Tax cut designed to increase consumer spending

Erik Nelson

In the first part of this series, President George W. Bush’s $674 billion tax and spending proposal was summarized. The proposal includes $350 billion in dividend tax relief and various reductions in personal income tax rates. Data indicates that richer Americans, especially those who own stock, would disproportionately benefit from the enactment of Bush’s proposal.

Theoretical merits

For years, economists have noted that the dividend tax has discouraged investment in public companies and discouraged companies from issuing dividends. In fact, the U.S. tax system is the only one in the world that directly taxes disbursed public company profits twice, once at the corporate level and again when corporate profits less corporate taxes are disbursed to the shareholders. Theoretically, the so-called double dividend tax can claim as much as 60 cents for every dollar of corporate profit. In practice, the double dividend tax rate is often much less due to accounting mechanisms and tax code loopholes that allow companies and their shareholders to reduce their tax burden.

However, regardless of the double dividend tax’s effective rate, the elimination of the shareholder portion of the double dividend tax would, in many cases, reduce a shareholder’s cost of investing. This reduction in investing cost would, in all likelihood, encourage higher levels of investment. Because – in the view of many economists – the U.S. tax system currently overtaxes savings and under-taxes consumption, Bush’s plan to repeal the shareholder portion of the double dividend tax has received a healthy dose of support from many economists.

There is some indication that Bush’s tax cut and spending proposal could mitigate corporate shenanigans that have rocked the stock market the past two years. Because companies could only disburse tax-free dividends or “deemed” dividends equal to their after tax earnings, public companies could experience shareholder pressure to keep their corporate headquarters in the United States, to use less tax-shelter mechanisms to avoid paying corporate taxes and to incur less debt.

Another potential benefit of the proposed dividend tax abolition is psychological. Increasingly, Americans see the stock market as a barometer of the economy’s health. While this perception can be spectacularly misguided (prior to the stock market crash of 1929 stock prices soared even while many normative economic indicators crashed) the allure of a continually increasing S&P index cannot be underestimated. Americans will spend money as long as they think the economy is healthy, and a humming stock market seems to convey well-being; perception is often more important to consumer confidence than reality.

As to the accelerated income rate tax cuts, the standard post-Keynesian view is that money spent by consumers does more to stimulate the economy than money spent by the government. Thus it is theorized that any tax proposal that puts more money in the hands of the people rather then the federal government, as the proposed income tax rate cuts would do, would juice the economy more than government spending or saving.

Erik Nelson is a University graduate student and Minnesota Daily editorial board member.

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