President Bush has surprised nearly everyone with his decision
to propose a big-bang economic growth package that includes a 100 percent
tax exemption on dividends received by individuals. Eliminating the double
taxation of corporate dividends will raise stock-market values, increase
investor returns, and improve both corporate governance and corporate
finance practices, in effect becoming the most significant pro-growth tax
reform since President Ronald Reagan slashed personal income-tax rates 20
This policy change will lower the effective tax rate on
dividends paid from corporate profits to 35 percent from roughly 70 percent.
Taxpayers receiving dividends will now keep 65 cents of each new dollar of
corporate profits, rather than the 30 cents they now retain under current
Since individuals and businesses spend and invest their money
more wisely than government, this tax reform will make the economy more
efficient and better able to grow to its potential. The move will also free
up more investment resources for shareholders and corporations, thus making
more funds available for entrepreneurship, business expansion, and job
creation in the years ahead.
Investors, of course, will now demand greater dividend payouts
from companies -- a good thing. Cash dividends will be tax-free, while
interest payments from corporate bonds will be taxed at the top personal
rate (which could drop to 35 percent under the president's new proposal).
Shareholders will keep 100 cents on each new dividend dollar, compared with
only 65 cents on each dollar of interest paid from corporate bonds. That
will force corporations to reduce their issuance of new debt and rely more
heavily on dividend-paying stock finance.
This tax-induced shift in shareholder demand from
interest-bearing bonds to dividend-paying stocks will have wide-ranging
benefits. It will stop firms from over-borrowing and debt leveraging up to
their eyeballs -- a practice that has worsened economic downturns and
hastened business bankruptcies. And as the system of corporate funding
better balances equity and debt, the business sector will grow healthier and
the economy stronger.
Also, a new model of corporate governance will take hold. Just
as taxpayers wish to keep more of what they earn from the government,
tax-free dividend payments will encourage shareholders to demand more of
what corporations earn. This will force companies to reduce their excess
cash-on-hand and pay more money out to their shareholders.
In recent years, too many CEOs have used corporate cash for
ill-conceived acquisitions that all too often put empire-building over
higher shareholder returns. Now, boards of directors will pressure
management to turn the cash over to investors. This change in corporate
behavior will streamline operations and avoid the failed
over-conglomeratization that sank stock market prices in the 1990s,
especially in the telecom, media and energy businesses.
Many firms, especially technology companies, will now be forced
to start paying out their unnecessarily high cash balances to shareholders.
Outfits like Microsoft, Cisco and Dell will undoubtedly go down this road.
Additionally, investors will more often judge corporate
creditworthiness on the basis of dividend yields (dividends divided by stock
prices), instead of conflicted research reports. In fact, greater dividend
payouts and yields will become the key benchmarks in judging the worth of
All this should be a much-needed tonic for the major
stock-market indexes. Since the current economic slump began in 2000, the
stock-market decline has been the economy's central problem. Shrinking
market capitalizations have damaged corporate creditworthiness and frozen
business operations. In all too many cases, huge stock-market losses induced
CFOs to play fast and loose with accounting ethics. Investor confidence
evaporated as Worldcom, Enron, Tyco, Adelphia and a list of others grabbed
the headlines. So, last year was the first since 1912 that an early economic
recovery was accompanied by a plunging stock market.
Bush's bold decision to eliminate the double taxation of
corporate dividends will help restore investor confidence and the vitality
of American businesses. Since business creates jobs, a healthier corporate
sector is crucial to a full flushing-out of the nascent expansion.
The Bush administration's new growth package will also include a
speed up of income-tax cuts for all brackets, a substantial cash-expensing
bonus for small business equipment write-offs, and a quicker implementation
of child tax credits and marriage-penalty deductions. Democrats, of course,
are dusting off their class-warfare arguments, criticizing the Bush plan as
another tax cut for the rich. But this is a content-less position that has
failed miserably in recent elections.
The president has correctly understood his midterm election
mandate to grow the economy and win the war against terrorism. On the war
front, he has proven his mettle since Sept. 11. And on the economy, he is
clearly willing to invest his new political capital in pro-growth tax
measures, as well as pro-market reforms for health care and prescription
drugs. The nation will benefit enormously as he moves swiftly on all of