Alan Reynolds

I recently worried that the Senate Finance Committee's efforts to slice up a low-calorie tax snack would turn into a stew with too many turnips and not enough beef. That is exactly what happened. Instead of eliminating or reducing the individual tax rate on dividends, the committee opted for a zero tax on the first $500 of annual dividends -- taxing all but 10 percent of any extra dividends at full income tax rates. This antique was reportedly dusted off by Olympia Snowe, Republican from Maine.

Before launching this attempted policy coup, CQ Today noted that the committee booted all economists from the room. Easy to see why. Mixing middling tax exclusions with steep tax rates is the textbook definition of foolish tax policy -- it keeps high marginal tax rates on a thin tax base. And that minimizes economic benefits while maximizing revenue lost: no bang for the buck.

The Economist figures the Grassley-Snowe scheme reduces individual's half of dividend tax collections by merely a fifth. Yet Sen. Grassley boasts that 86 percent of investors would be exempted from the tax. That means the other 14 percent of investors have been paying 80 percent of this tax, and Grassley's committee now wants the select few to pay 100 percent. Good luck. There's a sucker born every minute, as honorary economist P.T. Barnum taught, but more turn out to be mediocre senators than good investors.

In Washington, sticking 14 percent of taxpayers with 80 percent to 100 percent of any tax is described as "fairness." And cutting any tax is described as "regressive." Brookings Institution scholars Bill Gale and Peter Orszag, for example, condemn the Senate Finance Committee bill as "regressive" because "more than one third of filing units would receive no benefit." They receive no benefit for the same reason they are called "filing units" -- they are not taxpayers. That is also why opinion polls find that more than one third of these filing units don't give a hoot about tax cuts: They are not taxpayers, and few are voters.

The twin notions that all tax cuts are "regressive" and that having a few people pay for government is "fair" can be statistically massaged into a "distribution table." Such tables purport to show how much of any tax cut goes to taxpayers at various income levels. But the only way to do that is to start with the incredible assumption that people will hold the same shares of dividend-paying stocks in taxable accounts if dividends are taxed at 15 percent to 20 percent as they did when dividends were taxed at 39.6 percent.

Alan Reynolds

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