WSJ's irony

Christian Gregory christian11 at mindspring.com
Fri Jan 17 12:33:44 PST 2003


"In the latest iteration of Bush economics, borrowing is harmless if done by the federal government, but dangerous if done to excess by corporations."

WASHINGTON -- President Bush, purveyor of tax cuts as a cure for all economic ills, has a new tonic for an economy still suffering the hangover of a stock-market bust, war fears, accounting scandals, weak business investment and a corporate borrowing binge.

The answer: Reduce taxes for stock owners. Dividends would become tax free. Investors in companies that don't want to pay dividends would get a new break in capital-gains taxes.

The president's latest tax plan has other parts, of course, notably a speeding up of some scheduled income-tax cuts. It has generated much debate, particularly over the dangers of federal-budget deficits, which the plan could widen.

But the corporate tax cut -- $364 billion of the total $670 billion, 10-year tab -- is the plan's centerpiece and the core of the brewing political and economic debate.

Democrats were quick to seize on the fact that the bulk of the direct benefits would flow to stock owners, who tend to be the most affluent Americans. Senate Democratic Leader Tom Daschle of South Dakota calls it "The Leave No Millionaire Behind Act." Even some Democratic moderates who backed Mr. Bush on earlier tax cuts are balking. "I don't think you get enough bang for the amount you have to spend," says Louisiana Sen. John Breaux. Some Republicans turned up their noses too, among them recently departed Treasury Secretary Paul O'Neill.

Glenn Hubbard, the administration's top economist, argues that the economic benefit from the proposal would be "quite large," both from short-term gains in investors' portfolios and from the long-term effects of increased business investment.

A look at the White House case:

President Bush: "By ending double-taxation of dividends, we will increase the return on investing."

Increasing "the return on investing" is economist-speak for boosting the stock market. Higher stock prices are always welcome, but they would be especially so now. To a greater extent than in past slowdowns, the stock market's weakness isn't only a reflection of the economy's weakness; it is one of its causes. Shrunken portfolios are creating a drag on consumer spending, on companies' willingness to sell shares to finance new ventures and on business confidence generally.

Administration officials earlier cited studies suggesting the value of equity markets likely would rise by about 10% from dividend-tax elimination, though they no longer use that number. The rise would occur largely because the tax burden on stock investments would be reduced, increasing the amount of a dividend -- or a capital gain -- that an investor could keep.

Some academics say the administration is overestimating the benefit. Some say the plan would drive up interest rates by increasing federal deficits. Higher rates tend to undercut share prices.

The stock-market kick could be less than 5%, estimates Joel Slemrod, a University of Michigan tax economist.

Vice President Cheney: "Companies will be less inclined to over-leverage themselves with debt and more inclined to finance business expansion with equity."

In the latest iteration of Bush economics, borrowing is harmless if done by the federal government, but dangerous if done to excess by corporations.

For years, corporate-finance experts have bemoaned tax-code provisions that give companies a break for interest payments but not for dividends. This encourages companies to rely more on borrowing and less on selling shares. Higher debt makes companies more vulnerable to an economic downturn.

The Bush team says its proposal would right this imbalance. Under the plan, companies still would be able to deduct interest and unable to deduct dividends. The White House figures it doesn't matter whether the company or the shareholder gets the dividend-tax break. Either way, the return on shareholders' investments goes up, so investors are willing to pay more to own the stock.

In the real world of corporate boardrooms, however, that distinction could limit the plan's impact. If eliminating the bias toward debt were really the objective, "it would be somewhat more effective to do it at the corporate level rather than the individual level," says Peter Orszag, a Brookings Institution economist and former Clinton administration official.

Vice President Cheney: "Abolishing the double taxation on dividends will ... transform corporate behavior in America and encourage responsible practices."

The White House says the plan will clean up corporate sleaze in two ways -- by discouraging corporate tax avoidance as well as dicey book-keeping.

The dividend break would apply only to companies that pay taxes. Under the proposal, the Treasury says, "corporations will have good reason to pay taxes and not to engage in aggressive tax planning."

As for cleaning up the Enron-type accounting that has fed suspicion of the market, Mr. Bush and his allies -- who, on this point, include Federal Reserve Chairman Alan Greenspan -- say investors will buy stocks more for the dividends and less because of rosy reported earnings.

That is supposed to be good because dividends are tangible cash, and are therefore impossible to fake. Reported earnings, as has been painfully demonstrated, are easier to manipulate. "This should discourage companies from artificially inflating profits just to cause a temporary spike in stock prices," Mr. Cheney contends.

The fine print of the Bush plan undercuts this effect. In order to avoid putting too much pressure on companies to issue dividends -- which deprive them of cash for reinvestment -- the White House is allowing companies that don't want to pay dividends to give shareholders an extra capital-gains break instead. And the size of that break is pegged to reported earnings.

Even one of the chief defenders of the idea, International Paper Co. Chief Executive John Dillon, says the proposal "will not change our behavior with respect to [paying] dividends."

President Bush: "For America's 84 million investors, and those who will become investors, I propose eliminating the double taxation on stock dividends."

The White House has strained to make the dividend break appear to be a bonus for the masses. But that 84 million figure overstates the case.

Most American investors own stock in tax-free plans, such as 401(k) accounts. Since they don't pay taxes on their holdings now, they won't get any direct aid from tax cuts on stocks.

In fact, about 35 million U.S. households receive taxable dividends. Those tend to be the most affluent households, giving Democrats the opening for their biggest rhetorical attack on the plan.

The political and economic questions leave prospects for the dividend cut highly uncertain.

Senate Finance Chairman Charles Grassley is responsible for steering the plan through the Senate. Says the Iowa Republican: "We may end up with all of it, we may end up with nothing at all."



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