TAXATION

Eliminating Tax on Dividends
Won't Spur Economy and
Job Growth

February 2003

By Donald R. Saxon*

I don't get it. I do not understand how eliminating the tax on dividends will spur the economy and create millions of new jobs. It is not clear how the elimination of tax on a source of revenue available to a comparatively narrow slice of our population will work economic wonders. I am a firm believer in the use of the tax code to modify human behavior for the common good — I just don't think this will do it.

Most people who own dividend-paying stocks tend to be wealthy and elderly. Eliminating taxation of this revenue source, which this sliver of our population would receive anyway, will not encourage these wealthy and elderly people to purchase more durable goods. The elimination of this tax will not cause the dividend recipients to buy new cars, television, computers, cell phones, thereby putting Americans to work building and selling such goods.

This is not an issue of "class warfare," tax equality or rich v. poor. The issue is functionality. This simply will not work. Jobs are desperately needed. Some 88,000 jobs were lost in November and 101,000 jobs were lost in December. The elimination of this tax will not put people back to work.

The value of equity stocks may increase in value if dividends paid on those stocks are non-taxable. However, that increase would be temporary and, as of this writing, may have already been absorbed by the market. If the market is to be effective, both as an investment vehicle and as a barometer of economic health, it has to rise or fall as a result of changes in market fundamentals.

A company's stock should increase in value because that company is making better products, making those products more efficiently, providing better and more efficient services, generating more sales, resulting in intra-corporate profit, which allows additional expanded growth, new jobs and more sales. Any increase in the value of a company's stock because the dividends it pays are no longer taxable says nothing about the value of the company itself. Such increased value is artificial and unsustainable.

Better Ideas

There are better ideas, which include the following:

Making dividends paid deductible to corporations: A proposal that has received some publicity is that of making the payment of dividends deductible to the corporate payers. This would be a sea change in American corporate taxation and could very well change the equation involved in business structure and entity selection. However, it may be a good idea. The American system of corporate taxation places American corporations at a disadvantage when competing with companies from other countries. Making dividends deductible to our American corporations will make these companies more profitable, allow them to compete more effectively in the international marketplace, generate more sales, expand and hire more employees.

Corporations have little incentive to distribute profits because profits distributed in the form of dividends are non-deductible for federal and state corporate tax purposes. Deductibility of dividends will encourage more companies to distribute dividends. Microsoft has $40 billion in cash; many other high-tech companies also are cash-rich. If dividends were deductible either from current or accumulated earnings and profits, cash-rich companies would be encouraged to distribute some of that cash to their shareholders. The shareholders of growth/tech companies are demographically diverse. They include people more likely to spend distributed dividends on durable and other goods/services. Corporate deductibility of dividends will place a lot more money in circulation and create additional disposable cash.

There will be little, if any, loss of revenue. In fact, there may be an increase. The top individual rate is higher than the top corporate rate. The tax revenue is not disappearing, as it would if the dividends were non-taxable. Rather, taxation on that revenue is being shifted to the persons who receive the dividends, many of whom will be paying tax at a higher rate than will the corporation that issued and deducted the dividends.

Re-enactment of the Investment Tax Credit: The biggest loss of sales and jobs has occurred in the high-tech and communications sector. We need to get people buying and leasing durable equipment. It is the manufacture and distribution of durable equipment that provides the strongest long-term stimulus to the economy while employing our citizens in high-paying jobs. An ITC with which business enterprises could receive a tax credit for the purchase of durable goods would spur the purchase of those goods much more quickly than any general tax reduction. If the credit covered both computer hardware and software, there would be an incentive for businesses to acquire new systems or upgrade old systems and would put a lot of people back to work building and designing hardware and software systems.

The parochial value of this benefit could be enhanced by limiting the ITC to the acquisition of products manufactured in the United States.

Government acquisition: Although the ITC will help, we need more buyers. One of the largest buyers of equipment is the U.S. government. Many government computer systems are antiquated and need to be replaced. Perhaps now is a good time to make those purchases. Commissioner Charles Rossotti began requesting modernization of the IRS computer systems the day he took office; I am sure current acting Commissioner Robert Wentzel is of like mind. If the IRS bought the equipment, software and other services that it needs, this would put a lot of people to work, designing, building and installing the hardware and software systems.

There may be other federal government acquisition programs that could be accelerated, providing a shot in the arm for the economy.

In summary, eliminating tax on dividends received will not put more money into shareholders' hands, and it will not provide the economic stimulus needed. Allowing corporate deductibility of dividends paid will result in greater distribution of funds to a wide variety of shareholders, many of whom will use those funds to buy durable goods.

This change, combined with re-enactment of targeted tax incentives, such as the ITC and additional governmental spending for needed products and services, provides the best opportunity for economic stimulation.

*Donald R. Saxon is admitted in New Hampshire, California, and Nevada

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