January 07, 2003
Just One Minute Is Puzzled...

Just One Minute--an honeset and smart believer in the principles set forth in Republican Party campaign materials--is puzzled that the Bush tax cut has so few real positive supply-side benefits:

Just One Minute: ...a big portion of this part of the tax cut may simply represent "found money" for the current holders of dividend paying stocks, and would have no significant supply side incentive effects.... So, from a supply-side perspective for folks scoring at home, we have $68 billion of "good" tax cuts, most of the $364 billion associated with dividends as "not good", $91 billion for the child-care credit as "not good", and a bunch of "maybes". Now, Karl Rove is the reigning genius in Washington. But I doubt that supply-siders will be beating the drums for this tax package...

I think he's a little too harsh. Some of his "maybes''--the Alternative Minimum Tax, for example--seem to me to be clear "yeses."

Posted by DeLong at January 07, 2003 02:25 PM | Trackback

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>> most of the $364 billion associated with dividends as "not good" <<

Well, it's certainly a reduction in the marginal tax rate on investment income, and spurring investment is supposed to be a good idea.

It's is also good for corporate governance, reducing the incentive for managers to leverage a business riskily with debt. Formerly dividends were tax-disadvantaged relative to both debt finance, which could leverage a business to push share prices up, and to stock repurchases as a means of returning funds to investors, utilizing the higher leveraged share price. (And of course the higher share prices benefitted the executives through their stock options as well). But we all know now that leverage works both ways for the share price when bad days arrive.

Now dividends will be tax-favored relative to stock repurchases, creating an incentive for businesses to focus on cash flow rather than leverage, which on recent experience most people I'd think would take to be a good thing.

Posted by: Jim Glass on January 7, 2003 09:06 PM

Oh, groan, the Alternative Minimum Tax! I am guaranteed not to have a table-pounding position on that. However, the $29 Billion of adjustments seemed low to me - maybe a down payment on a third round of tax reform.

So, with a few details in hand, I can now link to the International Herald Tribune, my go-to source for US tax news (OK, its a piece from the Times, but they don't have it yet - go figure.)

Bush's plan is called inadequate on alternative tax : apparently, the relief is small and temporary.

Here, we have an estimate from the OMB Watch saying:

Simply adjusting the AMT for inflation would keep the AMT relatively constant, but, according to the Joint Committee on Taxation, it would cost more than $100 billion over the next decade. To insure that taxpayers get the full benefits of the Bush tax cut, the JCT estimates that it would cost almost three times that much, or $292 billion over 10 years. With the provisions of the Bush tax cut shrinking federal revenue, it will be difficult -- or impossible -- to find an extra $292 billion to fix the problem.

So, $29 Billion is not fixing the problem.

Now, as to Mr. Glass, I am actually starting to admire one aspect of this proposal - the investing public will be much more interested in the actual taxes paid by corporations, which could make a lot of tax management schemes less attractive. However, as a non-fan of the corporate income tax, my hope is that the reduction in tax management will be accompanied by increased efficiency. Of course, accountants sign off on all of these tax-oriented transactions as having a distinct economic motive anyway, so perhaps that is not an issue. Perhaps.

As to the other point, it's certainly a reduction in the marginal tax rate on investment income, and spurring investment is supposed to be a good idea , well, yes.

However, what is the curent marginal tax rate on equity investment, and what will it fall to? If the marginal investors are pension funds, or mutual fund managers who are compensated on a pre-tax retuen basis, the marginal tax rate guiding decisions goes from zero to zero.

For a taxable investor, the current scheme is share repurchases at the corporate level and sales of stock (at cap gain rates) at the personal level to recreate a target dividend stream. I have not attempted to model this, but I suspect the effective rate is quite low.

So I worry that this dividend exemption solves a problem that people have already worked around, and that the efficiency gains of a simpler solution are not that great. Also, the tax code has so many distorting influences that solving one problem at a time seems to me to be impossible.

Well, if this passes, I guess we will see. Excellent grist for the folks working on a PhD in Economics. And a full-employment act for accountants and tax attorneys.

Posted by: Tom Maguire on January 9, 2003 07:15 PM
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