The Secret of Bush's "Stimulus" Package


By Howard Gleckman Nearly as much misinformation is floating around about President Bush's tax plan as about the possible invasion of Iraq. Much of the debate surrounding the proposed $670 billion tax cut is built around two critical assumptions: that it's an economic stimulus and that it will end the "double taxation" of dividends. Both, unfortunately, are wrong.

Let's tackle the stimulus argument first. At first, the White House claimed the plan would pump $100 billion into the economy over the next year, then conceded it would provide only about $58 billion. Senate Budget Committee Democrats say the stimulus actually would amount to less than $40 billion. Either way, in a $10 trillion annual economy, the impact of such a modest effort at pump-priming would be small. Even some of the White House's most ardent supporters concede the point. Kevin Hassett, an economist at the conservative American Enterprise Institute, says flatly, "It is not stimulus."

So what is it? Well, the centerpiece of the plan, the cut in dividend taxes, is really a longer-term effort to slash taxes on investment. Its benefits, if any, will accrue over many years, as people and businesses use their money in more efficient ways.

BUMPER-STICKER LOGIC. The problem is that all the rhetoric in this debate is misleading. It's a great bit of bumper-sticker logic for Bush to say the plan ends double taxation of dividends. After all, who would be in favor of taxing something twice? Even Democrats wouldn't want to do that.

The Bush plan actually is both more and less than advertised. It's more extensive than most people realize because it would cut taxes not just on dividends but also on capital gains. It's less because it doesn't really end the double tax on dividends.

Let's look at that issue first. Most dividends today are not double-taxed at all. Some are taxed once. And many aren't taxed at all. That's because about half of all investors, such as pension plans, already are tax-exempt, so they pay no tax on the dividends they get. Many companies are so astute in their use of tax breaks that they don't pay any tax either. So, those dividends are already tax-free on both ends. This piece of the plan benefits only dividend-paying companies and their shareholders who pay tax.

PROFIT PICTURES. The Bush plan would do much more than just cut taxes on dividends, though. It would also provide a generous new capital-gains tax break for some shareholders.

To understand how, take a short trip into the arcane world of corporate finance. When a company makes a profit, it can do only two things with the money. It can hang onto the cash -- called retaining earnings -- or it can ship some straight to it shareholders in the form of a dividend. Some companies, such as Cisco (CSCO), bank every dime. Others, such as my employer, The McGraw-Hill Companies (MHP), pay a steady dividend.

Each method can do good things for a company's stock price. To get a dividend, investors will be willing to pay a little more for a share of stock. On the other hand, if a company retains earnings, having that extra cash around can make the company more valuable and boost its stock price.

SHIFTING THE BURDEN. The Bush plan benefits shareholders either way. It would let them get dividends tax-free. But it would also eliminate taxes on the capital gains that result from retained earnings. If you're a shareholder, it's a win-win proposition.

There's one catch. For shareholders to enjoy those tax-free investment returns, the company must first pay taxes on its profits. To the degree a business lowers its own tax bill, investors would have to pay the taxes -- either on dividends or on capital gains when they eventually sell the stock.

Sounds sensible. To get back to the bumper sticker, it might help make sure that corporate income really is taxed just once.

RESTRUCTURED LOGIC. Will it work? Tax experts are deeply divided. Some say the plan will radically change the way companies behave and their shareholders are taxed. Others say it will make very little difference, as companies figure out new loopholes.

Congress is going to debate this plan well into the spring. And everyone will hear a lot about what the proposal does and does not do. But as the debate drones on, forget about that bumper-sticker slogan. The Bush plan is not an end to double taxation of dividends. It simply restructures the way dividends are treated for tax purposes.

Much of it won't affect dividends at all. The bottom line: It's really a $300 billion tax cut on owners of business capital. That might be a good thing. But it's about time policymakers stop talking in code and debate what the plan would actually do. Gleckman is a senior correspondent in BusinessWeek's Washington bureau. Follow his views every Tuesday in Washington

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