Dubya’s Dividend Delight

Illustration by Robert Neubecker

If President Bush actually understands his own tax proposal, he is smarter than he gets credit for, but I beg leave to doubt. A clear explanation has eluded most journalists who have attempted it, including this one. (My own attempts ended up sounding like the famous Monty Python “Summarize Proust Competition” skit.) “The tax code is too complicated as it is,” Bush declared during the 2000 campaign, warning that his opponent would “make it more complicated.” But the mind of Al Gore never conjured up a mess like this.

One reason the tax code is so complex is that it is clotted with special favors. The complexity serves both to extend the favor and to protect it, since, as Bob Dylan has noted, you can’t criticize what you don’t understand. The Bush proposal to stop—or sorta stop—taxing stock dividends is a good example. Only people whose curiosity is fortified by a direct financial interest are likely to figure it out. The dense thicket of rules and exceptions will drive away, or drive mad, almost anyone else.

The Bush plan is like a pot of soup made by someone who decides it needs more salt, then adds water to make sure it’s not too salty, then worries that it’s gotten too watery and stirs in some flour, then decides it needs more salt. Making dividends tax-free is supposed to correct the tax code’s tilt in favor of retained earnings, but there’s a large capital gains tax break for companies that retain their earnings, in case this new arrangement tilts things too far toward paying out profits as dividends. The plan starts by excluding dividends from a stockholder’s taxable income, then adds rules limiting the exclusion when the corporation itself has taken too many deductions and exclusions, then excludes certain kinds of exclusions from this exception to the main exclusion. And so on.

The Bushies offer three justifications for all this. First, they say, the tax break for dividends will raise stock prices, which will be an immediate kick in the rear for the economy. If I were an economist of the conservative “rational expectations” school, I might reason that a $364 billion tax break for stocks (the estimated 10-year cost of this one) will raise the value of stocks by more or less exactly $364 billion. And when you factor in the knowledge that the government will have to suck that $364 billion back out of the economy by either spending less or taxing more or borrowing more, the net stimulus effect should be approximately zero.

But the administration apparently prefers the conservative-derided “Keynesian” view that the government can stick a dollar into the economy, stir up many dollars’ worth of activity, and get its dollar back. This could be done by building $364 billion of rapid transit systems or buying $364 billion of land for national parks. But that, of course, would be big government interfering with the economy. Better to just try to manipulate the stock market.

A second justification for the Bush plan is fairness. While Democrats have been bellyaching in their tiresome way about how much of this tax break goes to the wealthy—class warfare at its worst, as the president points out—the White House has zeroed in on the really important unfairness, which is to people who own shares of stock. These victims are “taxed twice”: when the corporation pays tax on its profits and when the shareholder pays tax on her dividends or capital gains.

Well, this might be unfair if it were true. But it usually is not. Companies find more and more ways to avoid the corporate income tax. Unlike, say, interest on a savings account or money-market fund, which are taxed every year, corporate profits are allowed to compound tax-free until they are paid out as dividends or the stock is sold. A notorious quirk in the tax law wipes out a lifetime of taxes on stock that is passed on to your heirs. Dividends and capital gains are also exempt from the Social Security and Medicare taxes. One way or another, it is the rare dollar of corporate profits that bears a tax burden heavier than the burden on an employee’s wages.

A third argument is that taxing corporate dividends discourages investment and harms the economy in the long run. It’s true enough that any tax discourages the activity that is being taxed. (An exception might be the estate tax, which this bill would also abolish. Although Bush likes to call it the “death tax,” he does not insist that ending it will encourage people to die.) But for any amount of revenue you think the government needs, lifting the burden of one kind of tax means adding to the burden of another. Republicans ought to believe that the best system is one where the tax burden is roughly the same on different forms of economic activity, so that markets can allocate capital and labor with as little government interference as possible. But Bush seems to be a fiddler.

It’s odd. Stock dividends play a much smaller role in the economy than they used to. Ending the alleged “double tax” is a hardy perennial of conservatives, but it was on no one’s urgent wish list except that of Glenn Hubbard, the chairman of Bush’s Council of Economic Advisers, for whom it’s been a hobbyhorse for years. Now a chorus of Republican politicians and other conservative voices declare daily that taxing a stock dividend check just like a teacher’s salary check is a monstrous injustice and a huge peril to our prosperity. They’re saying it because Bush is saying it—but why is he saying it?

Bush, in a funny way, seems to be a man of ideas. He doesn’t have a lot of them himself, but hand him one and he’ll run with it, undeterred by opposition, or by subsequent evidence and logic. He has the unreflective person’s immunity from irony, that great killer of intellectual passion. Ask him to reconcile his line on Iraq with his line on North Korea and he just gets irritated. Tell him he can’t be for tax simplification and offer a Rube Goldberg contraption like this at the same time and he’ll say, “Oh, yeah—just watch me.”