Tag Archives: Tax Reform

In Defense of the Dividend Tax

14 Mar

A few weeks late to this conversation, I admit, but I finally had a chance to catch up with my long overdue writing “assignments” and have had a burning desire to write this piece.

“Seldom has there been a clearer example of a policy that is supposed to soak the rich but will drench almost all American families.”

Recently, the Wall Street Journal published an article railing against Obama’s 2013 budget, which included a proposal to triple the tax rate on corporate dividends. Not surprisingly, the author’s position was that this was an atrocity, an attack on the middle class and further “proof” that the Obama administration’s economic policy is stifling growth. The author essentially argues that the double taxation of corporate profits are an unnecessary burden on flag-waving Americans, the tax increase disproportionately affects older Americans reliant upon steady income streams produced by dividend-paying stocks, stocks are less valuable because they are now discounted, and that the correlation between dividend tax rates and corporate dividend payments implies that companies won’t pay out dividends now because of the change in tax policy.

I find this argument to be flawed on many accounts, mainly on the grounds that it assumes that dividends are essentially an unalienable right of investors that their payment is an assumed “business-as-usual” responsibility of corporations. Additionally, the argument completely ignores the bigger picture of the tax hike’s intended affect on the economy as a tool to indirectly encourage corporations to direct their funds towards investments other than to their shareholders’ bank accounts.

First of all, corporations have no obligation to pay dividends, and they will not be adversely affected by this tax hike. Dividend-paying organizations have been able to grow their revenues, go public, and pay dividends in the first place because they introduced products and services that met a market need; their success is due to the customer, not to the shareholder. Take Apple for example – the tech giant is sitting on  nearly $100 BILLION in cash and only now are analysts so sure of the fact that it “is likely to declare…a dividend before the year is out.” Apple didn’t become a $500B company by placating investor demands – and really it, or any other company with  any significant value proposition – so investors should be lucky to have dividends at all in the first place!

Additionally, the author tries to paint a picture of a sad, old wrinkly fart that is more or less going to be financially ruined because of this tax hike: “IRS data show that retirees and near-retirees who depend on dividend income would be hit especially hard. Almost three of four dividend payments go to those over the age of 55, and more than half go to those older than 65, according to IRS data.” This is partly true. The 55+ demographic obviously comprises a disproportionate amount of the stockholders in the U.S. because these are consumers at the acme of their income-earning years, but let’s be real: anyone who “depends” on dividend income doesn’t really depend on dividend income. If you are in a place financially to where 25% or less of your investment portfolio (surely you’re diversified to the extent that dividend-paying stocks account for  less than a quarter of your investments, right?!) is your main source of income, then I have to imagine that you’re not going to be that adversely affected by this tax increase; particularly if the companies in which you’re invested stop paying dividends and instead use that excess cash to buy back stock, or invest in their operations – which could in turn further increase the value of your portfolio!

The author completely misses the point – tax policy can drive economic growth. Regardless of the tax rate, the significant majority of shareholders of dividend-paying stocks are not going to take that windfall and immediately recirculate those funds back into the economy; however, if companies are de-incentivized to pay dividends, they have a stronger impetus to invest in initiatives that create value for their customers, themselves, their shareholders…in essence, the economy as a whole.

Increasing the dividend tax might force a niche demographic to rethink the allocation of its investment portfolio, but more importantly, this proposed change in tax policy has the potential to directly impact the economy. That’s a good thing, right?

 

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Tax Reform – Key to “Winning the Future”

19 Aug

Oh no! It's so bad! Again!

I sure hope Andrew Ross Sorkin has been taking notes. Between the debt ceiling showdown and the downgrade of U.S. debt, the economic uncertainty and financial volatility of summer of 2011 is going to leave everyone from academia to the boardroom scratching his head for years to come, so you can rest assured that financial journalists are warming up their word processors, itching to pull the story together.

As the markets oscillate and photographers capture the quintessential “this is bad this is really bad” shot of Wall Street traders grasping at their faces with despair, one can’t help but wonder what leadership elected officials in Washington plan to do to improve the economic outlook. In the past I would trump the virtues of Adam Smith’s invisible  hand, but given the absurdly high unemployment rate and the juxtaposition of record cash levels on corporate balance sheets to the budget deficits of government at all levels,  I don’t think we can improve the economic situation without significant assistance from Washington.

At some point in the not too distant future,  difficult decisions regarding the U.S. government’s expenses and revenues will have to be made. This is a great time for members of Congress to put on their architect hat and envision what kind of U.S. they want to build. Do we want to have strong infrastructure and education systems, a significant percent of energy from “clean” sources, and low unemployment, among other desirable things? If that is the U.S. we want to live into, then we have to work backwards to the decisions we make now. As any homeowner knows, moving into the house of your dreams requires starting with a blueprint that defines the vision, and a roadmap of project milestones and to-dos that must be achieved along the way.

In order to achieve some semblance of fiscal health, I propose the following tax reform. Keep in mind this is by no means exhaustive, and please, feel free to weigh in on the discussion.

  • Eliminate (many, but not all) tax deductions and credits. For instance, why are we still encouraging and incentivizing home ownership via mortgage interest tax deductions? If a consumer has the means and desire to own a home, that’s wonderful, but the government should not encourage living outside of one’s means. Also, to make the case for sustainability, urban economists such as Ed Glaeser argue that a suburban lifestyle has a much larger environmental footprint than an urban one, so we shouldn’t de-incentivize urban rentals in favor of home ownership
  • Institute a financial transactions tax for transactions over $1mm. The financial crisis of 2008 made it all too clear that reckless trading has severe implications outside of  the two parties executing a trade, but the public should not be held responsible for such recklessness. A tax as small as 0.25% would add tens of billions of dollars of revenues, and would not critically impact the liquidity of the market. Only institutional traders or high net-worth individuals are trading in these increments anyways, so it is not unreasonable to demand an insurance premium for a sense of market stability
  • ELIMINATE FARM SUBSIDIES. Because it simply does not make sense to subsidize obesity via cheap high fructose corn syrup.
  • Reform corporate tax code to the extent that effective tax rates are uniform across all corporations. A uniform effective tax rate would provide a sense of stability in the markets, and would give corporations a better sense of long-term liabilities. This can only be achieved if loopholes, tax credits and deductions are realigned as well. I think it would be feasible to increase the average effective tax rate through a combination of reducing the nominal corporate tax rate and eliminating tax loopholes
  • Legalize it. It is mind-boggling that Americans can legally purchase and consume 80-proof alcohol, cigarettes, and McDonald’s McNuggets, but they cannot legally purchase and consume marijuana. Legalizing and taxing marijuana at 8-10% would not only add billions to the government’s coffers, but it would also create thousands of (legal) jobs and drastically reduce the violence in Mexico and near the border.
These are just a few thought starters, but the point is that the path to a fiscally sound government, and therefore a healthier economy, is going to require additional revenues in addition to spending cuts.