that only stockholders of tax-paying corporations benefit from this break.
One of the side effects of this proposal -- which I doubt that many people in the White House realized -- is that each corporation would have to announce every year how much in federal income taxes, if any, it had paid.
Can you imagine the uproar when someone made a list like that public?
Alas, even if this plan gets passed, I doubt we'll see this type of disclosure. For what I'm sure are perfectly good reasons, Treasury would allow companies to count foreign income tax credits as taxes paid to the United States. So you can see corporate America lining up to seek more loopholes -- add back the deductions for pollution bonds, employees cashing in stock options, state, local and Social Security taxes, all sorts of other high-minded stuff -- until the disclosures would become meaningless. But you've got to commend the Treasury people for being intellectually honest.
Letting corporations deduct interest payments but not dividend payments has skewed balance sheets toward debt. That's bad. But the way to fix it is to let corporations deduct dividends the way they deduct interest. That idea "had a short shelf life," a Treasury tax techie said last week, because it's much more costly than Bush's plan.
The idea that cutting dividend taxes will save us should have a short shelf life, too. This is beyond voodoo economics. It's just a mistake. Call it booboo economics.
Sloan is Newsweek's Wall Street editor. His e-mail address is firstname.lastname@example.org.