States Fear Removal of Dividend Tax Could Worsen Budget Deficits

AP ^ | 1/8/03 | yDavid A. Lieb

[Jean S]

Already facing huge budget deficits, some state and local governments fear President Bush's plan to eliminate taxes on corporate dividends could end up costing them money they can't afford to lose.

Because most states tie their income tax codes to the federal tax code, an end to federal dividend taxes could also result in a loss of state tax revenue.

States could get hurt in another way, too: Bush's proposal could make stocks a more attractive investment than the bonds issued by states and municipalities for building schools, roads and other projects. To attract investors, local governments might have to offer higher interest rates on their bonds, and that would make it more expensive for them to borrow money.

The loss of state tax revenue could top $4 billion for the 2003 tax year, the Federation of Tax Administrators, a national organization of state revenue departments, said Wednesday.

It is difficult to forecast the effect on the bond market. But "in the long term, it may be an even larger impact because your borrowing costs are increased forever," said Harley Duncan, executive director of the Washington-based federation.

The end result is that the president's stimulus plan could cost states far more than the $3.5 billion that they would receive in aid under Bush's proposal.

The National Conference of State Legislatures and the National Governor's Association have raised concerns about the plan.

"It's a potential destimulant in what is supposed to be a stimulus proposal, and it potentially exacerbates the states' fiscal conditions in a negative way," said Michael Bird, an NCSL legal counsel in Washington.

White House spokesman Ari Fleischer said Wednesday that repealing the federal dividend tax is not one of the measures in Bush's package meant to stir immediate growth. Instead, it is "a chance to do something fundamentally good for long-term growth," Fleischer said.

The NCSL puts states' collective budget shortfall at more than $70 billion for the next fiscal year. A study by the Center on Budget and Policy Priorities says that shortfall could be as large as $85 billion.

It is possible that state government groups are overstating the potential harm of the president's plan.

When the federal government allowed businesses to take a 30 percent extra tax write-off as part of last year's economic stimulus plan, government groups predicted it would cost states $14 billion over three years because it would reduce state tax revenue.

But 30 of the 41 states that collect income taxes decided not to pass along the federal tax break to state taxpayers. The result: The projected loss to states has been lowered to $4 billion over three years, Bird said.

To separate themselves from the latest proposed federal tax break, about 20 states would have to specifically change their state laws.

In Missouri, where federal tax breaks automatically are passed on, Democratic Gov. Bob Holden said that the repeal of the federal dividend tax could cost the state $95 million during the next fiscal year.

"When federal taxes are cut, the states suffer," said Holden, who is struggling to make up a projected $1 billion budget shortfall. "The problem is that the federal government can run a deficit, but Missouri government must have a balanced budget. We are left with the choice of cutting programs that help citizens."

As for the potential effect on bonds, California state Treasurer Phil Angelides said repealing the federal dividend tax would undoubtedly drive investors away from bonds "at a time we have enormous infrastructure needs."

Governments may simply forgo construction of such things as schools, stadiums or roads because the debt service on bonds will become too burdensome, Bird said.

AP-ES-01-08-03 1734EST

[gov_bean_ counter]

These folks have to get their stories straight. On the one hand we have the Libs telling us that so much dividend income is tied up in nontaxable 401ks that there will be no stimulus effect. Now we have this. Which is it?

[gundog]

...could end up costing them money they can't afford to lose.

Which will, of course, distract them from the real business of spending money that they don't have.

[Dog Gone]

It is possible that state government groups are the Associated Press is overstating the potential harm of the president's plan.

[Free the USA]

http://www.freerepublic.com/perl/bump-list

[Cicero]

People will go out and spend it, and they'll collect more sales taxes. Get a life, you leaches.

[Dave S]

On the one hand we have the Libs telling us that so much dividend income is tied up in nontaxable 401ks that there will be no stimulus effect.

They also neglect to point out that the 401-K folks will benefit from higher prices for their shares as the dividend repeal is expected to increase share prices 10% or so.

[NJ Mountain Goat]

Consider that the dividend income received in a §401k gets converted from non-taxable income into taxable ordinary income under Bush's plan. (This is much like owning a muni in your IRA.) Plans might reallocate investments from dividend paying companies to non payors.

Then consider that munis bonds would need a higher yield to compete with now tax-free yields on stock dividends. Again, plans might reallocate from stocks to higher yielding bonds.

Combined, if §401ks, §403bs, and big pensions like CALPERS respond in their best interests, we could end up with dividend paying stocks held by individuals, and non-dividending stocks held in plans. So after the dislocation of rebalancing portfolios, the dividend income will end up with taxpayers.

A better idea might be to make dividends deductible at the corporate level, but still taxed to the recipient. It doesn't buy votes, but it does put equity and debt at a parity, and should remove the existing bias towards more debt.

[nothingnew]

"It's a potential destimulant in what is supposed to be a stimulus proposal, and it potentially exacerbates the states' fiscal conditions in a negative way,"

Oh goody!...Another newspeak word to add.

These f_c_s spend too much money is all it is.

FMCDH

[Lancey Howard]

These threads about whining government parasites make me laugh.

[WaveThatFlag]

The fact that the redistributors have no real concept of how the economy really works is emphasized by their failure to pick up on the effect that this change is going to have on the municipal debt markets. This is the one potentially harmful outcome of this proposal (though I believe that the increased taxrolls created by a spurred economy will more than upset their decreased ability to raise capital though bonds).

[Dog Gone]

I'm not sure that making it harder for state and local governments to borrow is altogether a bad thing. I vote against most bond issues, except for infrastructure improvements, routinely.

[WaveThatFlag]

Unfortunately, bonds pay for a lot of infrastructure improvements. If it becomes more expensive to borrow money, your taxes are going to increase.

[Dog Gone]

Maybe I'll protect against that by buying the munis with their new higher interest rates. ;-)

[WaveThatFlag]

Yeah, but you'd probably be much better off putting together a "Dogs of the Dow" portfolio.

[Dog Gone]

My portfolio automatically becomes the Dogs of the Dow. I need to quit being the pathfinder here, I think, and adopt that trailing technique.

[WaveThatFlag]

I referring to the dividend benefits as opposed to the market performance.

[Dog Gone]

Well, that's a good point, too, but I don't think that tax-free munis are going to be put out of business by stocks paying good tax-free dividends. The stocks still carry price risk that some investors simply will not take.

[WaveThatFlag]

No municipalities won't stop issuing debt. But the bulk of muni investors buy munis because of the tax considerations, not because of their credit quality. That's why there is a thriving market for non-investment grade muni paper. The presence of a new tax-exempt option will definitely draw a large share of investors away from munis. This will force municipalities to raise rates to attract buyers. This is inevitible. It also means that you will be paying higher taxes locally, either to finance the debt or as alternative funding to public works projects.

Don't get me wrong: All taxation is bad, and I am in favor of the President's revisions. I am merely pointing out that the redistibutors have failed to pick up on the one argument that might sway public opinion. This is because they have never bothered to fully comprhend the markets that they attack. They prefer to place all their eggs in the class warfare basket, because they understand class warfare, and it has worked for them in the past.

[tortoise]

Unfortunately, bonds pay for a lot of infrastructure improvements.

Yes, but this is a premise that should be attacked. Many (most?) states and locales use bonds to pay for infrastructure improvements yet there are quite a number that do not in any significant sense. The difference largely amounts to fiscal discipline. States with fiscal discipline are FAR less likely to need bonds for infrastructure improvements, so simply using good management of resources would mitigate most of the problem of bond rates increasing.

If they managed their money wisely, this wouldn't hurt them no matter how you slice it. It is only their mismanagement that has left them in a vulnerable position. Cry me a river.