A Stealth Tax Cut? (excludable distribution account)

INVESTOR'S BUSINESS DAILY ^ | Friday, January 10, 2003 | Editor

[Isara]

Stimulus: All the talk about President Bush's $674 billion stimulus plan has been focused on dividends. But slipped in among its provisions is a possible bombshell that could be very bullish for stocks.

It's called an "excludable distribution account." If that doesn't sound sexy, it should. At least if you own stock. These accounts potentially will boost returns for all shareholders - not just those who own shares that pay dividends.

The Bush administration - wisely, we think - wants to avoid giving stocks that pay dividends an advantage over other stocks.

The reasons for this are simple: Job growth, new products and innovations come primarily from small, fast-growing companies - exactly the kind that don't pay dividends.

If you give big companies an advantage over them, you kill off much of the economy's dynamism.

But how can you continue to encourage those companies to do their wonderful economic magic and still make the tax code fairer?

Bush's answer, we think, is ingenious: Since small companies don't pay dividends, but instead retain their earnings to invest further in growth, why not give a tax break for retained earnings?

That's exactly what Bush's tax writers did. Under the new proposal, after companies pay taxes they may put what remains of their profits - which accountants call retained earnings - into an EDA.

If the company doesn't pay that money out in dividends, but keeps it for the company's own use, its shareholders get a tax break.

The break comes when investors sell their shares. When that time comes, the cost basis of their shares - that is, what they paid for them - is adjusted upward based on how much has been put into the EDA.

That means, for tax purposes investors' taxable capital gains would be reduced, too. In effect, investors get a cap-gains tax cut.

Here's how it works. Say you bought XYZ Corp.'s stock for $10 a share. The company sets up an EDA, and over the next year puts the equivalent of $2 a share in it. XYZ doesn't pay that money out in dividends; it invests it back into the business.

Now say a year or so later, you sell the stock for $20 a share.

Ordinarily you'd have to pay a 20% tax on the $10-a-share capital gain - an amount equal to about $2 a share. But under Bush's plan, the retained earnings of $2 a share in the EDA are added to the cost basis of your stock. So you have to pay tax only on an $8-a-share gain - about $1.60. That's a 20% cut in cap-gains taxes.

This is more than just clever tax accounting; it's clever politics as well. The Bush people know that they would get hammered hard for putting a capital gains tax cut in their stimulus plan.

Democrats would love to have another "tax cut for the rich" to use as fodder against any tax cuts. So the Bush folks came up with their EDA accounts - which will encourage all people to plow their money back into the working economy through investments.

We're glad to see that the president wants a level playing field for all investments. In this case, it will mean more jobs, more growth and more new products - real stimulus for the long term.

[Isara]

Talking about fairness, this is another example of well-thought-out plans from this administration for all people.

[ladtx]

I'm not a financial guy but this sounds brilliant to me.
Watch the Dems demagogue it tho'. "Money for the wealthy."

[goodnesswins]

Woooo Hooooo.....I just LOOOOVE THIS President and his Administration! I think this will be HARD to demagogue....because it's money plowed back into a corporation....and ONLY when stock is SOLD is it accounted for.

[upchuck]

I'm very glad to hear about this. It got little mention in the lamestream press. Probably because they figure it's too sophisticated for Joe Sixpack to understand. But they underestimate Joe.

Although this will undoubtedly help the economy, it does add another layer of complexity to the tax laws. Here's what we really need.

[Willing To Listen]

HOW THE TAX SYSTEM REALLY WORKS


A good time to resurrect this description of "how taxes work"...


This is a VERY simple way to understand the tax laws. Let's put tax cuts in terms everyone can understand.

Suppose that every day, ten men go out for dinner. The bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this.

The first four men, the poorest would pay nothing; the fifth would pay $1; the sixth would pay $3; the seventh $7; the eighth $12; the ninth $18; and the tenth man, the richest would pay $59.

That's what they decided to do. The ten men ate dinner in the restaurant every day and seemed quite happy with the arrangement, until one day; the owner threw them a curve (in tax language a tax cut).

"Since you are all such good customers," he said, "I'm going to reduce the cost of your daily meal by $20." So now dinner for the ten only cost $80.00.

The group still wanted to pay their bill the way we pay our taxes. So the first four men were unaffected. They would still eat for free. But what about the other six, the paying customers? How could they divvy up the $20 windfall so that everyone would get his "fair share?"

The six men realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would end up being PAID to eat their meal. So the restaurant owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.

So the fifth man paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, the ninth paid $12; leaving the tenth man with a bill of $52 instead of his earlier $59.

Each of the six was better off than before. And the first four continued to eat for free.

But once outside the restaurant, the men began to compare their savings. "I only got a dollar out of the $20," declared the sixth man, but he, pointing to the tenth. "But he got $7!" "Yeah, that's right," exclaimed the fifth man, "I only saved a dollar, too. It's unfair that he got seven times more than me!" That's true!" shouted the seventh man, why should he get $7 back when I got only $2? The wealthy get all the breaks!" Wait a minute," yelled the first four men in unison, "we didn't get anything at all. The system exploits the poor!"

The nine men surrounded the tenth and beat him up. The next night he didn't show up for dinner, so the nine sat down and ate without him. But when it came time to pay the bill, they discovered, a little late what was very important.

They were FIFTY-TWO DOLLARS short of paying the bill! Imagine that!

And that, boys and girls, journalists and college instructors, is how the tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up at the table anymore.

Where would that leave the rest? Unfortunately, most taxing authorities anywhere cannot seem to grasp this rather straightforward logic!



NOTE:

The copy I received of this credited a Professor of Business Law as the author. When I complemented him for his wisdom via e-mail, he said: "I am unaware of the true author's identity, which is unfortunate, since the piece has generated considerable interest. Unfortunately, one of my students sent it along and erroneously contributed the authorship to me."

[Sacajaweau]

I read this before. It was worth reading again. Please forward it to Hitlery.

[Principled]

Yes, upchuck. NRST.

[tnlibertarian]

I am so glad you posted this. I had heard it before and went looking for it to use as ammo against a liberal friend of mine. I couldn't find it. I copied it and will print it off and give it to him. The problem is that it makes too much sense for him to pay any attention to it.

[bert]

W the giant killer has with one swipe of the sword eliminated dividends and Capital gains penalties for small corporations......

The Rats are being slayed in their holes.

Hows that for a mixed metaphor.

[Madcelt]

thank you for posting. This has answered some of the questions I have had. I'm still learning more about 401K plans and my own retirement-health insurance plans. (Which I invest in the company I work for. "Gotta believe in em")Granted I'm still in the dark on the workings and so forth but I will eventually get there.

[Willing To Listen]

I am so glad you posted this. I had heard it before and went looking for it to use as ammo against a liberal friend of mine. I couldn't find it. I copied it and will print it off and give it to him. The problem is that it makes too much sense for him to pay any attention to it.

I have pasted it on a number of threads because I like you, think it just says it as clear as a bell.

[Mo1]

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[bvw]

This distribution account is bad. Eliminate corporation taxes. Period. You want ALL companies to pay dividends, as they can. It keeps the ledgers honest. This little gimmick is a big invitation to all sorts of cheats and liars. I con't even begin to plumb the schemes it will generate -- deep sh!t!

[ancient_geezer]

Talking about fairness, this is another example of well-thought-out plans from this administration for all people.

I can think better ways to tax, why bother with an "income" based tax at all. Income based taxes are intrinsically unfair in that they target the contribution of citizens to the nation as opposed the benefit derived from the nation.

Thomas Hobbes from Leviathan

• It is fairer to tax people on what they extract from the economy, as roughly measured by their consumption, than to tax them on what they produce for the economy, as roughly measured by their income

 

John Linder (R Texas) offers a comprehensive bill to kill all income and payroll taxes outright, and provide a revenue neutral replacement based soley on consumption:

H.R.2525
SPONSOR: Rep Linder, John (introduced 07/17/2001)
A bill to promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national retail sales tax to be administered primarily by the States.
Refer: http://www.fairtax.org & http://www.salestax.org

[rwfromkansas]

H.R. 25 this year. Now, hopefully it can get a vote.....

[Taxman]

YUP! A shrewd move, indeed.

Wait'll "W" proposes to eliminate the "Death Tax" in its entirety. And sooner than 2010.

Cannardly wait to see the Liberal/Socialist/Marxist Bastards bloviate and froth at the mouth over this one.

Shoot, before he is done with his tax agenda, the US may, just may, mind you, have a brand new tax code, fit for a modern society in the 21st Century. Why, he might, !GASP! even replace the income tax with a National Retail Sales Tax and abolish the IRS!

Lets Roll, "W!" “I have sworn upon the altar of God eternal hostility against every form of tyranny over the mind of man.” [Thomas Jefferson, letter to Benjamin Rush, 1800.]

We will never be a truly FRee people so long as we have the income tax and the IRS.

Click here to help us scrap the Code, scrap the IRS and abolish the VLWC!

We will never be a truly FRee people so long as we have the income tax and the IRS.

You can also click here to sign a petition in support of Fundamental Tax Replacement.

We will never be a truly FRee people so long as we have the income tax and the IRS.

[bvw]

The reasons for this are simple: Job growth, new products and innovations come primarily from small, fast-growing companies - exactly the kind that don't pay dividends.

This is BS. Utter mentally incompetent BS. Companies don't pay dividends because dividends are taxed.

Now when that tax is removed from corporations, some bright and greedy grifters of CFOs, CEOs and propfessional corporation boosters such as marketeers and flacks will sell "Rosy Scenario" for a premium. It says we can invest your return better than you can. What does that nearly always come to mean? Think about it.

And remember NOTHING prevents an investor from buying more stock in that company with his dividend payment, or even from stopping the company from setting up an automatic dividend re-investment plan.

This, me mates, me buckos, is a robber's litte easter egg of a gift emplaced in a law.

***

And say, look at the "class warfare" all over the following justification for this theft:

If you give big companies an advantage over them, you kill off much of the economy's dynamism.

Big companies, big is bad, eh? Propaganda targeting the mentally weak wacko liberal set.

And it continues ... moe pitching that liberal wacky, "magical thinking" mindset:

But how can you continue to encourage those companies to do their wonderful economic magic and still make the tax code fairer?

[SJackson]

The accountants full employment act of 2003.

I hate to throw cold water on the idea, but the concept of indexing capital gains was dropped because of the complexity of doing the calculations over multiple periods of time. This proposal, which will substitute a multitude of "indexes" for a single one, will be completely unmanageable.

[OK]

I agree with you. This is a gimmick to prop up an overvalued stock market bubble. How would Enron stockholders have benefitted from this? I guarantee you that if we have two more years of sideways to down markets, nobody will want to own stocks that don't pay dividends. I wouldn't buy any mature company that doesn't pay dividends.