The high-income builder's subsidy

Alan Reynolds
Posted: Feb 27, 2003 12:00 AM
Of all the illogical arguments against ending or easing the double-taxation of dividends, none is quite as ridiculous as those who claim the same tax treatment should be given to investments in which no double tax is involved. When the Bush tax plan first came out, a few critics actually complained that tax relief applies only to mutual funds that invest in stocks, not to so-called dividends from funds that invest in bonds. That is because such nominal dividends are really interest payments that are (SET ITAL) not double taxed because corporations deduct the matching interest expense. Others complained that the Bush plan does not exempt all dividends at the corporate level. But that is because more than half of such dividends are not double-taxed because they are paid to tax-exempt institutions, pension funds and foreign investors. Meanwhile, the uniquely cheeky municipal bond lobby is arguing that interest income from tax-exempt bonds held by banks or insurance companies should entitle their shareholders to dividend tax relief, although there is not even a single tax on tax-exempt interest, much less a double tax. The latest gripe, from the tax credit lobby, is just a variation on this same avaricious theme. A few industries favored with tax credits claim they should be allowed to pretend that the full corporate tax has been paid when calculating dividends exempt from personal taxes. The housing lobby even bought a report from Ernst & Young that brazenly proposes "treating Housing Credits as taxes paid." Never mind that these tax credits are the exact opposite of taxes paid. Tax credits are taxes not paid by companies and therefore not double-taxed. "Tax Credits Lose Appeal in Bush Plan," screams a recent Washington Post headline. "Under Bush's proposal," the article explains, "companies would have to choose between taking the credits and foregoing them to give tax-free dividends to their shareholders." This is K-Street lobbyist gibberish. Tax credits are worth 35 cents on the dollar. Foregoing the tax credits would mean choosing to instead pay the equivalent sum in extra taxes. To forego $1 million of tax credits would not leave a company with an extra $1 million to pay as dividends. It would just leave the company owing $1 million more to the IRS, and therefore with $1 million less to reinvest. Perhaps this alleged choice was supposed to mean the company might choose to pay dividends rather than make an investment subsidized with a tax credit. But that, too, makes no sense, because the investment would produce future income, which should be reflected in higher stock prices. Even the most generous of dividend-paying corporations rarely pay out more than 30 percent to 40 percent of after-tax profits as dividends. The rest is retained and reinvested, and the less paid in taxes the more to reinvest. More assets per share means higher share prices, resulting in capital gains for shareholders. Since individual investors pay only 20 percent on the resulting gains, they would not want to see companies shun tax credits worth nearly twice that much. The tax credit that has attracted the most lobbying effort and press attention, though it is just one of many, is "the low-income housing tax credit." Naive reporters may assume this subsidizes people with low incomes, but the loot really goes to high-income builders and investors. It would be no different if Congress enacted a "low-income auto tax credit" to bribe Ford and General Motors to make 40 percent of their cars really cheap and tacky. Low-income people are not the ones lobbying for third-rate housing projects any more than they are lobbying for GM to reproduce Yugos. People on a tight budget find better value in used cars and older homes. Housing economists, such as Edgar Olsen of the University of Virginia and Ron Feldman of the Minneapolis Fed, have always been highly critical of the congressional pretense of helping poor people by subsidizing builders. The low-income housing credit pays 70 percent of the cost of developing a project. Such projects are usually developed by limited partnerships that sell the tax credits to corporations, including Fannie Mae and Freddie Mac. Only 40 percent of these heavily subsidized apartments have to be made available to those with an income at or below 60 percent of median county income, which is rarely very poor. In a study for the National Bureau of Economic Research (, Olsen notes that "well before they reach the midpoint of their useful lives, these projects have provided less desirable housing than the housing occupied by voucher recipients." A less critical study by Wharton School scholars Todd Sinai and Joel Waldfogel finds that "on average three government-subsidized units displace two units that would otherwise have been provided by the private market." If tax credit lobbyists were able to persuade Congress to treat tax credits as if they were taxes, The Washington Post figures this "would increase the cost of the dividend proposal by as much as 50 percent." That is a revealing measure of how much these tax credits are worth to those who get them. If the tax credit lobby makes too much noise opposing reasonably fair taxes for investors in industries that actually pay taxes, they just might find the effort backfires by calling unwelcome attention to their often quite dubious hidden subsidies. Despite the heroic illogic of special interests asking Congress to treat tax credits as if they were taxes, some politicians sometimes do put well-organized special interests above the broader interest of the investing public. Capitulating to the tax credit lobby may even appear politically safe, since the biggest section of that gravy train was cleverly labeled as a "low-income" subsidy. Follow the money, however, and you will find it is coming out of your pockets and going into the pockets of interest groups whose incomes are anything but low.