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A Stimulus Plan That Will Pay Dividends
by W. James Antle III
18 January 2003

An in-depth analysis of the President's stimulus plan.

The president’s stimulus bill isn’t perfect. It doesn’t fundamentally overhaul an income-tax system that is essentially contemptuous of wealth creation and property rights to one’s income. It doesn’t address Austrian concerns about Federal Reserve monetary manipulation and the resultant malinvested sectors. It contains new government spending, rather contracting the public sector so the private sector may expand. The very phrase “stimulus bill” implicitly pays homage to Keynesian economics.

Yet it is a far bolder plan than nearly anyone had anticipated and it is far more weighted in favor of tax cuts. The tax cuts are far less constrained by socialist class-warfare concerns on the left and inordinate deficit-hawk hysteria on the right than the one President Bush signed into law in 2001. The Bush stimulus plan is five times larger than the nearest Democratic alternative.

Ending double-taxation of dividends is a just and sensible policy. Corporate earnings paid out as dividends may be subject both to a 35 percent corporate income tax rate and the top individual income tax rate of 38.6 percent, leading to an overall marginal tax rate greater than 60 percent. This contributes to the tax system’s bias against investment and reduces the incentive to pay dividend income, promoting wasteful corporate spending and preventing shareholders from accurately determining the value of the companies they are investing in. Overtaxing dividends also encourages corporations to rely heavily on debt rather than equity financing because they can deduct interest. Uneven treatment of income derived from various sources also tends to distort the economy by promoting the allocation of resources to avoid taxes rather than based on market needs.

Chris Edwards, director of fiscal policy for the Cato Institute, has noted that the United States taxes dividends more punitively than other comparable countries. Citing data from the Organization for Economic Cooperation and Development, he observed that most other nations offer relief from double taxation. Of 30 OECD nations, only the U.S., Ireland and Switzerland do not do so. Since Ireland and Switzerland have lower corporate tax rates, it is the U.S. that imposes the severest dividends tax burden.

Liberal arguments that this is a tax cut for the rich are absurd in an economy where the middle class relies on the stock market for their retirement. Even those who hold 401(k)s will reap benefits if a dividends tax cut causes the value of the stocks they hold to increase. Half of American households now own stock and the likely result is that the amount of dividend income earned will increase. Economist Gary Robbins estimates that for every dollar of foregone revenue, reduced dividends taxes will increase gross domestic product by $5.
Dividends will not be the only income subject to lower tax rates. Reductions in marginal income tax rates scheduled to take place in 2004 and 2006 will instead apply to this year’s income. This will improve incentives to engage in behavior likely to yield marginally higher income – i.e., to work, produce and invest. Reports that the Bush administration would make a concession to class warfare by not accelerating cuts in the highest income tax rates proved unfounded. This is both morally right – wealthier taxpayers have an equal right to retain their income – and economically sound. As Stephen Moore of the Club for Growth wrote in Newsday, “Cutting the highest income-tax rates is especially stimulative because roughly two out of every three Americans paying the highest tax rates are small business owners. They are the wealth and job producers in our economy.”

Those who are fixated on the plan’s alleged $674 billion price tag should understand that the real priority should be increased economic growth, which in turn is the leading source of tax revenue. Lower tax rates tend to increase the amount of income subject to taxation, while increased economic growth further enlarges the tax base. This is why tax cuts lose far less revenue than static projections estimated, based on the reality that changes in tax policy do in fact change taxpayers’ economic behavior. Increased incentives will lead to increased growth over time.

Nor should the focus be on how many rich people will benefit from the tax cuts. President Bush’s bill includes an increase in the earned income tax credit and child deduction, as well as a reduction in the bottom tax rate. But it is inevitable that those liberals will portray as rich will reap a large percentage of any meaningful tax cut simply because they far and away pay the most taxes. Yet this category of taxpayer does not describe a static group of plutocrats. Americans rise and fall from the lower and higher income percentiles over time in different stages of their lives. For example, 86 percent of Americans in the bottom income quintile in 1979 had moved up a bracket by 1989, with a higher percentage having progressed all the way to the top quintile than remained in the bottom.

Democratic plans fall flat. Increased government spending will not lead to greater wealth creation; moreover, government can only obtain the money to spend by taxing, borrowing or inflating. Temporary stimulus proposals, such as a payroll tax holiday, will at best offer temporary stimulus, rather than any lasting improvement in incentives or long-term growth rates. What is not needed is further encouragement of consumption, something Americans always have an appetite for. Instead the economy needs increased production and the creation of wealth and income that will make consumption more sustainable.
President Bush has proposed tax cuts conducive to economic growth, business investment and job creation. It now remains to be seen to what extent Congress, with its various groups of self-styled centrist deficit hawks and anti-tax cut liberals in both parties, will pass them.

Email W. James Antle III