WASHINGTON — U.S. President George W. Bush’s new economic agenda is entitled “Taking Action to Strengthen America’s Economy,” but it is more than that. While some critics claim to have discerned a very narrow focus, the dividend component in particular will have far-reaching implications for the global economy.
The plan proposes to eliminate the double taxation of dividends in the United States. Currently, companies pay taxes on their profits. Then, when the company pays out money as a dividend, these payments are taxed again on the individual level. Of the profits devoted to dividends, shareholders may keep as little as 40 cents on the dollar. Why should that matter internationally ?
In recent years, dividends seemed to have fallen out of favor and investors were mainly counting on share appreciation. However, the bursting of the e-commerce bubble has again brought back a focus on regular dividend payouts by corporations. Even Microsoft announced on Jan. 16 a first time dividend to its shareholders.
The size of such payments are designed to reward investors, give them stability and to keep them willing to supply their money to the company. A firm will therefore want to provide a level of dividend payout amount that achieves these goals.
Let’s look at some numbers: Today if a firm wants to provide for a net return of 2 percent to an investor who holds $2,000 worth of shares, it needs to allocate $100 of its profits to achieve this goal after the 35 percent corporate taxes and almost 39 percent of high-income investor taxes are paid. Once the double taxation is eliminated at the investor level, the firm has several alternatives. It can raise the investor’s return by 63 percent to a 3.25 rate, or maintain the same net return to the investor, needing to allocate only $62 of its profits. Firms may well decide to shift their payouts so that investors get a higher return and the firm retains more funds for investment. This aspect of the plan is thus likely to lead to more consumer spending as well as higher investment levels.
The increase in investment — if done prudently — is likely to lead to more advances and innovations on the part of firms and lead, therefore, to greater global competitiveness for U.S. companies. This investment component is likely to be less immediate than an increase in consumer expenditures, but in the long term, it may well set the stage for the global positioning of U.S. firms.
We can tell that the taxation of dividends matters by looking at the policies of our key competitors. Today most nations with long established stock exchanges tend to have some preferential policies in place to reduce the tax burden on dividends. Typically such policies provide for at least partial offsets of taxes already paid once, or for a lower than customary flat tax on dividends.
The European Union has a council directive that discourages double taxation among corporations. The Japanese Diet has a proposal for further tax reductions on dividends. The few countries that do not offer any double-taxation relief at least have low capital income tax rates. Clearly, all these countries have recognized that in today’s world of global financial markets money has become commodified. Investment flows to those countries and firms that offer the best opportunities.
Eliminating the dividend double taxation will not only help U.S. firms and shareholders pull even with their competitors abroad but will also allow them to forge ahead based on a plan that is clear, simple and fair. Unlike in some other countries that have reduced taxation of corporate profits, this relief will affect consumers directly.
One possible result will be an increased attractiveness of U.S. stock exchanges to foreign listers. Once the proposal is implemented, it will be easier for all firms to reward their investors and encourage them to provide funds. The proposal will also make individual investment flow from abroad more attractive. No taxation is much better than automatic tax withholdings — at least psychologically, even if investors are able to qualify for a refund from their own tax authorities.
Elimination of dividend double taxation in the U.S. is likely to cause major adjustments abroad as well. Just as the deregulation of the telecom sector has spread worldwide, reduction of these taxes are likely to virtually make it a requirement for other countries to follow suit and eliminate their still existing excessively high dividend tax burdens as well.
U.S. dividend policy can shift from followership to that of leadership. The elimination of double taxation will leave more money in the pockets of investors around the world and make the use of capital more efficient globally. It’s good to see that the pursuit of important domestic objectives can make a major positive difference for so many people in other countries as well.
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