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133 IRET Congressional Advisory 1 (2002)

handle is hein.taxfoundation/iretcgadv0130 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote growth and efficient operation of the market economy. August 30, 2002 Advisory No. 133 DIVIDEND TAX RELIEF AND OTHER MEASURES AIMED AT BOOSTING THE STOCK MARKET - METHODS AND CONSEQUENCES Savers have been hard hit by the loss of about $7 trillion in the value of U.S. stocks since March, 2000. The economy has been feeling some of the pain as well, as people reduce consumption and businesses find it more expensive to raise capital. Much of the recent decline in federal revenues and projected budget surpluses is due to the weaker Much of the economy and lower capital gains tax revenues. Restoring growth is crucial to restoring federal budget surplu finances. These issues were weaker econon raised at the President's recent gains tax rei economic conference at Baylor growth is cr University. federalfinanc Following the economic conference, President Bush announced that he is considering a number of ideas to provide tax relief for shareholders and other savers. Among the proposals under review are tax relief for dividends, an increase in the amount of capital losses that shareholders may deduct against other income, expanded contribution limits for IRA and pension arrangements, and reduced capital gains tax rates. The hope is that such actions will boost the stock market and restore a healthier rate of growth to the economy. Boosting the stock market is not in and of itself an appropriate objective for tax policy. However, tax policies that improve the efficiency of the economy and remove tax barriers to growth would certainly raise stock prices as a consequence. Stock prices are the present value of what people expect corporations to earn, after-tax, in the future (and what people are willing to pay, today, to obtain ownership of that future income). This makes the market a good reflection of future economic conditions and a good rece ties ses ly an eniue uicial ?S. indicator of whether the tax changes will help or hurt growth. Dividend relief and the other proposals being hinted at would move the tax system in the direction of fundamental tax reform. They would reduce or remove ,nt decline in artificial barriers to growth in ........ proje the current tax system, and nthey would promote capital s due to the formation, productivity, d lower capital employment and higher wages. S. Restoring As a side effect, they would to restoring indeed boost the stock market. These proposals are not radical or extreme. Any tax system that sought to be completely unbiased in its treatment of saving versus consumption would go even further than the proposals under discussion. Why dividend relief? The current tax treatment of dividends is one of the most egregious examples of the income tax bias against saving and investment.1 Dividends are treated worse than capital gains and interest, and are the most heavily taxed form of returns on saving. They face combined federal corporate and individual income tax rates of 60% (plus state and local income taxes). (See table.) Past tax bills have cut the tax rate on capital gains. Dividends deserve some attention this time around. Redressing the unequal treatment of dividends would also improve corporate governance. The taxation of dividends affects equity-financed investment. Returns on equity-financed investment first face the corporate income tax. Then, if the after- I SI 0 I g6~ I e S.

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