One of the most controversial provisions of the Senate Finance Committee's tax bill would require withholding of taxes owed on interest and dividends. Why is there such resistance to this proposal? After all, every dime of hard-earned wages is subject to both income tax and payroll tax withholding. Unearned income is accorded other sorts of favored treatment by the tax system, so why shouldn't taxes owing on it at least be paid as promptly and fully as taxes on wages?
The polite case against withholding on interest and dividends is that--as Sen. Robert Kasten said on the opposite page Friday--it would "discourage savings and investment, penalize the elderly and create an administrative nightmare." Let's inspect each of those arguments.
The first misconception is that 10 percent withholding drains money from the country's pool of savings. This is false on two counts. One is that the Treasury is not collecting anything it isn't already owed. It's simply collecting it a little sooner. In any case, when the Treasury collects more money, this reduces the public debt--which is financed by private investors who buy government bonds--and this frees up more money for private investment. In the short run, it's a wash. In the long run, reducing the debt increases private savings, since the cost of paying interest on the public debt is lower.
As for the impact on individual savers, it is completely negligible--unless you weren't planning to pay the taxes you owe at all. The honest investor would lose only the tiny bit of interest that would have accrued on the amount withheld during the course of the year. To give you an idea of what that means: an investment of $1,000 at a 10 percent annual interest rate yields $100. Over the course of the year--not at the beginning of the year--the Treasury would collect $10 in withholding. The interest lost on that withholding would be about 50 cents. At the end of the year, if the taxpayer doesn't owe that much, he gets the $10 back. Otherwise it offsets the taxes he would have to pay anyway. Anyone who thinks that an effective reduction in yield of five one-hundreths of 1 percent is going to cause people to withdraw their savings and go on a spending spree is living in some strange world.
As for the elderly, the proposed rule would allow all old people except those with substantial taxable incomes (in which Social Security isn't counted) to apply for an exemption. Many probably wouldn't claim the exemption since they would prefer having the tax withheld gradually to paying a lump sum at the end of the year. But filing an exemption form would certainly not be an intolerable burden for either the elderly or their banks, brokers or savings institutions.
These institutions must already file information reports with the Treasury listing all interest and dividends paid to each investor. All that will have to be added is an indication of whether or not an exemption from withholding is claimed. Nor, in this age of electronic banking, is it credible to claim that financial institutions can't handle the task. Sure, there will be start-up costs and a certain amount of grumbling, but the nation managed to survive the much bigger job of implementing withholding on wages in the early 1940s, and in those days there weren't computers on hand to help out.
Since the polite case for opposing withholding doesn't hold much water, what can be the source of congressional resistance? Can it be that those taxpayers who now conceal almost $50 billion a year in investment income from the Treasury have gotten organized as a lobby? Doesn't seem likely, but the idea is so eminently reasonable that the opposition is baffling.