Given the resistance from Republican senators Olympia Snowe of Maine and George Voinovich of Ohio, the administration got the best possible deal on how to keep alive the President`s proposal to end the double-taxing of dividends. The two Senators finally agreed to vote for the Budget Resolution that preserves at least a $350 billion tax cut over ten years which would need only 50 votes to pass. Without a BR, any tax bill would have to have 60 votes if opponents decided to filibuster. It may be $350B is all that will eventually pass -- probably between Memorial Day and July 4 -- but Snowe and Voinovich agreed that if a conference committee of the Senate and House tax writing committees does report out a bill exceeding $350 billion, it would only need 50 votes. In other words, they are allowing for the possibility the administration may get them to change their minds in a month or so -- or persuade other Senators to do so. If the administration is no more successful in making its arguments for tax cuts with budget deficits as high as they are, almost nothing will have been gained by this compromise.
On the other hand, the time gained may enable the administration to think about the content of a $350B package. There is now talk of phasing in the 100% exclusion on the dividend tax, which would be pretty messy to administer. It would be easier to do the 100% over five years, another possibility being kicked around, on the assumption that when it is about to expire in five years the Congress would then extend it indefinitely. The White House might push for this in the House and then see what happens. There`s no certainty they could do this and even get the votes of all the GOP Senators who have supported the White House on the dividend tax, as it would put at risk the other tax cuts under consideration, which have little growth kick, but popular appeal. Treasury Secretary John Snow and his troops would have to find out if there are 60 votes for any other these measures, which could then be adopted outside the Budget Resolution.
The reason we spend so much time keeping you informed on these moves is the extreme importance of the double-tax issue to the health of the financial markets and the economy. Secretary Snow says it would add at least $1 trillion to the value of equities, which translates into several hundred points on the DJIA. A 100% exclusion would eventually mean an extra 3% per year in GDP in perpetuity! In terms of income, the greatest beneficiaries would be Labor, not Capital. The returns on Capital would leap forward, with one tax barrier completely gone, but when Capital becomes plentiful as a result, Labor becomes relatively scarce.
We will have another problem to worry about, though, if the administration is successful in getting his bonanza for the markets and the economy. It will sharply increase the demand for dollar liquidity, and in the absence of a mechanism at the Fed for supplying liquidity on demand (which would occur with a commodity standard), the price of gold will head lower and we will be back in the deflation soup. The return of "pricing power" we are now seeing will then dry up. But we always prefer to get the tax cuts in place and then hope policy can change on the monetary front to prevent deflation from offsetting expansion.