Time to Eliminate Double Taxation of Dividends

It’s been almost 40 years since Congress enacted President Kennedy’s tax cuts and set off an economic boom. Still, only a handful of Democrats – Sens. John Breaux (Louisiana), Zell Miller (Georgia) and Ben Nelson (Nebraska) come to mind – have learned the profound lesson he taught: “It’s a paradox that high tax rates cause less revenue,” and “the purpose of cutting taxes is not to incur a deficit but to achieve the more prosperous, expanding economy that can bring a surplus.”

Some Republicans haven’t learned the lesson, either, even after President Reagan taught the refresher course 20 years ago. By voting against President George W. Bush’s tax cuts, three Republicans in particular – Lincoln Chafee (Rhode Island), Olympia Snowe (Maine) and George Voinovich (Ohio) – are undermining the president’s effort to revive our lagging economy with tax-rate reductions the way Kennedy and Reagan did before him.

If this were the NFL, the two parties could simply engineer a trade – the three Republicans who don’t get it for the three Democrats who do. But this being politics, the three Democrats who do get it could serve their country and their own constituencies by playing this one, if not for the Gipper, then for Camelot and voting with Bush in memory of what Kennedy did for this country during another period of economic difficulty.

This isn’t rocket science. The way to get more revenue for the government and reduce the national debt is to bring down tax rates and stop double-taxing saving and investment. You can’t go to a zero rate because you’ll get no revenue, but you can’t go to 100 percent because you won’t get any revenue there, either. People won’t work and invest if you take everything they earn.

And they certainly won’t save and invest if you tax them twice as much as you do if they spend the money or borrow it.

A company may deduct the wages it pays employees, the money it pays a vendor for inventory, the rent it pays a landlord or the interest it pays a banker, and it is the employee who is responsible for paying the taxes. But when a company pays dividends to stockholders, not only may it not deduct the dividend payment from its taxes, the shareholder must also pay taxes on the dividends. That’s grossly unfair. It also distorts the way companies finance their operations. Since interest paid on debt is tax deductible while dividends paid on investment are not under the current tax code, companies have an incentive to borrow money rather than raise equity capital.

As Arthur Laffer pointed out, tax rates have to be set at the level of equilibrium at which people are willing to work their hardest, take entrepreneurial risks and invest their surplus income, which will create the most dynamic economy and generate the highest level of revenues.

Snowe says she is “firm” on preventing any tax cut from rising above $350 billion over the next 10 years. She contends that the president’s proposal, which calls for twice that amount of tax cuts, would create “too much red ink.” But the Congressional Budget Office already has said that the president’s full tax cut, including his provision to eliminate the double taxation of dividends, would increase investment and speed up economic growth so that the so-called “revenue loss” would be considerably less than the $725 billion usually attributed to it by static analysis. In fact, the Heritage Foundation projects that taking the increased economic growth into account, the real revenue loss to the Treasury would be only $274 billion, $75 billion less than the senator from Maine says she is willing to tolerate.

For the sake of argument, let’s accept the full $725 billion static figure and then look at how Snowe’s argument falls to pieces even under an unrealistic, worst-case scenario. Even if enacting all of the president’s tax proposals meant revenues would be $725 lower so that total increased deficits would be $375 billion more than the $350 billion Snowe says she is willing to tolerate during the next 10 years, we would be talking about increased deficits of a minuscule 0.2 percent of GDP.

No clear-thinking person can seriously believe that temporarily higher deficits of two-tenths of 1 percent of GDP will be economically harmful. But any businessperson or economist who has studied the tax code will tell you that eliminating the double taxation of dividends would be economically very beneficial. What’s harmful to the economy is continuing to put a 60 percent cumulative tax rate on dividends as Chafee, Snowe and Voinovich insist we must do.

According to the President’s Council of Economic Advisers, eliminating double taxation will encourage businesses to increase capital investment by reducing the cost of capital some 14 percent, which will mean more jobs for more American workers. It’s time to end the double taxation of dividends once and for all.