President Bush’s economic plan is perhaps the most brazenly devious act of federal tax policy since Jimmy Carter permitted massive de facto tax hikes by refusing to adjust income brackets for inflation in the late 1970s. In fact, it probably is the Carter policy, but we’ll get back to that. Since Plan Bush also does some good things, we can address those first. In terms of corporate governance, the Bush move to eliminate the tax on dividends is almost a pure improvement, a terrific plan in any number of ways. That is why boosters of the move–like Burton Malkiel in The Wall Street Journal–focus on its corporate side and not its macroeconomic side. Taxing dividends really does distort corporate incentives. First, since interest can be deducted from taxes but dividends cannot, companies have good reason to finance operations through debt rather than equity. This creates instability, bankruptcies and lost jobs. Second, a dividend tax prompts companies to cling to their money rather than paying their shareholders, creating mini-liquidity traps that can become not-so-mini over time. Microsoft, famously, has $40 billion in cash just now. Third, this stinginess with dividends helps prime the pump for the great stock-option swindle, as companies sit on earnings to drive up stock prices to the point where executive nabobs might deign to cash them in. And finally, the taxation of dividends encourages all sorts of accounting scams too complex for me to wrap my head around.
There will be other benefits, too–removing taxes on dividends will make stocks more attractive and almost automatically drive up their value. Although, as is less well understood, this will be a one-time-only bump, and thereafter the dividend benefit will be an undetachable part of the stock price, just as the mortgage-interest tax deduction is now undetachable from housing prices. For just this reason, the dividend tax regime, if enacted, will be eternal–absolutely politically un-undoable–since to repeal it would involve the government’s straightforwardly robbing people of the assets that may constitute their nest egg.
Blowing away so many corporate-governance problems at one stroke is quite an achievement. So why doesn’t the Bush team want to sell their plan that way? Part of the reason may be Enron. The President came to power wading through Enron money up to his thighs. Enron is famous for just two things, neither of them having anything to do with helping the economy in the slightest or bringing a single worthwhile product to market: First, it is the worldwide symbol of exactly the kind of corporate shenanigans that investors will be relieved to see the Bush plan address; and second, it was the single largest contributor to the 2000 Bush campaign.
Instead, the Bushies are focusing on how much money individual taxpayers will "get" out of the plan. I have a press release from the RNC that chuckles about how Democrats want to "target" tax cuts at certain classes of people to make them jump through hoops. It says: "While Democrats Want More Power In Washington To ‘Target’ Tax Cuts To The ‘Right’ People, President Bush And The Republicans Want Tax Relief For All Tax-Paying Americans." (Although it is hard to think of a narrower way to "target" a tax cut than to cut the taxes on dividends.)
This press release continues: "Under The President’s Plan, 92 Million Taxpayers Would Receive An Average 2003 Tax Cut of $1,083." Here is where the President is getting a little too cute for his own good. Because these are mean, not median figures. The mean income of one millionaire and nine people starving to death is $100,000. The median is pretty intense hunger. The four-figure tax cut comes from adding together a few people who are going to get a zillion dollars back, and the vast majority who are going to get close to zilch. According to William Gale of the Brookings Institution, those earning over $1 million get $88,873 back, or 3.9 percent of their incomes. Those earning under $40,000 will get somewhere between .01 and 1 percent.
Bush’s money people present these givebacks as fair, since, as the President’s former chief economic adviser Larry Lindsey puts it, they are "almost exactly proportional to taxes paid." Those making over $200,000 a year now pay 45 percent of the taxes and they’ll get 40 percent of the cut. Those who make under $100,000 pay 28 percent of taxes and will get 34 percent. That’s fine and dandy with me. But talk of fairness is absolutely meaningless, or at least premature, because the President hasn’t told us how his tax cut is going to be paid for. (Although he’s given us a hint, which I’ll get to.)
Thanks to the Bush plan, the deficit will rise next year to $350 billion–that’s the largest in history, and that figure assumes the Iraq war goes off without a hitch. Taxes will have to be raised somehow, somewhere. To discuss the "fairness" of the plan without discussing whom the tax hikes will fall on is like saying a hundred dollars is a "fair price" without specifying what it is you’ve bought or sold.
We’ve established that, for political reasons, there can be no turning back on the elimination of the dividends tax once it’s enacted. There has been no hint of raising the corporate tax. Are taxes going to be raised on the people who benefit most from this dividend tax cut?
Not bloody likely. The linchpin of supply-side logic is that large concentrations of capital are more efficient than small ones. And this is true for the most part: Give a guy a million dollars in tax breaks and he may use it to start a company. Give a guy 25 dollars, and he’ll spend it on…well, maybe not booze, but certainly on nothing more economy-stoking than a pair of lawn clippers. If the Bushies think this taxation logic works when they’re implementing a tax cut, there is no reason to assume they would follow the opposite taxation logic when implementing a tax hike.
So here is the broad hint the President dropped about who’s actually going to pay for the plan: Throughout the argument over the package, the most withering insult Republicans applied to Democrats’ (admittedly lame) alternative was that its stimulus was only "temporary." There is almost nothing temporary in the Bush plan…except for one tiny thing: relief from the incredibly punitive and ultimately extremely regressive "alternative minimum tax" (AMT). This parallel tax regime was passed decades ago to keep fatcats from avoiding taxes altogether. What it does is shut down deductions on people once they reach a certain level of income, and assesses taxes that start at 26 percent and rise from there. It doesn’t matter if you give half your money to charity and have nine children, all of whom are on respirators–your payment does not budge. The AMT has not been adjusted for inflation. So thanks to bracket creep and the changing structure of deductions, it is kicking in automatically for millions of new taxpayers every year. Today it can apply for incomes as low as $30,000. According to the Tax Policy Center, 11 percent of those earning $100,000-$200,000 a year now pay the AMT, but this will rise to 94 percent in 2010. By then, 43 percent of those earning $50,000-75,000 a year will be paying it too.
Within a few years, if nothing is done, the AMT will replace the income tax as the upper-middle class’ major tax. We are now, in fact, in the midst of an automatic shift out of an income-tax regime and into an AMT one. No one seriously expects it to remain in its current form, but (a) bracket creep persisted for years under Jimmy Carter, despite howls of protest, and (b) if we want to do anything about it, it is going to cost an additional trillion dollars to fix–a trillion dollars that we no longer seem to have.
Perhaps Carter’s problem is that he didn’t understand the politics of bracket creep. The temporary AMT relief is scheduled to expire a few weeks after the 2004 election.