January 30, 2003

January 30, 2003 | Commentary on Taxes

Ed013003c: Tax Reform Benefits Everyone

We could learn something from France and Germany.

No, not on Iraq. Both nations, alas, seem content to let Saddam Hussein play cat-and-mouse games with U.N. weapons inspectors. But when it comes to taxes, they made a move more than a decade ago that U.S. policy-makers would do well to emulate: They cut taxes on dividends.

Here's one area France and Germany agree with President Bush. He has included a dividend tax cut in his latest economic proposal, confident that it will spark long-term growth. In fact, the president goes our European allies one better, saying we should eliminate altogether the second layer of taxation that our government imposes on corporate earnings.

Critics say such a move would help only the rich. But ending the double taxation of dividends would benefit millions of Americans, not just an elite class of investors. Stock ownership is much more common today than it used to be. Roughly 84 million Americans now own equities, either directly or in tax-deferred retirement plans.

It's true that, under the Bush plan, people with equities in retirement plans wouldn't receive tax credits for their dividends. But to say they gain nothing at all is misleading. A share of, say, Microsoft stock owned in an IRA is the same as a share of Microsoft owned directly. If stock prices rise as a result of a dividend tax cut -- and that's exactly what we can expect -- then every individual who owns stock, directly or through a retirement plan, will benefit.

But we'll get more than just higher stock prices if we end the double taxation of dividends. Eliminating this extra burden on capital income will prompt economic growth. Once corporate managers can obtain funds less expensively, they'll have more capital to invest -- and therefore more jobs to offer.

I say "corporate managers," not "corporations," for a reason. It's easy to forget that a wide array of people pay for "corporate" taxes in one form or another. From wealthy investors to hourly wage earners, many individuals shoulder the burden of corporate taxes. When taxes are high, corporations have less money to pay their workers -- and consumers are stuck with higher prices. Focusing on "corporations paying their fair share" is clearly misguided.

The same is true of other clich├ęd class warfare arguments. Take the charge that fundamental tax reform benefits "only the rich." Assuming that we can even agree on who "the rich" are, what is it they do with their money that hurts others? Our economy benefits whenever anyone, regardless of income level, has more money to save, invest and spend.

Of course, getting that extra money can be tricky under our tax system. As Americans earn more money, the government takes more of the next dollar they earn. For instance, when a single taxpayer's annual income goes from $27,000 to $28,000, his or her top marginal tax rate rises from 15 percent to 27 percent. In this case, instead of keeping 85 percent of the last $50 they earn, they keep only 73 percent, an amount equal to about $36.

Looked at differently, to actually keep that last $50 after taxes, this taxpayer now has to earn almost $70. In other words, this taxpayer must spend more time working for the government if he or she wants to keep that last $50. Since the tax rates rise with income (and certain deductions are phased out), the amount of extra work needed rises with income, making it even harder to keep the next dollar earned.

As President Bush said in his State of the Union address, "the best and fairest way to make sure Americans have [more] money is not to tax it away in the first place." Fundamental tax reform will allow all Americans to keep more of their money instead of sending it to Washington, and dividend tax relief is an important part of such reform. After all, France can't be wrong about everything.

Norbert Michel is a policy analyst in the Center for Data Analysis at The Heritage Foundation (www.heritage.org).

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies

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