I am writing a diary to hopefully, get the debate started on the recent tax cut bills that were passed by the Senate and House.
The House passed a bill with capital gain and dividend tax cuts cutting the cap gains rate from 20% to 15% and the dividend rate from the ordinary income rate to 15%.
These cuts are a continuation of the Bush tax cuts from a few years ago and basically amount to extensions.
More below the fold:
The tax cut issue is an important issue and we really need to have a debate prior to full reconciliation by the House and Senate.
The question is - are these tax cuts good for America? First, we must recognize that we have trillions of dollars in debt and a huge annual deficit. Second, we must realize that any tax cuts must be paid for by borrowing the money from investors. Saudia Arabia, China and Japan are the most active consumers of our national debt.
The question is - does the economic benefit of the tax cuts outweigh the financial burden of borrowing the money from China or Saudia Arabia + interest?
In regards to the capital gains taxes it is true that raising the capital gains taxes from 15% to 20% would raise the cost of capital and slow investment to some degree. In the current economic environment it is important to keep the cost of capital low and keep the stream of investment steady. One could argue that borrowing money for this purpose is beneficial to the health of the economy - for the purpose of this diary I will give that argument the benefit of the doubt.
However, in regards to the dividend tax cut I would assert that there is no economic benefit to lowering the dividend rate from the ordinary income rate to 15% and certainly not enough to warrent increasing the national debt.
If you ask what happpens when the rate is lowered from ordinary income (say 35%) to 15%, I will show you.
Income Statement (example):
Sales 10,000,000
(CGS) 7,000,000
Total 3,000,000
(Accounts Payable) 500,000
(Payroll) 500,000
(Rent) 100,000
(Misc. expenses) 100,000
(Depreciation) 300,000
Total income 1,500,000
(Taxes) 500,000
Net Income 1,000,000
Ok, now if you are a business owner and you have the choice of giving yourself a 1,000,000 dividend and pay 15% in taxes and park the money in municipal bonds or leave the money in the business what will you do? I'll bet you will give yourself a 1,000,000 dividend.
However, if you have a choice of giving yourself a 1,000,000 dividend and paying 35% in taxes or leaving the money in the business what will you do? I'll bet that you will think long and hard about spending money on expenses that will reduce your tax burden and that will grow the franchise value of the business before paying yourself a dividend that will come with a large tax burden. Well, what expenses increase the franchise value or sales levels? The expenses that help grow a business are payroll, PP&E and other operating expenses. Therefore, you may very well see more business investment if the dividend taxes are at ordinary income tax levels not less.
In regards to the dividend tax there is also a fairness issue. Why should a private business owner pay 15% on their end of year bonus when you have to pay roughly 30% on your bonus and/or income?
I know some of you are now saying - why is he only talking about privately owned businesses? Ok, in regards to the effect on publically owned businesses there really is none. If you reduce the dividend tax it may entice businesses to pay a little more in dividends, but that generally comes from money that would have gone to buy back stock anyway and probably adds no meaningful market value to the security. In regards to the effect on investors, the effect would be that wealthy investors would pay 35% and lower income investors would pay the ordinary rate, which is determined by their income levels.
To summarize, I think there needs to be more of a discussion about reducing the dividend tax and the potential positive impact to the economy, if any, and weighing that against the cost of borrowing the funds and the increase to our national debt. In addition, we need to consider the fact that 100 billion will probably be spent on Iraq next year and can we afford to give up 30 billion to 40 billion in tax cuts that are not necessary?
The debate needs to happen now as the tax cut bills are in committee in congress awaiting reconciliation and I think this is an issue of great importance. In my view, the answer is - say no to dividend tax cuts.