Dividends Revisited

Billmon

Awhile back I posted something on the Bush Adminisration's wacko plan to abolish the tax on dividends. (I realize some of you thought it was a bit long, but then there were those who thought Tolstoy's War and Peace was too long, too. Some folk just don't appreciate great literature.)

Anyway, I wanted to return for a quicker hit on the subject: a.) because there are some wrinkles I didn't know about earlier, and b.) because Paul Krugman does a good job of explaining them, here.

Cutting to the chase, this ain't a dividend tax cut. It's a "repeal the corporate income tax through the back door" tax cut.

Why do I say that? Because it turns out that not only will dividends not be taxed, corporate profits that are NOT paid out in dividends (a.k.a. "retained earnings") also won't be taxed.

How's that supposed to work? Companies would tell their shareholders how much earnings they've held back each year; shareholders would keep track of those amounts and would be able to deduct them from any capital gains if and when they sold their stock. Making it, in effect, tax-free income.

But, as you can probably guess, it ain't that simple: To try to keep the cheating from getting totally out of hand, companies would only be allowed to pass out tax-free income IF they could prove they'd paid enough corporate income tax themselves. Presumably, the IRS regs on this would keep the lawyers and accountants fully employed at least into the next century.

But, if corporations would still pay income tax; how is this a back-door repeal of the corporate income tax?

Simple. The whole issue here is the fact that -- theoretically at least -- profits are taxed twice, at the corporate and the individual level. There are two ways to change this: abolish the individual tax or abolish the corporate tax. Either way, the net effect is roughly the same: lower taxes on profits.

So why not just get rid of the corporate income tax? Sure would be cleaner than this nutty scheme. But I guess the Mayberry Machiavellis realized that after Enron, Worldcom, etc., asking for total repeal of the corporate income tax was just too over the top, even for a Republican Congress.

So, voila! "The Tax Complication Act of 2003," as Krugman calls it.

Now that wasn't so bad, was it?

Posted January 13, 2003 09:53 PM | Comments (30)