Taxes, Taxes, Taxes
The Bush administration is expected to propose an economic stimulus plan that would exempt 50% of an individual's dividend receipts from taxation. Other facets of the plan include a targeted tax credit for corporate capital expenditures, an acceleration of income tax cuts currently scheduled for 2004, and an extension of federal unemployment benefits. What is conspicuously absent is a Democratic suggestion to reduce payroll taxes for lower-income workers. Aides are concerned that the President is vulnerable to charges from Democrats that he is focusing on higher-income taxpayers, and had encouraged him to drop the plan to accelerate the 2004 cuts.
“If you pay taxes, you’re due tax relief, and the time that it’s needed most is now, as opposed to later,” the official said. “The president is concerned about helping those who are shouldering the burden of this recovery.”
Nearly everyone pays taxes in one form or another. Yet not everyone is going to get the tax relief they are apparently due under this plan. Any meaningful tax reform cannot look at income taxes in a vacuum, as though they are the only taxes that matter. Furthermore it is not only the higher-income taxpayers that are shouldering the burden of the recovery. Lower-income taxpayers consume goods as well, and they spend a higher percentage of their income to do so. They deserve tax relief, and the best way the federal government can provide it to them is to reduce payroll taxes. The President says he does not want to, because it would endanger Social Security. I submit that he should acquiesce to the Democrats on this, and then turn it around and use it as a spur towards Social Security reform.
I also object strenuously to the characterization of rate cuts for higher-income taxpayers as the primary means of economic stimulus. The consumption rates of lower-income taxpayers are much higher, since there is a certain level of consumption that one almost needs to do in order to survive (generally referred to as fixed consumption). In uncertain times, it is not a given that higher income taxpayers will use the additional disposable income for consumption, since their fixed consumption is already well covered. They may, in fact, choose to put it in safe investments, such as government bonds rather than even equities. Lower income taxpayers have a higher probability of using the additional disposable income for consumption.
If the idea is that the higher income taxpayers create wealth by creating jobs, than the tax cuts should be targeted at companies, not individuals. This is why I favor the targeted tax credit for capital expenditures. Such a credit will incent businesses to purchase capital equipment, driving up the revenues of the manufacturers and resellers, which could lead to new jobs. However, reports say that the acceleration of rate cuts is likely to be dropped as part of a compromise anyway.
Nor do I see how a tax cut on dividends provides much economic stimulus. The logic appears to be that it will improve investor confidence and encourage people to invest in profitable companies. I don't see how dividend tax cuts improve investor confidence. Investor confidence has been shaken by a series of accounting scandals and concerns over analyst independence, not by taxation of dividends. I further don't see how this encourages people to invest in profitable companies. Many highly profitable companies do not pay dividends (see also Microsoft). Indeed, profitable companies in aggressive growth industries rarely pay dividends, preferring to reinvest all corporate profits in growth strategies. It is usually the more mature companies that pay dividends. While I do think it is sound long-term policy, and in fact would prefer to see 100% of individual dividend receipts be tax-exempt (as it ends double taxation), I simply do not see it as much economic stimulus.
All in all, the only facets of this plan I see providing economic stimulus are the targeted tax credit for capital expenditures and the extension of unemployment benefits (as it will almost certainly be used for consumption). In fact, I wouldn't even say the extension of unemployment benefits will lead to stimulus as much as it will prevent decline. I have to say I'm disappointed in the reported plan.
Comments
Here's where you are wrong: consumption isn't the problem. On the contrary, consumer spending and confidence are what pulled the economy through the recession, while investment is still pretty much dead.
Nobody, I hope, believes that having tax free dividends and tax breaks for the wealthy will encourage consumption, the rich consume all they want anyway. But it will help investment. And this is what the government needs to do.
Besides, like Fred Barnes writes in the Weekly Standard, the President doesnt need to give in to the Democrats on anything. He has to revitalize the economy. If he's successful, he will be reelected, if not, the Dems will come after him remorselessly, without his compromises helping him one bit.
Posted by: pampam | January 4, 2003 03:39 AM
You didn't say how not taxing dividends will encourage investment right now. It does not address the root causes of why investment is lagging, which are not in any way related to taxation of dividends. To stimulate investment, those root causes need to be addressed. This is a good idea which doesn't go far enough, but it isn't stimulative.
I was also not suggesting he give in to the Democrats because he needs to. I was suggesting that he do it so that he can then turn around on them and push for Social Security reform, something he and the Republicans claim to want. The Democrats suggested this concept, and they are the ones who usually protest any kind of cuts to Social Security. Wouldn't this then be an opportunity for the Republicans to press forward the case that Social Security needs reform, especially since there will be even less revenue flowing in to the system? Roles seem to have changed, with the Democrats pushing for cuts to Social Security and the Republicans worried about compromising it. Makes me doubt whether Republicans are really interested in Social Security reform at all, and wonder if they just talk about it to get libertarians to vote for them.
Posted by: Lesley | January 4, 2003 07:12 AM
As much as I would like to see payroll tax relief for philosophical reasons unrelated to the current economy I don't believe it or any other proposed tax plan will have a possitive impact on the economy. We have to remember how the current downturn began and look at what is sustaining it. We are where we are because of a market correction to the investment bubble of the 90's it was inevitable and was being predicted throughout the late 90's so should have come as no surprise. Had that been all there was to contend with investments would have begun there slide in late 99, as they did, and would have begun a gradual long term recovery, probably by early 2001 or so. But more came, much more.
In September of 2000 the second intifahda began (following the June collapse of Camp David) which led to fears of regional instability and rising oil prices and all this in the midst of a growing energy crisis in California that began with deregulation just when several other States were on line to deregulate. All this served to worsen the mood of investors during the bear market that was still in decline. All this was followed by the election crisis the following november. All though the election of 2000 may seem like no big deal in retrospect remeber it was the first such crisis since 1876 and had the media, ignorantly, howling constitutional crisis. Not good for investor confidence.
All this was followed by the hint of something smelly at Enron in the summer of 2001, follwed by 9/11, the collapse of Enron, the war on Terror including the invasion of Afghanistan, a sereis of Israeli invasions in to the West Bank and palestinian terror attacks on Israelis, Anthrax scares, the announcement of shady dealings at Global Crossing and a host of other large business's, mixed signals from the Bush administration on Israel-the Economy-Big Business-and evereything else that wasn't terror related, the arrest of several dozen corporate execs. Harvey Pitt, the Axis of Evil, building towards an unpopular war with Iraq, Nukes in North Korea and so on and so forth.
My point is what started out fairly benign has evolved in to something very differnt. The world is a very very different place now than it was just three years ago when this bear market began.Making future plans, investment or otherwise, is difficult because no matter where you turn what you see is instability and potential chaos. We are a world in crisis and on the verge of major upheaval. We all know it, but carry on anyway. But asking investors to find the confidence to invest in this situation is asking for the miraculous. Without the assurance of a reasonable measure of return investment is unlikely and at present NOTHING presents a picture of reasonable return, the future is just to uncertain.
So there is no tax measure or any other stimulus plan the Bush administration can offer that will strengthen this economy. Only a sense of returning global stability will do that. The Bush adminisrtation should be looking at ways to bolster those sections of the economy that are suffering the worst now and likely to suffer in the comming years while we work our way through the comming period of upheaval.
Posted by: Dietz | January 4, 2003 08:24 AM
Reducing taxes on dividends may affect people's investment patterns, but I don't think it will spur more investment in stocks. Lower dividend taxes may prompt investors to buy dividend vs. non-dividend stocks, not to buy more stocks in general. Whether that stimulates the economy is a question I can't answer without having seen the research - are people better off with capital gains than with dividend payouts? Presumably, capital gains provide more income than a stock dividend, but that depends on how good the average investor is at picking stocks that appreciate in value.
Posted by: Jon | January 4, 2003 10:13 AM
what makes taxes on dividends a bane to investment is probably very self-interes oriented and simple.
people don't like being taxed twice for the same thing. in this case, they make earnings on a stock investment, which produces more interest on the stock. they are taxed when they "realize" these earnings. then, let's say the company pays out dividends. well, then they get taxed for earning income again on it.
i say stocks shouldn't pay dividends, and the tax on dividends had a stimulating effect on stock investment, to counter what i said before. see, if a company is paying dividends that goes to me. shouldn't the money go instead to the company, to make that stock worth more?
Posted by: d fresh | January 4, 2003 05:01 PM
That really depends on where the company is in its lifecycle. Companies in the growth stage should not pay dividends, as their profits are better spent investing in future growth strategies. Companies that are mature, cash cows, or in saturated markets should pay dividends. Paying dividends does increase the price of a stock, since the investor expects not only a capital gain, but a regular dividend payment as well. What it should come down to, all things equal, is whether the premium you will get paid for issuing dividends is greater than the increase to the price from investing in growth strategies.
Most companies who do pay dividends are the mature ones, so the individual investors who buy their stock are doing so in many cases for the dividend income rather than capital appreciation. This is a common strategy for senior citizens, who receive approximately 25% of dividend payments in this country. It is their intent to hold the stock until their heirs inherit it. Institutional investors, who may be buying the stocks for portfolio diversification among other things, are exempt from paying the tax on dividends anyway, so they are indifferent to it.
Posted by: Lesley | January 4, 2003 08:03 PM
wow. that opens some ideas up. more later?
Posted by: d fresh | January 5, 2003 12:30 AM
Sure. Any time. I'm a finance geek.
Posted by: Lesley | January 5, 2003 11:20 AM