As published in the Washington Times, March 16, 2003
President Bush has proposed that once a corporation has paid the tax due on its profits, those “after tax” profits should not be taxed again when distributed to the corporation’s owners – the shareholders – as a dividend. Some have suggested that this proposal is of little interest in the technology community since very few technology companies pay any dividend. This suggestion misses the point on three important grounds.
Most technology companies depend for a sizable portion of their revenue on the capital goods purchases of their customers in the manufacturing, banking, insurance, transportation, communications and other sectors. These are also the sectors most likely to pay dividends. The strength of these capital purchases depends in significant part on the cost of capital these companies enjoy. With the elimination of the double taxation on dividends, it is natural to expect that this cost of capital will decline making capital purchases more attractive. And these effects are large. The Administration’s economists estimate an investment stimulus from the President’s plan equivalent to a 4-7% investment tax credit. So, for the technology sector, the elimination of the double taxation of dividends is a welcome stimulus in that their customers will enjoy an improved economic incentive to purchase technology products.
Secondly, and of greater importance, the elimination of double taxation would encourage citizens back into the equity markets. The technology sector depends on equity for its lifeblood. Most technology companies find much of their value in the intellectual property they have developed. The value of these assets is not on their balance sheet and, thus, is rarely acceptable as collateral for any lending activity. Loans in the technology sector are virtually only available for the financing of laboratory and manufacturing equipment and, later, in the form of receivables financing. In companies such as software companies or fab-less semiconductor companies where intellectual property represents virtually all of the value of a company, these assets are not sufficient to supply the capital needed for growth of the enterprise. Equity investors are required. The recent post-bubble period has caused many investors to remove their funds from equity markets – a move that is very negative for technology companies. Any stimulus that would encourage investors back into the equity markets is a good, strong move for the technology sector.
Lastly, as technology companies mature, particularly those where intellectual property is their principal asset, many will have little need for large capital expenditures and can become very cash-flow positive. Traditionally, these excess cash balances have been used in stock buyback programs rather than in dividend declarations since the tax consequences of dividend payments were so negative. This “buy back” trend could be significantly altered with the passage of the President’s proposal. But, where cash is required for corporate growth, another feature of the President’s pro-growth proposal would eliminate the double taxation of retained earnings as well. When growing companies retain earnings for expansion and new investment, shareholders get an increase in the basis of their shares, so that retained earnings are not taxed twice either. Thus, there is no taxation of the capital gain from accumulated retained earnings. This little noticed feature of the President’s proposal is particularly important for two reasons — it makes sure that all corporate income is taxed only once and that business executives make decisions based on their business judgment, not the tax code.
Technology companies will benefit from an elimination of the double taxation of dividends and retained earnings for each of these reasons – their customers will enjoy a lower cost of capital, investors will return to the equity markets and technology companies will begin a practice of either distributing excess cash instead of resorting to stock buybacks or using their retained earnings for expansion. Each of these factors will encourage investment in technology companies.
E. Floyd Kvamme is a Partner Emeritus at the venture capital firm of Kleiner Perkins Caufield & Byers, Chairman of Empower America and serves as Co-Chair of the President’s Council of Advisors on Science and Technology.