Stimulating the rich

January 07, 2003

DOUBLE TAXATION of corporate dividends - first as corporate profits and then as income to stockholders - doesn't make a whole lot of economic sense.

But attempting to cure this distortion by making dividends tax-exempt for investors, reportedly the centerpiece of the economic stimulus plan to be announced today by President Bush, also isn't very logical - unless the goal is tax relief for the well-off.

Here's what's wrong with this idea:

The president's plan would be costly (an estimated $300 billion in lost taxes over a decade).

At least two-thirds of the tax break would go to the top 10th of all taxpayers, those making more than $100,000 a year.

As these wealthy investors are more apt to save - not spend - their windfalls, it's hard to see how it would provide much of a short-term boost to the U.S. economy.

Perhaps, as the administration argues, tax-free dividends would bump up ailing stock prices, re-inflating shrunken retirement accounts and raising investors' confidence. But even then, this would be fertilizing a short-term flowering - not the long-term growth - of the economic tree.

All this makes it hard to swallow the regressive notion that wealthier stockholders shouldn't pay taxes on dividends, while less well-off savers who may invest in, say, U.S. savings bonds should keep on paying their fair share of taxes.

Even though it might be cast as a corporate handout, ending double taxation of corporate dividends makes much more productive sense if accomplished by giving companies - not investors - a tax deduction for dividends.

This corporate deduction would have to be partial: It would be much more costly than making dividends tax-exempt for investors, because half of all dividends are paid to pension or retirement funds and thus do not even trigger taxes.

But even a partial corporate deduction for dividends would still make more sense. Here's why:

It would tend to raise corporate profits, promoting greater capital investment. Rising levels of such investments - stagnant since the terrorist attacks in September 2001 - would provide more stimulus and a firmer foundation for an economic recovery than tax breaks for well-off stockholders.

It also would make funding corporate investments with borrowing less attractive. Right now, companies receive tax deductions for their interest payments, a key incentive encouraging over-borrowing. Wall Street - and the economy - would derive long-term benefit from much less leveraged companies.

So the administration may be correct in asserting that double taxation of dividends is a distortion that needs fixing in the interest of economic health. But it's got the wrong fix in mind, one that seems less about stimulating the economy than about rewarding the most affluent.

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