Finally an economic plan that adds up

President Bush’s critics reacted in predictably uniform fashion to his latest economic proposal: Playing the class-warfare card.

Good luck making that charge stick. America isn’t France. The politics of hate-and-envy doesn’t resonate here like it does in Europe. We want more freedom and opportunity.

Consider the president’s call to end the double taxation of dividends, which is sure to give the stock market a boost and improve American competitiveness. Under his plan, businesses will still pay tax on corporate income, but individual stockholders no longer would have to pay a second layer of tax on that income when it’s distributed as dividends.

There’s no question that a dividend tax-cut would produce growth. Even Marxist economists recognize that investment is the key to long-run growth and rising wages. Yet the tax code punishes investment by taxing the same dollar of corporate income twice. Indeed, it’s possible for the same dollar of income to be taxed up to four times. Discarding one of these extra layers of taxation will encourage businesses to invest more. This will lead to more jobs and higher living standards.

It also will mean higher stock prices. The value of financial assets is determined by how much after-tax income businesses can expect. Removing the second tax on dividends will increase that future income flow and therefore help the stock market. Financial experts say the stock market could expand by about 10 percent under the Bush plan, boosting national wealth by nearly $1 trillion -- welcome news for workers who have watched their IRAs and 401(k) accounts shrink.

But this isn’t just an economic issue. Repealing the double-tax on dividends is the right thing to do. It’s high time government stopped imposing penalties -- or granting preferences -- depending on how people get or spend their income.

The president’s plan promises several other benefits. Under current tax law, for instance, companies are encouraged to use debt, not equity, to finance investments. Why? Because dividends are taxed twice and interest on corporate bonds is taxed only once. If Mr. Bush's plan is approved, this bias disappears and companies will have a strong incentive to strengthen their balance sheets. This would mean fewer bankruptcies.

The tax code also creates a perverse incentive for companies to hoard earnings. Why? Because the double-tax on the earnings they keep (capital gains) is lower than the double-tax on the earnings they distribute (dividends). The president's plan would end this anti-dividend bias, giving companies an incentive to attract investors by offering dividends instead of promising capital gains. This would improve corporate governance (fewer Enrons, anyone?) since firms no longer would feel as much pressure to boost share prices by making unwarranted claims about future revenue. Instead, investors would judge a company by the amount of cold, hard cash it pays its shareholders.

Perhaps most importantly, the Bush plan also would boost U.S. competitiveness abroad. According to a Cato Institute survey, only three of the world’s 30 developed nations -- America, Switzerland and Ireland -- double-tax corporate income. And since Switzerland and Ireland have lower corporate tax rates, this means America has the most punitive and anti-growth dividend tax in the industrialized world.

This is an embarrassment -- and it clearly puts America in a disadvantageous position. About one-fourth of our competitors don’t impose any double-taxation on dividends, while almost all the rest have policies that provide at least partial protection from double-taxation. By ending the double-taxation of dividends, President Bush hopes to bring America from last place to first place in this critical measure of global competition. This means more jobs for American workers and more capital for American companies.

Of course, the president’s opponents began criticizing the proposal before it was even introduced. But their class-warfare arguments don’t make much sense in a global economy. You don’t help the poor by imposing high taxes on the rich. Such policies simply drive money from the U.S. economy and benefit our competitors.

Agreed. I'm impressed with the multitude of issues/problems this president was left with,..and how well he is handling ALL of them.

Seems you can't please some conservatives. Sheesh.. if President Bush was a Democrat, he'd be worshipped like a god for what he is doing. We'd never hear the end of it in the media!!

We are good at being judge and jury regarding SOME conservatives,..and even speeding up their removal from office if they have done wrong. But when they are doing an excellent job like this President is,.. we complain more than we compliment. Go figure!! The information is out there, like this article. But people would rather discuss inane issues, and have b*tch sessions. Reminds me of high school sometimes.

There are issues we will disagree with the President about,.. but 99 percent of the time, we are in total agreement with him.

He is amazingly adept at handling the MESS/JOBS he has inherited and those that come with the office. It is extremely complex, a fact that Clinton didn't seem to grasp. You can't let things just "sit" for 8 years and not have problems. We will see the results of a man DOING his job in the near future. But,. will Americans see it? Will they grasp the complexity of governing a HUGE country in a HUGE World?

We say prayers daily for his success, and for his well being. We remember to give thanks that a man of honor is in high office. A man of principle and foresight.

We are also acutely aware of how important having a Commander in Chief that you respect is to our troops. Sure would be nice if "others" could understand the importance of that, huh?

FRegards FRiend,.. Vets

Growth and Pro-Tax Reform
by Daniel J. Mitchell, Ph.D.
Executive Memorandum #847

January 8, 2003 | |

The Bush Administration has announced a supply-side tax package that will significantly improve the economy and make America more competitive. Its crown jewel is a proposal to eliminate the double taxation of dividend income. This dramatic initiative, which is an important part of fundamental tax reform, will increase investment, improve corporate governance, and attract capital to the U.S. economy.

The White House also has proposed to immediately implement the personal income tax rate reductions that were approved in 2001 but were not scheduled to be fully effective until 2006--fixing a bizarre policy that encourages taxpayers to delay economic activity. In addition, the President is seeking a three-fold increase in the amount of small-business investment that can be immediately deducted ("expensed"), thus reducing a perverse bias in the tax code and taking a further step on the road to fundamental tax reform.

The Problem of Double Taxation
The Internal Revenue Code imposes two layers of tax on corporate income. Companies must pay a 35 percent tax on profits. If the remaining after-tax income is then distributed to shareholders, it is subject to another layer of tax, since individuals must include dividends in their taxable income. Depending on an individual's tax rate, the effective tax rate on corporate income can exceed 60 percent. Moreover, companies generally have to overstate their profits thanks to depreciation, foreign tax rules, and the alternative minimum tax. This income can also be hit by capital gains taxes and the death tax, further exacerbating the tax code's bias against investment.

The President's Solution
The Administration proposes to end the double taxation of dividends by allowing individuals to "exclude" dividends from their tax return, while preserving the current 35 percent corporate tax that is imposed on this income. The President's plan recognizes that dividends are after-tax payments and puts an end to the discriminatory and unfair practice of making individuals pay a second layer of tax on this income.

Alternatively, the double tax could be eliminated by keeping the tax on individuals and instead allowing companies to deduct dividends--similar to the tax treatment of interest payments to corporate bondholders. While both approaches help to ensure that the income is taxed only one time, the President's approach is simpler to administer and promotes privacy, since individuals presumably would no longer have to report their dividends to the IRS.

Multiple Benefits
Eliminating the double tax on dividend income will increase growth by dramatically lowering the effective tax rate on business equity investment. Tax rates currently can exceed 60 percent, making many investments that could be profitable not worth undertaking. The President's bold proposal will result in more jobs for American workers and more capital for American businesses.

The President's plan will have additional benefits. Currently, subjecting dividend income to an extra layer of tax creates a bias for corporate debt. The White House growth package will put debt and equity on a level playing field, encouraging companies to restructure their finances and improve their balance sheets, reducing bankruptcies.

Another benefit is the plan's impact on investors' attitudes. Current tax law imposes a heavier tax on dividends (distributed earnings) than on capital gains (retained earnings). President Bush's proposal will eliminate this anti-dividend bias, and companies will be more likely to attract investors by offering periodic payments instead of promising capital gains. This will improve corporate governance, since firms no longer will feel as much pressure to boost share prices by making unwarranted claims about future revenue. Investors then will be more likely to judge companies by the dividends paid to shareholders.

International Competitiveness
According to a Cato Institute survey, only three of the world's 30 developed nations--America, Switzerland, and Ireland--double tax corporate income. Given that Switzerland and Ireland have lower corporate tax rates, America has the most punitive and anti-growth treatment of dividends in the industrialized world. This is an embarrassment, and it clearly puts America in a disadvantageous position. Nearly one-fourth of our competitors do not impose any double taxation on dividends, while almost all the rest have policies that provide at least partial protection from double taxation. Eliminating the double taxation of dividends can bring America from last place to first place in this critical measure of global competitiveness. This means more jobs for American workers and more capital for American companies.

Making Tax Rate Reductions Effective Immediately
The President also is proposing to immediately implement the tax rate reductions that are scheduled for 2004 and 2006. This is particularly important for short-term growth since workers, savers, and investors now face a perverse incentive to defer economic activity to take advantage of future rate reductions. Making the tax rate reductions immediately effective will encourage people to earn more income and therefore simultaneously boost consumption and saving. The plan also will be a boon for small business, since a substantial share of "upper-income" taxpayers are non-incorporated companies. Equally important, lower tax rates will make America more competitive in the global economy.

Small Business Expensing
The final supply-side component of the President's growth package is a reduction in the tax penalty on new investment. Under a neutral tax system, companies should only have to pay tax on their net income--the difference between total revenue and total costs. Under current law, however, businesses can deduct only a fraction of new investment expenses in the first year and must wait years to deduct the full cost of a new investment. President Bush's tax reform initiative will help reduce this anti-investment bias by increasing the amount of investment that can be immediately deducted ("Section 179 expensing") from $25,000 per year to $75,000 per year. (Ultimately, lawmakers should allow all investment costs to be immediately expensed, a policy that is part of the flat tax.)

Good tax policy will lead to faster economic growth and more prosperity. President Bush's tax plan meets this test and is also an important step on the road to tax reform. Like the flat tax, it is based on key principles of reform, including low tax rates, taxing income only one time, and taxing companies on profit instead of cost. The President's growth package will create a stronger economy today and a better tax code tomorrow.

Daniel J. Mitchell, Ph.D., is McKenna Senior Fellow in Political Economy at The Heritage Foundation.

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