TOPICS > Economy

Dividend Debate

February 12, 2003 at 12:00 AM EDT


PAUL SOLMAN: With the economy barely creeping along, the stock market still somewhat off balance, Pres. Bush’s intention to rev business back up with a dividend tax cut seems as strong as it was when he first proposed it early in his State of the Union address.

PRES. GEORGE W. BUSH: We should strengthen the economy by treating investors equally in our tax laws. It’s fair to tax a company’s profits. It is not fair to again tax the shareholder on the same profits.

PAUL SOLMAN: At issue is the so-called “double taxation of dividends,” a longtime bugaboo for some economists, especially White House adviser Glenn Hubbard.

GLENN HUBBARD: Let’s suppose I earn $100 as a corporation. Currently, I pay tax at the corporate rate, so 35 percent goes to the federal government. If I then, as a company, pay a dividend to you, you then have to declare that dividend and pay tax again, even though I already as a corporation pay tax on it.

PAUL SOLMAN: So corporate profits get taxed twice, thus supposedly penalizing investors, but not if the president gets his way.

PRES. GEORGE W. BUSH: To boost investor confidence and to help the nearly ten million seniors who receive dividend income, I ask you to end the unfair double taxation of dividends. (Applause)

PAUL SOLMAN: Ending unfair taxes, a line Republicans rose to applaud. But what’s the dividend proposal really mean? Well, dividends are that portion of a company’s profits that it divides among shareholders, any company. Harley-Davidson, for instance. Harley has increased its dividend payout at a fast pace in recent years. And Harley has a gang of enthusiasts who own its stock. The president’s plan, says Harley’s CEO, would benefit his stockholders, and thus benefit Harley.

JEFFREY L. BLEUSTEIN: If a dividend that we give them means more to them, they’re just going to love us that much more.

PAUL SOLMAN: As simple as that?


PAUL SOLMAN: The administration’s argument is a bit more complex. It thinks investors are less likely to buy stocks like Harley’s if their dividends are taxed. And when people invest less in a company, that company has less money to spend on expansion.

GLENN HUBBARD: What happens? I do less investment as a company in plant and equipment, in expanding my business, and that ultimately holds back economic growth. It’s something that doesn’t fit well on a bumper sticker, but very, very important for all of our wages and incomes going forward.

PAUL SOLMAN: So the administration wants shareholders like Harley’s to buy more stock, thus boosting Harley’s stock price. And at the Harley dealer convention, at least, there was some evidence that the tax cut would have the desired effect.

PAUL SOLMAN: If the president’s proposal goes through to exempt dividends from taxation, do you suppose that you will buy more stock?

MIKE HAMLIN: I would be selective in what I purchase, but yes, I would be buying more stock.

SCOTT McKAY: I would reinvest the dividends.

PAUL SOLMAN: So more Harley stock?

SCOTT McKAY: More Harley stock, yes.

PAUL SOLMAN: Now, more stock buying should drive up the market – good for consumer confidence, for spending. But also, firms like Harley could sell new stock at the higher stock price, and thus raise money more cheaply, making it cheaper to invest in new projects. It may not fit on a bumper sticker, but this is the main argument for the dividend tax cut.

GLENN HUBBARD: Suppose you’re a business executive and you’re trying to decide, “do I put this new piece of equipment in or a new factory?” you have a hurdle rate. You know, this is a rate the project has to achieve in order to be doable.

PAUL SOLMAN: That is, you don’t gear up for a project if it doesn’t look like it will clear a certain rate of profit after all the costs. But if you can lower your costs, you’ll lower the rate you need to make a profit, make the project an easier ride.

GLENN HUBBARD: By putting in the president’s proposal, we dramatically lower the hurdle rate.

PAUL SOLMAN: You mean the hurdle that a company needs to jump…

GLENN HUBBARD: To jump over in order to make it worthwhile. And so basically what the president has said is instead of two layers of tax in that, we’ll now have one that lowers the hurdle rate, making it much more likely to invest.

PAUL SOLMAN: So the dividend tax cut sounds as logical as an assembly line. But when it comes to taxes, it’s always possible to throw a few wrenches in the works. And wrench number one: even Harley’s Jeff Bleustein, who, you may remember, likes the tax cut, says lowering the cost of money, or capital, won’t induce Harley to invest more.

JEFFREY L. BLEUSTEIN: I don’t think it’s going to make much of a difference. I mean, we are generating enough cash flow in our business to fund our investments in capital items. Our return on that is many, many times our cost of money, so we’re not, you know, we’re not down to that fine line where we’re reducing our cost of capital a little bit is going to mean more investment.

PAUL SOLMAN: In fact, Bleustein thinks, a lower cost of capital and hurdle rate might actually induce investments that shouldn’t be made, a lesson learned in the not-so-distant dot-com days. Responsible investments will depend, Bleustein thinks, on more than a slightly lower cost of capital.

JEFFREY L. BLEUSTEIN: So, no government tax program is going to change that mentality of “Let’s do the right thing for the business, not just to get a tax break,” or something like that.

PAUL SOLMAN: Moreover, says Lee Sheppard, a journalist for the publication “Tax Notes,” companies don’t need cheaper money given current interest rates.

LEE SHEPPARD: The hurdle for the cost of capital is prevailing interest rates. They are very, very low now. That means the cost of capital is very, very low. It doesn’t really need to be lower.

PAUL SOLMAN: Well, but the marginal investment that a firm might make…

LEE SHEPPARD: Has to clear an interest rate hurdle and that’s a pretty low hurdle right now.

PAUL SOLMAN: Also, say critics, American firms already have loads of unused capacity. Is it wise to give them a tax break to build more plants and equipment just now? Of course, the president has a more basic argument as well: The “unfairness” of double taxation. But one response to that is double taxes are everywhere, even here at the convention: on Harley Davidson’s themselves, the various examples of Harley art; Harley accessories.

PAUL SOLMAN: If you want any of Uncle Fish’s Harley jewelry, for instance, you will be taxed.

JEWELER: This is the top of the line Uncle Fish Harley-Davidson item, it’s got the shield running throughout the whole bracelet, and it’s got a carat 30 of diamonds, very fine-quality diamonds.

PAUL SOLMAN: Those are diamonds?

SPOKESMAN: Those are real diamonds, fine-cut, fine-quality diamonds.

PAUL SOLMAN: And how much is this item?

SPOKESMAN: To the dealer it’s $2530.

PAUL SOLMAN: That’s $5,000 retail you will pay for with income that’s been taxed, then in most states, you’ll pay a second tax: A sales tax. In other words, we all see double taxes in our daily lives. Moreover, critics say, corporate double taxation is becoming something of a misnomer, because fewer and fewer companies pay much of a corporate tax at all, much less a double tax.

LEE SHEPPARD: Right now, we’re having a lot of trouble collecting a single level of tax from large publicly traded companies.

PAUL SOLMAN: Sheppard says that, over the years, companies have learned to play the game and steer clear of corporate taxes. Moreover, they’ve even figured out a technique for giving cash back to shareholders without paying dividends: buying back their shares. But here’s another more straightforward problem, say critics, with the president’s plan. It tends to be only the richest among us who actually pay the double tax on dividends. First of all, of course, about half of us don’t have stock at all, but for those who do most hold it in tax exempt accounts like 401K pension plans, plans that are already tax-free.

LEE SHEPPARD: Most regular people, middle class people who own shares, own them in some kind of tax-free account like a 401K account or an IRA or a pension. They’re not getting taxed on the dividends; it’s really a relative handful of rich people who own their shares in taxable holdings, in taxable form who are getting taxed.

PAUL SOLMAN: But the main reason not to race to end the tax on dividends, say critics, may be its cost — both real and potential. First off, the plan will enlarge the federal budget deficit by some $364 billion over ten years. As it is, after all those years of progress on the deficit, we’ve shifted into reverse and are heading back to an era of increasing government debt. Won’t that raise long- term interest rates, make money more expensive, and thus offset the benefits of people buying stock?

GLENN HUBBARD: It is true, on the one hand, that deficits put modest upward pressure on interest rates. On the other hand, this tax change the president has proposed increases long-term growth. We think that the effect of the economy of the growth effects of what the president’s proposing outweigh the effects of the deficit on interest rates.

PAUL SOLMAN: And that’s the key bet that you’re making.

GLENN HUBBARD: That is the key, I wouldn’t call it a bet, I would call it our judgment and the president’s judgment.

PAUL SOLMAN: But that…that’s the key presumption here?

GLENN HUBBARD: That is absolutely an important presumption.

PAUL SOLMAN: Even if this presumption is true, however, there remains one last bump in the road. A dividend tax cut may seem like a small thing, says Lee Sheppard, but…

LEE SHEPPARD: Because of the way the system works, the corporate tax system works, it is actually a very big thing, and it has ramifications across the board. And they cannot all be predicted.

PAUL SOLMAN: You’ve been covering taxes for how long?

LEE SHEPPARD: Nineteen years.

PAUL SOLMAN: How big a change in the tax code is this, on a scale of one to ten?

LEE SHEPPARD: About an eight or a nine. It’s right up there.

PAUL SOLMAN: And with a change that significant come loopholes that thousands of tax lawyers, many of them here on Wall Street, are handsomely paid to find. One is David Miller, who cites a long history of tax games played with dividends at the corporate level.

DAVID MILLER: All of the tricks that corporations have played over the years, individuals can play here, corporations can play here. So it’s just a function of borrowing the tricks and the shelters and the loopholes from past provisions and applying them here.

PAUL SOLMAN: Indeed, the administration has made several changes to its proposal already, in response to problems it hadn’t anticipated. In the end then, there are a host of unknowns and perhaps only one thing certain: that while the dividend tax cut may sound like an issue for the experts, the administration is wheeling out something quite new and significant for the tax code, the economy and thus for us all.