Posted on 05/30/2003 11:35:00 AM PDT by ModernDayCato
At less than half the Bush Administration’s original January 10-year proposal, the $350 billion tax bill was passed on May 23 by 231 to 200 in the House (Ways and Means Chairman Bill Thomas, R-CA) and by 51 to 50 in the Senate (Finance Chairman Charles Grassley, R-IA).
Stimulating the private sector and fighting deflation now are considered more important than balancing a budget deficit that is said to be caused by the slowing economy and the costs of the fights against terrorism and Iraq (projected 2003 shortfall: ~ $300-400 billion; 2004: ~ $350 billion).
Because of the bill’s sunset provisions, 83% of the bill’s tax reductions are to take place in the first three years; if these cuts are allowed to expire, it may lead to one of the largest tax increases in history; if the expirations get extended, the bill’s cost would be ~ $710-810 billion.
Although not totally satisfied with the bill, given the disagreements among Congressional Republicans, we believe President Bush was happy to have a bill by Memorial Day to get rebate checks in the mail by July.
In 2003, the economic drag from state and local spending cuts and tax increases (~ 0.3-0.7% of GDP) must be weighed against the boost from Federal tax cuts (~ 0.4-0.5% of GDP).
The Senate agreed that Medicaid payments would last only two years and not become a permanent subsidy to the states.
Considerations
The Tax Act may: (i) increase consumer aftertax income and thereby boost household spending; and (ii) reduce taxes on dividends and capital gains and thereby alter investors’ capital allocation decisions, revive the stock market, spur companies to pay out more of their earnings in cash, and stimulate job creation through increased business investment. The estimated Tax Act stimulus, according to Morgan Stanley projections, is approximately $125 billion in the year beginning 7/1/03 (1.3% of GDP).
Whether the tax cut is spent, saved, or invested, it should help households improve their overall financial position.
By raising the AMT exemption through 2004 to $58,000 for married couples and to $42,250 for unmarried taxpayers, the bill should prevent more taxpayers from being subject to the Alternative Minimum Tax. The U.S. Treasury estimates that 2.3 million filers were subject to the AMT in 2002, with this group projected to rise to 40 million by 2013 (pre-the tax bill and before any future AMT-overhaul).
While the Tax Act should provide some degree of short-term economic stimulus, it is deemed to lack the elements necessary to produce longterm growth.
An estimated 58% of the benefits of the bill will go to the 8.6% of taxpayers earning > $100,000 per year, and 5% of the benefits will accrue to the 50% of taxpayers earning < $30,000 per year (according to the Urban-Brookings Tax Policy Center).
The investment behavior of tax-free investors (who receive nearly half of all dividends) will probably not change substantially as a result of the new law.
Owing to their dependency on the future prevailing economic and political outlook, the various sunset provisions may raise doubts in companies’ and equity investors’ minds about how to incorporate and model the dividend tax cut in their financial and investment planning.
The bill does not adjust such “stealth taxes” as the personal exemption phaseout and the limitation on itemized deductions, and should fall considerably short of a meaningful reform in the tax code, ignoring new tax rules for multinational companies and Medicare reform.
It should still be more tax-advantageous for companies to: (i) issue debt rather than equity; and (ii) borrow to repurchase stock rather than pay dividends.
It is possible that over time, U.S. budget deficits and interest rates may be higher than otherwise, with the costs partially offsetting the benefits of a marginal improvement in the tax code. Economic and Tax Implications
Effective 5/6/03: (i) the top long-term capital gains tax rate drops to 15% from 20%; and (ii) for low-income taxpayers, to 5% from 10%, before phaseout in 2007.
Effective 1/1/03, the top dividend tax rate drops to 15% from 38.6%; for low-income taxpayers, the tax is phased out in 2007.
Effective 1/1/03, the income tax brackets decline from: 38.6% to 35%; 35% to 33%; 30% to 28%; and 27% to 25%; reduced withholding from employees’ paychecks in all brackets will begin in July and refund checks, reflecting the higher child tax credit, will be mailed in 3Q03.
Lower taxes on dividends should make common and preferred dividend income from U.S., ADR, and foreign (if the country has a comprehensive tax treaty with the U.S.) stocks more attractive relative to the interest income from taxable straight bonds and bond-value convertible bonds, which will still be treated as ordinary income.
Investors may wish to focus on assets generating: (i) current dividends; and/or (ii) long-term capital gains, rather than short-term capital gains (which are taxed at a maximum Federal rate of 35% rather than 15%). Examples of long-term capital gain type assets include physical real estate, private equity, and venture capital.
It may cost short sellers approximately 30% more to reimburse stock lenders for foregone dividend income (“substitute dividends”).
For mutual funds, the tax act may stimulate: (i) increased investor attention to the expenses subtracted from dividends and other sources on income-oriented stock funds; and (ii) new legislation to allow fund investors to defer capital gains taxes until they sell their fund shares.
Investors may search among the utility, telephone, energy, financial, and selected other sectors for companies with: (i) generous dividend yields; (ii) solid dividend coverage; (iii) prospects for dividend growth; and/or (iv) large cash flow generation (e.g., software and media companies).
Because they are not currently taxed at the corporate level, many REIT dividends and MLP income distributions should generally be taxed at ordinary rates rather than at the new lower dividend rates.
Selected capital equipment companies (e.g., in the technology, telecom, and industrial sectors) may experience increased order activity from businesses purchasing equipment before the increase (from 30% up to 50%) in bonus depreciation expires at the end of 2004.
Because of the decline in marginal tax rates, tax-exempt bonds may in the short term be slightly disadvantaged relative to taxable bonds.
This is sweet and one of the reasons the bears are quickly going to find themselves in even deeper water than they already are. Basically, what it means, is that people who short stocks of companies which pay dividends will still have to pay all those dividends, themselves, but they won't receive any tax benefits for it - so their proportional losses are now going to be even greater than at first blush.
As for the rest of the article, the author obviously leans DemoncRAT and can't bring himself to realize that - unless DemoncRATs are elected in bunches - these cuts are not going away, will only increase in amount, and surely become permanent after the 2004 election.
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