A Boon to Ordinary Investors

This op-ed originially ran in the Washington Post on Tuesday, March 11, 2003; Page A23

I believe there is an urgent need to pass President Bush’s plan eliminating the double taxation of dividends. Such a change would revive investor confidence in equity investing, restore an appropriate balance between the interests of corporate executives and shareholders, and create new jobs.

The need for a bold tax proposal is greater than at any time in the past half-century. For nearly three years, investors have watched the value of their equities shrink as the stock market bubble burst. At the same time, a series of high-profile corporate scandals has evoked outrage and distrust, and investors remain sidelined with concerns about the long-term threat of terrorism and the immediate risk of war with Iraq. With all these factors contributing to the shakiness of the economy, a boost to investor confidence has to be a priority of tax policy.

Bush’s call for eliminating the double taxation of dividends is exactly the kind of response that is required. Since it was announced in January, however, the plan has had a mixed reception. Critics have called it a sop to the rich and suggested it won’t provide immediate stimulus to the economy.

I disagree. I have been working with investors for more than 40 years. I can’t think of any other tax policy that would, at one stroke, be more beneficial to ordinary investors.

The impact would be enormous. In the short term, I would expect to see the stock market rise 10 percent to 15 percent, sending an immediate bolt of renewed confidence through our entire economy.

Over the long term, corporations would go back to focusing on returning money to their investors. Stock ownership would mean more than merely hoping that the share price climbs higher.

At its most basic level, our current dividend tax is unfair. Companies pay a corporate tax when they earn a profit. But then, when they pay out a dividend to shareholders, that same money is taxed again at the individual level. Hence corporations decide that the double tax is inefficient. As a result, they stockpile their cash rather than rewarding shareholders for their investment.

That doesn’t make sense. We should encourage companies to reward their shareholders, even when the stock market is flat. If more companies paid dividends, stocks would once again have intrinsic value. Investors could again focus on a company’s real cash earnings rather than the up-and-down movements of stock price.

Further, corporations would be forced to become better stewards of their cash and their investments. Under today’s system, companies can deduct the cost of debt but must pay a tax if they return cash to stockholders. The consequences are easy to predict. Many companies have used their stockpiled cash to buy back their stock, in the hope of boosting its price and increasing the value of stock options. Others have incurred dangerously excessive debt to pursue ill-advised acquisitions. In each case the tax system has provided the incentive for excessive corporate leverage, putting companies at risk.

The end of the double taxation of dividends would realign and balance the system so that corporate management would no longer face perverse incentives. It would shift management’s focus away from debt and toward equity.

The winners would not just be the wealthy who collect dividends. That is a myth. Eliminating the double taxation of dividends would boost the value of equities, and equity investors with money in 401(k)s or with mutual funds in IRAs would benefit directly.

Most important, if the dividend tax penalty were ended, companies would no longer have an incentive to sit on their cash. Instead, entrepreneurs and small businesses would start investing again. That is the only way an economy creates jobs. The president’s plan would free the capital necessary to get small business hiring again.

Arguing that this change would be expensive also misstates the facts. The president’s total stimulus package, at an estimated annual price tag of $67 billion, costs less than 1 percent of GNP (67 one-hundredths of a percent, to be exact). The elimination of dividend taxes is only half the total. It is a tiny investment relative to its potential impact.

The elimination of dividend taxes would offer ordinary investors a better way of measuring the return on their investments and give companies and entrepreneurs the right incentives to invest and create new jobs.

If we are going to stimulate the economy, we need a tax policy that bolsters confidence, improves corporate governance, unlocks the stagnant capital inside companies and lifts the stock market across the board. Only the elimination of the double tax on dividends achieves all these goals. Congress ought to pass it quickly.

The writer is founder and chairman of the investment company that bears his name.