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Critical Days
Bush must make some tough decisions about the tax cut.


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President Bush’s plan to eliminate the double taxation of corporate profits, by exempting dividends from taxation, appears to be on life support. Even before his tax package was reduced from $726 billion to $550 billion in the House and $350 billion in the Senate, the proposal was in trouble. Now, it looks very sick indeed.

There are many reasons for the failure of the dividend plan. It was never very well understood because the Treasury Department didn’t issue a report explaining its rationale in detail. Its principal advocate, Council of Economic Advisers Chairman Glenn Hubbard, left after being denied the job of Deputy Secretary of the Treasury. And President Bush’s attention has obviously been focused elsewhere.

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But there are really two key reasons why the dividend plan never picked up traction. First is an utter lack of support in the corporate community, and second is concern that eliminating taxes on dividends may not provide much of a short-term stimulus to the economy.

The lack of support for the dividend plan among corporate executives is not surprising — in fact, it is a sign that President Bush is on the right track. They don’t want to be forced to operate their businesses for the benefit of its owners, the shareholders. They would rather continue to run them as personal fiefdoms, paying the corporation’s earnings to themselves instead of paying dividends.

One of the least well-understood reasons for President Bush’s plan is that it would help correct the corporate governance problem evidenced by the Enron, Worldcom, and other scandals last year. As long as profits are double taxed, executives have a good reason not to pay dividends. But without dividends, shareholders are totally dependent on earnings reports to tell how well their investments are performing. As we now know, these proved to be too easily doctored by executives needing to hit quarterly earnings targets in order to get stock options. It was a system open to abuse.

By encouraging corporations to pay out their earnings to shareholders, the dividend plan would impose discipline on corporate executives and force them to manage on behalf of the corporation’s owners rather than themselves. Precisely for this reason, they oppose the president’s plan. But fearing a political backlash, none will say so publicly. Instead, corporate lobbyists simply did nothing to support the plan.

At the same time, continued slow growth in the economy has made the need for short-run stimulus more pressing. The dividend plan was always more tax reform than short-run stimulus. But with full recovery still ahead and a presidential election next year, attention has shifted toward stimulus and away from reform.

The only way the dividend plan could be viewed as stimulative is if it has a sharp, positive impact on the stock market. If it provided a 20 percent bounce, as some economists thought was possible, then this might stimulate investment spending by businesses and improve consumer confidence. But if the dividend plan is watered down to a 50 percent exclusion at most — as seems inevitable — then there is no reason to think that the stock market will react enough to matter economically.

Consequently, many insiders are now saying that it may be prudent for the president to withdraw his dividend plan and resubmit it later as part of a tax-reform package. Given that the full plan, with its $400 billion price tag, is politically impossible now, it makes more sense to reprogram the revenues into other areas with more potential stimulus.

Many economists think that increasing depreciation allowances would do more for the economy now. This would encourage businesses to invest in new capital equipment because that is the only way they would get a tax saving. One popular idea would be to allow a 100 percent write-off for high-tech equipment in the year of purchase. With lagging capital spending being the economy’s principal weak spot, such a proposal would directly target that spot.

If President Bush insists on pressing forward with his dividend plan under these circumstances, I fear the following: a dividend exclusion that is so severely watered down that it will have no meaningful economic impact, but which uses up all the revenue available for true stimulus, making it impossible to enact something like expensing for high-tech equipment. The result could be a worst-case scenario — large revenue losses with no economic stimulus and, perhaps, a weak economy going in to 2004.

In coming days, President Bush will have to make some critical decisions about his tax plan as the House Ways and Means Committee and Senate Finance Committee begin to mark-up a bill — a task that they must finish by May 8. He should not let pride in his own proposal stand in the way of achieving something that will help the economy now.



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