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Wednesday, January 8, 2003

I feel the earth move

In the professional world in which I operate -- tax nerds -- this week there has been some major, major news. Our leader, George W. Bush, is proposing to eliminate the income tax that individuals must pay on dividends they receive from corporations whose stock they own. Academics have proposed this (or something similar) for many years, but when it comes from the White House, and the White House's party controls Congress, it might actually happen.

Already the commentary pro and con is flowing hot and heavy. Meanwhile, slower students of tax law such as myself are pondering some of the implications of the President's proposals. It seems to me that if they pass, it will make less sense to put money in an IRA, at least if the IRA is going to be in the stock market. For example, the big advantage of the Roth IRA is that the earnings on your account are never taxed. But if you skip the Roth, just put all your money in the stock market, and hold on for the dividends, under the Bush plan, I think the same thing will happen. You'll have dividends all your life, but pay no tax on them. And in contrast to dividends earned by a Roth, you will be able to spend dividends on stocks you own individually any time, any way you want, without penalty. I guess the Roth will still be better if you have capital gains, because the Bush proposal wouldn't exempt those outside of an IRA. But if you're not expecting too much in the way of capital gains (such as with preferred stocks), using the Roth will just add a bunch of red tape and needless restrictions. A traditional IRA or 401(k) plan holding stocks may also become a stinker, because withdrawals from those accounts apparently will still all be taxed, whereas dividends on stock that one owns individually won't be.

Not that these changes will necessarily be a bad thing. But the landscape sure will be different. And there are going to be a lot of losers as well as the hoped-for winners. For instance, fewer people will be interested in holding bonds, because bond interest will still be taxable, while dividends on stocks won't be. When fewer people want to buy bonds, bond prices fall, and interest rates go up.

As for the malarkey about the proposal helping senior citizens, come on. Most seniors are very low income people, and so even if they do have some stocks, they pay little or no tax on the dividends. The only oldies who will be laughing all the way to the stock broker's office will be guys like Rumsfeld, Cheney and Bush Sr.

Another thing that occurs to me is that this plan may be a major step down the road toward a pure wage tax. The President says dividend income shouldn't be taxed. Maybe if he gets re-elected, next term he'll say interest shouldn't be taxed, either -- bonds should be treated the same as stock. Sounds plausible. Then the real estate lobby jumps up, and the next thing you know, rents aren't taxable income, either. The oil and mining folks grease a few campaign palms, and before long royalties are exempt, too. Somewhere in the shuffle, the tax on capital gains, already very low, and the tax on other income from property sales can be dispatched as well.

At that point, the only kind of income that will be left to tax is income from labor. Now that's a hot dream for the GOP.

In any event, I hope there's lots of time for ample public debate before this plan is voted on. But given the haste with which the 2001 tax cuts were enacted, I wouldn't count on it!

UPDATE, 1/9: As it turns out, the Bush plan will be even more favorable to individuals who own stocks than I first thought. Not only would actual dividends be tax-free, but companies that didn't pay dividends could check a box on a form and make believe that they did. This would allow their shareholders to reduce or eliminate the taxable capital gains that they experience when they sell the company's stock. So not only does this proposal kill the dividend tax, but it also puts a major dent in the capital gains tax. Wage tax, here we come!

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