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Do you think top corporate executives are massively overpaid and unaccountable to shareholders? Are you worried that companies such as Microsoft Corp. are too big and just keep getting bigger? Have you become convinced there are too many mindless mergers and acquisitions? Do you think even after the Enron scandal that there are companies out there manipulating earnings for a higher share price? Such concerns are voiced by those on both sides of the political spectrum.

But, say conservative economists, there is something the federal government could do to mitigate these problems: Repeal the double tax on corporate earnings and dividends, just as President George W. Bush has proposed to do in his growth package.

Experts with whom Insight has spoken about the Bush proposal say that in addition to a likely short-term boost for the economy by inducing people to buy more stock, the big dividend from Bush’s plans would be an almost certain change in corporate behavior to make public companies more accountable to shareholders. As Vice President Dick Cheney told the U.S. Chamber of Commerce on Jan. 10, repealing the double tax would “transform corporate behavior and encourage responsible practices.”

The problem with the current tax code on corporate earnings is this, say tax specialists: Shareholders are the owners of a publicly traded corporation, and when their business pays the corporate income tax it is really a tax on them, the owners.

Yet when a corporation pays them dividends from earnings, that money is taxed again, resulting in total marginal tax rates on dividends of up to 60 percent. So corporations have been given a government incentive to retain earnings and leave shareholders to reap any gains when they sell the stock. This produces all kinds of economic distortions.

For one thing, the tax on dividends encourages companies to go into debt because interest payments are tax deductible, while dividend payouts are not. Bruce Bartlett, a senior fellow at the free-market National Center for Policy Analysis, who was a deputy assistant treasury secretary in the George H.W. Bush administration, tells Insight, “It encourages debt, and companies become overleveraged.

This hurts them when there is an economic downturn and sometimes causes them to go bankrupt.” If dividends were not taxed, Bartlett and others say, companies could raise money by issuing more shares rather than borrowing.

Another big effect of the double tax is that it “distorts the incentives of corporate management,” Bartlett says. “It encourages them, when they have profits, to use that money for things that are not necessarily in the shareholders’ interests. For example, buying other companies, rather than giving that money back to the shareholders.”

The full repeal of the tax on dividends unveiled in Bush’s economic package came as a surprise to many. But getting rid of the double tax on corporate earnings long has been a staple of tax-reform proposals, including both the flat tax and the consumption tax, but was considered one of the hardest points to sell.

Critics long argued that the flat tax was unfair because workers would pay taxes on wages, but wealthy investors would not pay taxes on dividends. Never mind that this criticism ignored the fact that as owners of the corporation the investors would still, in effect, be paying the corporate tax, monies which otherwise would be paid in dividends.

Some say Bush was encouraged to abolish the tax on dividends last fall at his economic summit in Texas by discount broker Charles Schwab, but Schwab now says he suggested it almost as an afterthought. Bush and his advisers could well have read the Aug. 12 cover story in Insight “Tax-Code Trauma” that indicted the corporate tax code, including the double tax on dividends, for the role it played in the corporate scandals by encouraging executives to engage in complicated transactions opaque to shareholders.

A big push for the idea came from R. Glenn Hubbard, the Columbia University economist who is chairman of Bush’s Council of Economic Advisers. As a deputy assistant secretary along with Bartlett in the administration of George H.W. Bush, Hubbard authored a paper in 1992 titled Integration of the Individual and Corporate Tax Systems: Taxing Business Income Once.

Hubbard wrote that the double tax on dividends “distorts corporate financial decisions … encouraging debt and discouraging new equity.” Hubbard concluded that “the potential economic gains from reform are substantial.”

Hubbard continued his research during his academic career at Columbia and now says that if Bush’s plan goes into effect it should result in a 10 percent boost in stock prices and long-term growth from a positive change in incentives.

Meanwhile, Democrats are pouncing on the fact that only half of Americans own stock and, even among those who do, much of it is in pension funds. They claim that it will benefit only “the rich.” Never mind that the investor class is growing rapidly, with more and more Americans owning individual stocks.

Jim Cramer, the liberal cohost of CNBC’s Kudlow & Cramer, says he is getting tons of e-mail in support of Bush’s plan from investors with average family incomes who bought stock in the last few years and are anxious to see a sustained market rally.

But the best strategy for ending the double tax, say proponents, could be bringing up the corporate issues liberals complain about, such as economic concentration, and telling them to put their money where their mouths are if they want to change corporate behavior.

The National Meat Association, a trade group of meat packers, points out in its newsletter that “double taxation of dividends has been one of the driving forces of corporate concentration in both agriculture and other industries … yet some of the same legislators who want to impose regulatory controls on corporate mergers are now speaking out against dividend tax reform, which would remove a major incentive for these mergers.”

Without the double taxation, for instance, Microsoft would have less incentive to sit on $20 billion in cash from earnings, as it currently is doing, Bartlett says. “Microsoft would get smaller because it would have to pay out that cash to the shareholders,” he explains.

And the president’s proposal should reduce unwise acquisitions by big companies because chief executive officers (CEOs) will have to justify to shareholders why purchasing a particular company is better for their long-term interest than paying the cash as dividends.

“There would be less favoritism in favor of retained earnings,” says Stephen J. Entin, president of the Institute for Research on the Economics of Taxation and who was a deputy assistant treasury secretary in the Reagan administration. “The Cisco [Systems] shareholders who voted not to have a dividend last year might change their mind.”

This in turn would mean that more of investors’ money would flow toward small, entrepreneurial, public companies whose innovations would benefit the economy, Entin and others say. “Right now if you have a lot of money locked up in, let’s say, Cisco, and you want to get it in some firm that is perhaps yielding a higher return but don’t want to take it out as a dividend you’d have to pay tax on, Cisco would have to buy that other company,” Entin says. “[If the dividend tax were repealed,] you would have less pressure for corporate mergers and more growth of independent companies. There will be more competition for money and it will flow more readily to the highest returns.”

Concentration of industry is a big issue on Capitol Hill. Last year, the Democrat-controlled Senate, with many votes from Republicans, passed an amendment to the farm bill to ban meat packers from raising their own livestock. The amendment, opposed by Bush, was dropped from the final bill in conference.

National Meat Association attorney Phil Olsson says lawmakers such as Sen. Charles Grassley (R-Iowa), who supported the amendment and support dividend-tax repeal could say to their Democratic colleagues: “This would stop concentration. Which side are you on?”

Another way that ending the double tax could change the behavior of corporate chieftains for the better is by making it less likely that they would manipulate earnings.

Enron, which did not pay any dividends, hid debt and reported bogus profits. But with no tax bias against dividends, shareholders likely would demand that more CEOs show them the money.

“Dividends are hard cash, and you shouldn’t be able to manipulate them,” Chris Edwards, Cato Institute’s director of fiscal-policy studies, argues to Insight. “If you’re getting ‘x’ dollars a month from your ownership, there’s no way that the company can manipulate that. They’ve got to give you the cash, and if they cut the dividend payout, you know that something fishy is going on here.”

Bartlett adds, “If we’d had this legislation five years ago, we would have saved ourselves an awful lot of trouble” from some of the corporate scandals.

Liberal groups such as the Center on Budget and Policy Priorities say, among other things, that the Bush plan doesn’t do enough to crack down on tax avoidance. “The administration is talking about this issue of double taxation of dividends, but it’s ignoring what we’re calling the zero taxation of profits at the corporate level because of the aggressive use by corporations of tax shelters and other tax-avoidance techniques that have been reducing the overall amount of taxes that corporations have been paying,” says Joel Friedman, a senior fellow at the center.

But the Bush plan has strict recordkeeping requirements that any dividends paid must come out of a company’s earnings that have been taxed. As prescribed in Hubbard’s 1992 paper, the plan requires companies to pay dividends only out of what are called excludable distribution accounts of taxable earnings.

Some big technology companies already have announced they will pay dividends if the proposal becomes law.

Dividends help establish trust between shareholders – something that’s vital for the capital markets to work and something that’s been missing since the corporate scandals. That’s why the plan is likely to boost the market and the economy even before it goes into effect, supporters say.

And Cato’s Edwards offers another reason for ending the double taxation: international competitiveness. In a survey he conducted among the 30 developed countries in the Organization for Economic Cooperation and Development (OECD), the United States was one of only three that did not have some form of relief from dividend double taxation.

And the other two that don’t provide relief, Switzerland and Ireland, have lower corporate tax rates.

The U.S. corporate tax rate of 36 percent itself is now higher than the 31 percent average for European Union countries, and is the fourth-highest among OECD countries.

“Multinationals now span borders and send money back and forth and decide where they’re going to set up their plants and the like,” Edwards says. “It’s extremely competitive, and getting more so all the time in the international climate, and the main imprimatur is on what are called capital income taxes: dividends, interest, corporate profits.”

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John Berlau is a writer for Insight magazine.

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