Ending the Double Taxation of Dividends

by | May 3, 2003 | POLITICS

If President Bush and his team want a great argument to support their proposed elimination of the unfair double taxation of dividends and retained earnings, they should look to an excellent column in the “Week In Review” section of last month’s New York Times. That’s right, you heard me — the ultra-liberal, Bush-bashing, soak-the-rich, never-met-a-tax-cut-we-didn’t-hate […]

If President Bush and his team want a great argument to support their proposed elimination of the unfair double taxation of dividends and retained earnings, they should look to an excellent column in the “Week In Review” section of last month’s New York Times. That’s right, you heard me — the ultra-liberal, Bush-bashing, soak-the-rich, never-met-a-tax-cut-we-didn’t-hate New York Times.

In “When Cities Go Broke, the Options Are Few,” Sam Roberts wrote about the tough fiscal decisions facing New York City. He asked, is the city at “a tipping point at which taxes become so onerous that the individuals and businesses who pay the government’s bills leave?”

Hallelujah!

When a liberal admits that you can’t necessarily bring in big government revenues with high taxes — because people will eventually move away to stop paying them — you’ve got him started on a 12-step program leading to a supply-side epiphany, complete with visions of the Laffer Curve.

The next step is to get him to see that you might actually raise revenues by lowering taxes. Roberts is almost there. He wrote, “Many people forget that one legacy of the 1970’s fiscal crisis was, temporarily at least, lower taxes to lure business and to demonstrate that the city was serious about living within its means.” Funny how a writer at the Times is willing to admit the near self-evident truth of supply-side principles when they are applied to the area surrounding 43rd Street in New York City. But don’t be surprised — even liberals can get the point when their own interests are at stake.

And whether liberals admit it or not, Bush’s proposed tax-cuts for the whole nation are based on precisely the same supply-side truths.

Bush’s proposal to eliminate the unfair double taxation of dividends and retained earnings is all about keeping taxpayers from fleeing a place that is facing even tougher challenges than New York City. The “place” I’m talking about is the stock market.

Still trading near the bottom of what has shaped up to be the worst bear market since the Great Depression, the stock market needs all the help it can get. And the companies listed on the NYSE or the Nasdaq are only the highly visible tip of the economic pyramid. The whole pyramid needs help. The persistent high level of unemployment is evidence of the same malady that ails the stock market — investors have “moved away.”

When investors “move away,” sometimes they send their money overseas. But more often it means they’ll do something else with their money than invest it. Maybe they’ll mothball it in unproductive money-market funds. That means lower stock prices and fewer jobs, because high stock prices and more jobs come from the willingness of investors to risk their money on new ideas, new technologies, and new companies. Clearing away the unfair double tax on dividends and retained earnings could lure investors back.

Right now, when a corporation earns a dollar of profit, it pays corporate income taxes at the rate of 35%. When the company pays out those already-taxed profits to shareholders, those profits are taxed again on the shareholder’s personal income-tax return at a top rate of 38.6%. That’s right: The simple act of licking a stamp and mailing the shareholder his own money causes that money to be taxed a second time. It’s like a tax on taking money out of your left pocket and moving it to your right pocket.

Put those two taxes together, and consider what happens to a dollar in profits. At the corporate level it gets taxed down to 65 cents. By the time the shareholder has paid the second tax, all that’s left is 40 cents. So, this double taxation amounts to a 60% tax on the fruits of investment. And that’s just the federal tax. There are also the additional taxes levied on corporations and individuals by individual states.

During the good times America has been able to move forward despite these prohibitively high taxes on invested capital. But now we’re paying the price. Corporations learned to get cash to shareholders with stock buybacks (at high stock prices that didn’t take shareholder value into account) because capital gains are taxed at a lower rate than dividend income. And they learned to take on lots of debt because interest payments to bondholders are only taxed once. But when the boom of the 1990s ended, all that leverage became pure risk.

So here we are. The bad times are upon us. We’ve run out of tricks. If America wants its markets to be a place where investors want to live, we’ll have to end the unfair double taxation of investment income. If we do we’ll get an immediate recovery in the stock market.

My firm, Trend Macrolytics, has calculated that the first-order windfall should be at least 15%. That will mean an immediate boost to investor confidence, all the way from Wall Street to Main Street. But that’s just a down payment — the real payoff comes next.

With higher stock prices and higher investor confidence, companies large and small, new and old, will have access to the capital they need to create American jobs, keep America globally competitive, and keep America secure. Will greedy investors make scads of money in the process? You bet they will — and they deserve it.

If the elite liberal media are beginning to understand that high taxes won’t save New York City, maybe there’s hope for the political elite in Washington. Maybe the so-called “moderates” who are blocking the president’s tax-cut proposal will see that ending the unfair double taxation of dividends and retained earnings is the only way to get American investors to come home to the markets where they belong.

Don Luskin is Chief Investment Officer for Trend Macrolytics, an economics research and consulting service providing exclusive market-focused, real-time analysis to the institutional investment community. You can visit the weblog of his forthcoming book ‘The Conspiracy to Keep You Poor and Stupid’ at www.poorandstupid.com. He is also a contributing writer to SmartMoney.com.

The views expressed represent those of the author and do not necessarily represent the views of the editors & publishers of Capitalism Magazine.

Capitalism Magazine often publishes articles we disagree with because we believe the article provides information, or a contrasting point of view, that may be of value to our readers.

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