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Eliminating the Double Taxation of Dividends
An Old Debate with a New Twist

Earlier this year President Bush proposed to eliminate the double taxation on dividends. The proposal is estimated to cost $350 to $388 billion. It represents half of the President's economic stimulus proposal, which will be debated through out the year. It also has triggered an old policy debate about who enjoys the benefit of tax cuts and a new one as to how qualified savings plans' are impacted.

The Old Debate

For more on the Administration's economic stimulus package and its affect on pensions see "Scrambled Eggs" article in this issue.

As in the past, the split is down party lines. The House Committee on Ways and Means' Congressman Charles Rangel (D-NY) charges that elimination of double taxation of dividends is a sop to the rich because high-income individuals receive the majority of dividends. In addition, the elimination of the dividend tax will result in high-income individuals paying fewer taxes. Congressman Rangel adds that we would be better served reducing the federal deficit than tinkering with the dividends tax.

The Republicans counter is aptly summarized in a February report from the Joint Economic Committee (JEC). The report essentially says Congressman Rangel's argument ignores the fact that tax policy influences people's behavior. Further, the JEC argues that capital markets are sensitive to tax policy and that the benefits of the proposal are much more broadly distributed.

The JEC elaborates that eliminating the dividend tax will increase stock prices. Treasury Secretary John Snow claims that stock prices would increase by 15 %. The JEC asserts that an increase in stock prices increases the benefits for all stockholders including investors in tax-advantaged savings vehicles like pensions.

In a nutshell, the JEC also says that eliminating the tax will accelerate economic growth and solve most of the problems of the stalled US economy. And a prosperous growing economy benefits all Americans.

Who Has Dividend Income According to IRS Tax Filings for 2000
Income Group	Percent of all Returns	Percentage Who Reported Dividend Income	Percentage of all Dividend Income	Average Dividend Income*
Under $50,000	46%	17%	19%	$1,743
$50,000 to $99,999	31%	41%	18%	$2,550
$100,000 to $199,999	16%	67%	18%	$4,948
$200,000 to $499,999	5%	86%	16%	$12,617
$500,000 to $999,999	1%	93%	8%	$31,153
$1 million and up	1%	96%	21%	$134,755
*Average dividend income is the average for taxpayers who reported dividends. Source: Internal Revenue Service

A Qualified Savings Plan Perspective

While the JEC says everyone benefits from the dividends tax cut, groups representing retirement plans have begun to disagree. They have brought a new and albeit darker perspective to this debate.

In fact, the statesman of pensions, the Employee Benefit Research Institute's Dallas Salisbury recently testified that the "dividend exclusion would harm qualified retirement plans." He aptly points out that beyond shifting savings around, individuals could lose the benefits of the employer. These benefits, which he describes as "ancillary," are: acting as a fiduciary, economy of scale or the buying power of a company versus that of an individual, and, not to mention, the accountability of having an employer behind a pension plan rather than just a lone individual. They are tremendous advantages for individual savers or investors.

A recent study by T. Rowe Price have made arguments that President Bush's proposed plan makes 401(k) investments relatively less attractive to employees because the proposal lowers the effective tax rate on investments held outside of the plan, thus diminishing the tax advantage of the plan.

Groups like the Profit Sharing/401(k) Council of America, the American Society of Actuaries, the Small Business Council of America, and the Society for Human Relations Management charge that the Bush proposal erodes the tax incentives that encourage employers to offer qualified plans by limiting the small business owner's ability to take full participate in the plan. Additionally, they are afraid that the proposal will drain savings away from pension plans resulting in higher costs for the plan and more difficulty in meeting nondiscrimination testing requirements.

The American Council on Life Insurance sums up most arguments. They believe that the tax policy for dividends will undermine the "good social policy that encourages small business owners to provide retirement coverage for their workers."

Middle Ground?

Is there a way for policymakers to address qualified savings plans' concerns? In a word, yes. That is why some pension groups are calling upon the Administration and Congressional tax writers to have the dividend tax exemption also apply to employer-provided retirement plans. What do you think? Give your opinion in a brief poll by visiting www.stablevalue.org.

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