In law, the punishment must fit the crime. In medicine, the cure
must not be worse than the disease. In the economy, a fix can only be made
if the problem is identified and understood.
For nearly two years, Washington's economic cure-all has been to
throw temporary tax rebates and spending subsidies at consumers. But
consumers were not the cause of the much-lamented recession. Rather, it was
caused by a stock-market collapse and a profits crunch that destroyed wealth
and eviscerated credit.
Finally, the Bush administration has made this correct economic
diagnosis -- and it now can start working on the cure.
To remedy sinking equity values and impoverished investor
returns, the Bushies are about to propose a reduction in the double tax
burden on corporate dividends. Today, these valuable company payouts are
taxed once at the corporate level as profits, and then a second time at the
personal rate when they are received by investors.
Under current tax law, for every dollar of profits earned by a
company, Uncle Sam keeps 60 cents and the private sector gets only 40 cents.
Yet if the White House reduces the dividend tax rate for individuals to 20
percent from today's 39 percent, leaving the corporate tax rate on dividends
untouched, the private sector will keep 52 cents for each corporate dollar
of profit. Rather than the bulk of the money going to Uncle Sam, the
risk-taking investor class will be rewarded with the larger share.
The Bush economic team has been largely divided since its
formation almost two years back. Last September, the team's supply-siders --
Larry Lindsey and Glenn Hubbard -- lost out to deficit-mongers Paul O'Neill
and Mitch Daniels in the debate over the double taxation of dividends. But
as the saying goes, what a difference a year makes.
Today, Lindsey and Hubbard -- Bush's pro-growth economic
advisors -- are poised to win out with the strong support of Vice President
Dick Cheney. Their victory represents the beginning of the battle to
completely end the double taxation of dividends.
And that battle will appropriately start with the investor
Essentially, a 20 percent dividend tax rate for individuals
equates to a 30 percent reduction in the tax cost of capital as well as a 30
percent rise in return on investment. This will translate to a like increase
in the overall stock market. Think of it like this: With earnings remaining
at the same volume, the dividend tax cut and the related increase in
after-tax capital returns provides a 30 percent boost for equity asset
The rate of new capital formation will improve, too, as the tax
bite diminishes. The government will get less and the private sector will
keep more. With more available capital (after-tax), and with the higher
amount of capital yielding a better rate of return (after-tax), the economy
will grow at a healthier rate.
The dividend tax-cut plan will also force better corporate
governance. At lower tax rates, shareholders will clamor for higher
dividends. This will force CEOs to send surplus cash back to the
investor/owners, rather than use it on empire-building schemes or ego-driven
acquisitions. The public will begin to judge the worth of companies by the
dividends they pay, rather than the flawed scorekeeping of hired-gun
Meanwhile, the increased demand for dividends means that
companies will no longer be able to over-leverage themselves by borrowing
huge gobs of debt. When rainy day downturns come, as they always do, firms
will be better inoculated because dividend-receiving investors made them
keep more green cash on hand.
Higher dividends will transform business behavior. Cash-heavy
tech outfits, like Microsoft, Cisco and Dell, will start paying dividends --
pronto. Stock-market values in sectors like utilities, REITs, financials and
pharmaceuticals will benefit because they already pay dividends. And as
greater dividend payouts enhance the value of the entire stock market,
government tax coffers will overflow with revenue from new capital gains and
dividend tax payments.
In other words, as investment tax rates descend,
investment-related tax revenues will rise -- a perfect application of the
Laffer Curve. Moreover, when increased investment capital is used more
efficiently, the whole economic pie expands. That means new jobs and new
revenues at the same time.
All in all, a new Bush proposal to lower the dividend tax burden
is a win-win. To maximize the economic-growth leverage of this big-bang
plan, Congress should announce as early as possible that the measure will be
made retroactive to Jan. 1.
Oh, and by the way, dividend tax relief will realign the
investor class into the waiting arms of the GOP.