Bush turns a great idea into a tax monster

January 12, 2003|By JAY HANCOCK

STEVE FORBES must be choking on his Chivas.

Forbes is a publishing tycoon who ran for president on a platform of streamlining the tax code. Last week, he watched a fellow Republican prepare to toss a dozen new layers on the income-tax lasagna.

President Bush's fiscal stimulus package would promote job growth, all right - for lawyers.

As proposed, the measure would make life more complicated for investors, corporations and government. It takes the fresh, appealing idea of ending tax discrimination against stock dividends and turns it into a monster of ifs, ands, buts, therefores and notwithstandings.

Mr. President, you say you want to restore investor confidence in stocks and ensure corporate accounting is "fair and open and transparent and everybody understands the facts."

How will that be helped when, under your plan, dividends from the same company might be tax-free in some years, partially taxable in others and fully taxable in others?

Will investors be happy to learn that dividends from several companies in a portfolio might be taxed at several rates?

Does it fuel investor confidence when the White House proposes to effectively remove many of the tax incentives to own stock in personal retirement accounts? If dividends are tax-free anyway, why own dividend-paying stock in your tax-sheltered 401(k)?

Will it promote transparency if people have to keep track of their share of what are called "deemed dividends" in a company's retained earnings in order to get a tax break when they sell the stock later?

Mr. President, you're a Republican. You're for government simplicity.

Ending the double taxation of dividends is great in principle. It was a good idea when President Jimmy Carter thought about it in the 1970s, a good idea when President George H.W. Bush considered it in the late 1980s, and it's a good idea now.

Unfortunately, the White House has ignored the most elegant, simple way of solving the double-tax problem and, for reasons that seem purely political, stood the idea on its head and made it much more difficult to implement. President Bush has offered shareholders a fragrant, delicate rose and hired a hazmat truck to deliver it.

Dividends are part of profits that corporations pay in cash to shareholders. For publicly traded companies, dividends get taxed once - at top combined state and federal rates well north of 40 percent - when they're booked as corporate profits. Then they're taxed on the individual level, at similar rates, when they're paid out as dividends.

This double hit promotes much nonsense. It compels corporations to avoid dividends and build cash war-chests, which leads to stupid mergers and stock buybacks. It warps executive incentives by rewarding profits reaped through stock price appreciation more handsomely than those from dividends.

It gives companies an incentive to load up on debt, increasing chances of financial distress, because interest paid on debt carries corporate tax advantages that dividends paid on stock do not.

Of course, the sensible way to fix all this is to treat dividends and interest the same, which is to say, as deductible from income for corporations but taxable for individuals.

But the administration's spinners want to appear to reward "average investors" and avoid any whiff of corporate welfare. So they cobbled up last week's mess and ignored the fact that on the whole shareholders benefit just as much from equivalent corporate tax cuts as from tax-free dividends.

Ending dividend taxes for individuals is loaded with fiscal and financial dangers, and guarding against them has turned Bush's proposal into a bloated mass of codicils and caveats.

What if Bill Gates decides to cash out $10 billion in accumulated Microsoft profits in one fat, tax-free dividend? Well, the administration says you can only pay tax-exempt dividends from profits earned after 2002.

What if companies avoid corporate income taxes - if they lose money, perhaps - but want to pay a dividend anyway? That dividend would be taxable. Dividends from companies that don't hit a certain tax hurdle or come partially from profits earned before 2002 would be partially taxable.

What if the new law lures firms to pay out all profits in dividends and forgo crucial capital investment? To avoid this, Bush's measure would let investors accumulate "deemed dividend" credits for reinvested corporate profits, which would be cashed in as tax breaks when the stock was sold. This is really a capital-gains tax-cut in disguise.

Investors are supposed to greet Bush's plan with "Hurrah!" But they may just say, "Huh?"

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