A Tax Smorgasbord
Jude Wanniski
May 16, 2003


Chairman Don Nickles of Senate Budget argued on the Senate floor Thursday that a temporary 10% exclusion on dividend taxation would enable everyone to judge whether it would be good for the stock market. He said he could expect the equity market to rise by 10%, 15% or even 20% as a result of the change, and this would prove to doubters that the provision should be made permanent. I quickly e-mailed one of the Senator`s senior staff people that the Wall Street rally of the last month was mostly due to the progress the tax legislation had made relative to earlier expectations. If the version that comes out of a House-Senate conference can improve out of the smorgasbord scattered over the table, I said, there could be a further gain, but Nickles should be wary of making "success" contingent on a further climb by those higher numbers. If the conference somehow failed to come to any agreement, on the other hand, we should expect a decline in the Dow Jones Industrials of five or six-hundred points. We note that the Senate bill also includes a provision to drop the top marginal rate on repatriated profits to 5.25% from 35% for one year. With a gush of repatriated funds at the lower tax rate, estimates of tax revenue collection from this maneuver run into the billions, which would be a pro-growth way to raise revenues and offset the cost of other tax cuts.
It is not now obvious at all which direction the conference will take, as much will depend on how the White House sizes up the possibilities. It is clearly the preference of all supply-siders that the greater benefits will come from the House version, which provides for a 15% top rate on both dividends and capital gains, 5% on the two lowest income brackets. The Senate version has much less economic punch, because the temporary full exclusion on dividends would have to be heavily discounted by corporate planners. To really begin shifting corporate policy toward dividends, there would have to be a sense of permanence. The House version packs more punch because it not only knocks 20 points off the dividend tax but also takes capgains down by 5 points and this combination would have more immediate impact on the equities. The concern is that White House political advisors will prefer a 100% exclusion so Mr. Bush can claim political victory on his original proposal, but the economic team, especially Treasury Secretary John Snow, would prefer a stronger economy going into next year`s elections. If there is, Republicans would presumably make greater gains in the House and Senate and be able to build on what they have begun with this tax package.
In that regard, Gary Robbins of Fiscal Policy Associates believes the conference should boost the bonus expensing provision in the House bill to 100% from 50%. This would increase corporate cash flow by almost $150 billion in the first year. The nice part is that it would only add $10 billion to the total "cost" of the final package, which is computed over a 10-year period. If you take all the expense for capital equipment in the first year instead of 10% for each of 10 years, the government "loses" all the imputed revenue in the first year, but loses none in the next nine. Robbins likens this to a government loan to corporate America in this time of cash-flow troubles.
Most interesting this week has been renewed discussion of a top-to-bottom tax reform. Sen. Arlen Specter [R-PA] has been trying for the last few years to spark interest in a flat-tax system of the kind former House Majority Leader Dick Armey championed for years, the one Steve Forbes picked up in his 1996 run for the GOP presidential nomination. Specter this week proposed a "Sense of the Senate" amendment to the tax bill, calling for the Joint Economic Committee and Senate Finance to study the idea of "tax simplification." Sen. Max Baucus, ranking Democrat on Senate Finance, joined Chairman Chuck Grassley in supporting the amendment -- although he said he did not think the idea would get anywhere until the whole federal tax system broke down completely and the electorate demanded reform. Grassley said he thought it would be possible if President Bush got behind the idea in 2004 and the Democratic nominee opposed the idea. Bush would then have a powerful mandate, he opined. Amazingly, the Specter amendment passed 70-to-30, with every Senator who is running for President (plus Sen. Hillary Clinton of New York) voting against the amendment. In deciding to support the President's tax package after all, Ohio Republican George Voinovich said he did so after he got a commitment from President Bush to sponsor a commission to rewrite the entire tax code. "We`re going to do some honest-to-God tax reform," he said.
President Bush continues to argue for a bigger tax package than the $350 billion in the House bill and is presumably hoping to pick up a few more Democratic votes to support something like the $550 billion House package. If he can`t, it is expected the conference committee would have to water down the 5-15 measure on dividends and capgains to higher rates, perhaps 9-19, which will take much of the kick out of the package. In any case, the drift continues in the right direction, with the bill voted out of the Senate yesterday with Vice President Cheney breaking the 50-50 tie is so much more promising than the market could have imagined a month ago. It did make a huge difference for the Senate to agree to a $20 billion one-time tax relief package to state and local governments, as this brought a second Democrat into the fold, Ben Nelson of Nebraska. In the campaign to influence the final outcome, that bundle of cash may look like manna to the revenue-starved governors and mayors who have thus far been sitting on the sidelines. New York City Mayor Mike Bloomberg, who had been one of them, last Sunday did offer tepid support for the tax cuts. The $20 billion may warm him up some more. I now expect the conference report to be a little bit better than just okay.