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Dividend Days
The Bush administration has made the correct economic diagnosis.


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Larry Kudlow

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.

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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% from today’s 39%, 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 class.

Essentially, a 20% dividend tax rate for individuals equates to a 30% reduction in the tax cost of capital as well as a 30% 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% boost for equity asset values.

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 accountants.

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. More, 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 retro-active to January 1.

Oh, and by the way, dividend tax relief will realign the investor class into the waiting arms of the GOP.



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