Magazine article Insight on the News

Dividend Tax Relief May Spur Economy: Ending the Double Taxation on Corporate Dividends Not Only Would Stimulate the Economy, It Also Could Make Public Companies More Accountable to Shareholders. (the Nation: Tax Reform)

Magazine article Insight on the News

Dividend Tax Relief May Spur Economy: Ending the Double Taxation on Corporate Dividends Not Only Would Stimulate the Economy, It Also Could Make Public Companies More Accountable to Shareholders. (the Nation: Tax Reform)

Article excerpt

Do you think top corporate executives are massively overpaid and unaccountable to shareholders? Are you worried that companies such as Microsoft Corp. are too big and just keep getting bigger? Have you become convinced there are too many mindless mergers and acquisitions? Do you think even after the Enron scandal that there are companies out there manipulating earnings for a higher share price? Such concerns are voiced by those on both sides of the political spectrum.

But, say conservative economists, there is something the federal government could do to mitigate these problems: Repeal the double tax on corporate earnings and dividends, just as President George W. Bush has proposed to do in his growth package.

Experts with whom INSIGHT has spoken about the Bush proposal say that in addition to a likely short-term boost for the economy by inducing people to buy more stock, the big dividend from Bush's plans would be an almost certain change in corporate behavior to make public companies more accountable to shareholders. As Vice President Dick Cheney told the U.S. Chamber of Commerce on Jan. 10, repealing the double tax would "transform corporate behavior and encourage responsible practices."

The problem with the current tax code on corporate earnings is this, say tax specialists: Shareholders are the owners of a publicly traded corporation, and when their business pays the corporate income tax it is really a tax on them, the owners. Yet when a corporation pays them dividends from earnings, that money is taxed again, resulting in total marginal tax rates on dividends of up to 60 percent. So corporations have been given a government incentive to retain earnings and leave shareholders to reap any gains when they sell the stock. This produces all kinds of economic distortions.

For one thing, the tax on dividends encourages companies to go into debt because interest payments are tax deductible, while dividend payouts are not. Bruce Bartlett, a senior fellow at the free-market National Center for Policy Analysis, who was a deputy assistant treasury secretary in the George H.W. Bush administration, tells INSIGHT, "It encourages debt, and companies become over-leveraged. This hurts them when there is an economic downturn and sometimes causes them to go bankrupt." If dividends were not taxed, Bartlett and others say, companies could raise money by issuing more shares rather than borrowing.

Another big effect of the double tax is that it "distorts the incentives of corporate management," Bartlett says. "It encourages them, when they have profits, to use that money for things that are not necessarily in the shareholders' interests. For example, buying other companies, rather than giving that money back to the shareholders."

The full repeal of the tax on dividends unveiled in Bush's economic package came as a surprise to many. But getting rid of the double tax on corporate earnings long has been a staple of tax-reform proposals, including both the flat tax and the consumption tax, but was considered one of the hardest points to sell. Critics long argued that the flat tax was unfair because workers would pay taxes on wages, but wealthy investors would not pay taxes on dividends. Never mind that this criticism ignored the fact that as owners of the corporation the investors would still, in effect, be paying the corporate tax, monies which otherwise would be paid in dividends.

Some say Bush was encouraged to abolish the tax on dividends last fall at his economic summit in Texas by discount broker Charles Schwab, but Schwab now says he suggested it almost as an afterthought. Bush and his advisers could well have read the Aug. 12 cover story in INSIGHT [see "Tax-Code Trauma"] that indicted the corporate tax code, including the double tax on dividends, for the role it played in the corporate scandals by encouraging executives to engage in complicated transactions opaque to shareholders. …

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