Debating 'stimulus' role of dividend-tax cut

Not ambitious enough.

That's not how most people would describe President Bush's 10-year, $674 billion tax-cut plan of last week.

Yet that's the way Joel Slemrod, one of the nation's top academic tax authorities, describes the proposal to eliminate the personal income tax on corporate dividends - at least on some of them.

Probably most tax economists agree with the thesis that the "double taxation" of corporate income distorts the American corporate-finance system.

United States companies pay taxes on the revenues that drop to the bottom line at a 35 percent marginal rate. Then, if some of those profits are paid out as dividends, the shareholders are taxed on that income at a maximum federal rate for the well-to-do of 38.6 percent. The Treasury figures the maximum combined rate on dividends comes to 60 percent. Some states tax that dividend money further.

To Mr. Slemrod, the Bush proposal doesn't go far enough in that it makes no direct attempt to close the loopholes, tax shelters, and corporate-welfare measures that have dramatically shrunk the importance of corporate income taxes over the years. Less than half of corporate income is taxed even once nowadays.

Measured in relation to gross domestic product (GDP), the nation's output of goods and services, corporate income tax revenues have shrunk from about 4 percent of GDP in 1965 to about 1.5 percent now.

The Bush proposal is clever in that it utilizes a suggestion in a 1992 Treasury study that would make various tax dodges used by companies less desirable for them. If companies pay no tax on income paid out as dividends, then shareholders must pay income tax on the dividend income. Presumably shareholders would pay less for the stock of companies with taxable, rather than tax-free, dividends.

There is speculation that some companies might even decide not to duck Uncle Sam's tax collectors so often.

One problem with the dividend-tax plan is that it would add complexity to an already labyrinthine tax structure for both individuals and firms.

Wall Street has welcomed the idea of tax-free dividends. But most analysts doubt that it will emerge intact from what brokerage house Bear Stearns chief economist David Malpass describes as "the congressional sausagemaker."

Nonetheless, Slemrod, who teaches at the University of Michigan Business School, welcomes the Bush proposal as "the start of a debate."

Other economists object to the Bush dividend exemption saying it would cost the the federal government $364 billion in lost revenue over 10 years. That money could help bolster state revenues, provide prescription-drug benefits, or fund other programs they favor.

The dividend tax cut could cost states $4 billion to $5 billion a year, calculates the Center on Budget and Policy Priorities, a Washington think tank.

To sell its plan to the public, the administration tries to conjure up an image of the recipients of dividend income as poor old women trying to make ends meet. One official told reporters that "out of 12.6 million seniors with incomes over $15,000, 58 percent of them receive dividends."

But that group also includes millionaires living in Gold Coast mansions in Florida.

According to the Tax Policy Center in Washington, nearly two-thirds of the tax benefits would flow to the most affluent 5 percent of households. These are tax filers with incomes over $140,000, or an average income of $350,000. The top 1 percent - with incomes averaging $1 million - would get 42 percent of the tax-free-dividend goodies. Only 13 percent of this tax cut would go to people with incomes below $50,000.

The 226,000 tax filers making more than $1 million would save in dividend taxes roughly as much as the 120 million filers earning less than $100,000 this year. So the tax cut would primarily benefit the top 1 percent, whose total income now exceeds that of the bottom 50 percent.

In addition, the tax change could boost stock prices. John Rutledge, a Stamford, Conn., economic consultant, predicts a rise of 8.5 percent in stock prices, increasing investors net worth $799 billion.

Such forecasts, of course, are pretty much guesswork. But if Dr. Rutledge is right, the majority of shareholders with stock, those who hold it in tax-advantaged vehicles, such as 401(k)s, would also benefit. They might even feel wealthy enough to save less and spend more over time.

Slemrod, though, says of dividend-tax exemption: "It is certainly not a stimulus."

And the Congressional Research Service says the link between higher stock prices and extra consumer spending is "weaker, perhaps more delayed, than a direct stimulus," such as tax cuts for lower-income people.

So, to Slemrod, corporate-tax reform may be a good idea whose time has not yet come.