Commentary

A Plea to the Moderates

The tax battle is highlighting the importance of moderate senators hesitant to support the president’s dividend tax cut plan. I grant the moderates that the deficit numbers are a concern. But I ask them to put down their calculators for a minute and consider the millions of families that could use this tax reform to build long-term financial security.

The benefits of dividend tax cuts will ripple through tens of millions of savings accounts across the country. Financial firms will launch pro-saving marketing campaigns to get Americans to put their wages into new accounts holding dividend-paying stocks. When tax time comes each year, families that boosted savings will get their decisions reaffirmed when they see that their dividends were earned and reinvested without the government taking its usual pound of flesh.

Young families would have a great chance to build a nest-egg while sharing in the profits earned by the biggest industrial corporations. Those dividend-paying companies are the backbone of every state’s economy, including Procter & Gamble in Sen. George Voinovich’s Ohio, Textron Inc. in Sen. Lincoln Chafee’s Rhode Island, and Entergy Corporation in Sen. John Breaux’s Louisiana.

The president’s dividend tax reform is not one of those special interest breaks that tax cut-holdout Sen. McCain of Arizona loves to rail against. Instead, the Bush plan will create the broadest benefits and solve a long-standing problem. Indeed, President Franklin Roosevelt’s director of tax research at the Treasury noted in a 1944 report that the “double taxation of corporate profits is the principal problem raised in connection with the corporation income tax. At the present time, corporate profits are taxed first to the corporations, then again to the stockholders when they are distributed as dividends.”

Sixty years later, it’s still a key problem with the income tax. Bush has decided to tackle it by proposing one of the reform options considered in the 1944 report — an individual dividend exclusion. Other studies since the 1940s have recommended similar reforms, including a major Treasury report in 1992. This reform has the highest pedigree, and now Congress has the chance to make it reality.

Senators should know that the Bush dividend tax cut is not a budget vote they might regret later. Just the opposite — this reform will save senators from having to deal with future corporate scandals. The dividend tax creates a major distortion in U.S. financial markets that causes corporations to adopt financial engineering schemes to evade the double-taxation of equity. Goldman Sachs launched Enron into the world of “monthly income preferred shares,” which magically create deductible interest on corporate tax returns but count as equity on financial statements. The Bush dividend tax cut eliminates the need for such financial games. It will benefit Main Street not Wall Street because it will suck the air out of the tax shelter industry, which gains as much as $25 million per deal.

Tomorrow’s Enrons can be avoided by getting companies to pay out earnings and to go to investors to raise capital. Again, let’s go to Roosevelt’s Treasury for insight. A 1937 Treasury report noted that “it has often been remarked that corporate managements are far more prudent in the use of capital funds obtained through formal financing with the aid of investment bankers than in the use of capital funds arising out of reinvested earnings.” The 1930s solution to excessive earnings retention was the wrong one, but the basic idea that more dividends would give shareholders “greater control over the dispositions of their earnings” was understood.

Tax distortions that interfere with sound economics will cause nagging problems for legislators until they pass laws that get the economics right. The great thing about the Bush dividend plan is that it begins to solve both corporate governance and tax-sheltering problems that have challenged Congress recently. Throwing more legalistic Band Aids on these problems won’t work. Instead, the Senate should give economic solutions a chance, beginning with a full dividend tax cut.

Chris Edwards is director of fiscal policy at the Cato Institute.