Senate GOP expands dividend tax cut
WASHINGTON (CBS.MW) -- With the help of Vice President Dick Cheney, the Senate agreed Thursday to phase out for three years the individual income tax paid on corporate dividends.
Although temporary, the provision brings the $350 billion Senate tax-cut package closer to President Bush's centerpiece proposal for the full elimination of the so-called double taxation of dividends.
"This would have, I think, a very significant impact, positive impact on the stock market, on individual's 401(k)s, on people that have teacher retirement accounts and others. It would help them, I believe, dramatically," said Sen. Don Nickles, R-Okla., the amendment's sponsor.
Democrats said the amendment consisted of budget gimmicks that not only disguise its true size but also render it economically ineffective.
"This is a huge yo-yo tax provision. Now you see it, now you don't. ...You tell me if any corporation is going to be able to plan whether or not to pay dividends or not with a tax policy like that," said Sen. Max Baucus, D-Mont. "Of course they're going to wait until it's 100 percent."
Two crucial centrists -- Sens. Ben Nelson, D-Neb., and George Voinovich, R-Ohio -- backed the Nickles amendment, which would allow individuals to exempt half of their dividend income from taxation in 2003. From 2004 to 2006, all dividend income would be exempt. Full taxation of dividends at regular income tax rates would resume in 2007 unless Congress acts in the future to extend the provision.
Nelson joined long-time tax-cut advocate Zell Miller, D-Ga., and 48 Republicans in voting for the amendment. The proposal lost the support of centrist Republican Sen. Olympia Snowe of Maine, but held the support of another key GOP moderate, George Voinovich of Ohio. Two other Republicans -- Rhode Island's Lincoln Chafee and Arizona's John McCain -- voted against the amendment.
Tie breaker
That produced a 50-50 tally, with Cheney then casting the tie-breaker.
Passage of the underlying bill was expected later Thursday.
As originally written, the tax-cut package would have exempted the first $500 of individual dividend income from taxation, as well as an additional 10 percent of such income above $500. The additional exemption would rise to 20 percent after five years.
The approach was designed Senate Finance Committee Chairman Charles Grassley, R-Iowa, to gain the favor of Snowe, who holds a crucial vote on the panel. The provision, however, disappointed most Senate Republicans and the White House, who had hoped for a bigger and bolder approach.
The temporary nature of Nickles' amendment was necessary to hold the size of the total tax package below the net $350 billion cap required under the "reconciliation" portion of the Senate's budget resolution. The reconciliation process shields tax legislation from Senate rules that would require a 60-vote supermajority.
Critics said the 2007 expiration was a gimmick to disguise the true size of the proposal, particularly since sponsors clearly hope to extend the provision before it expires. Anticipating criticism, Nickles on Wednesday said such accusations were "hogwash" since all tax cuts under reconciliation must expire after 10 years.
Opponents contend that measures that expire before the end of the reconciliation period are particularly deceptive, designed solely to mask their 10-year costs.
The liberal Center for Budget and Policy Priorities estimated the Nickles amendment, if extended beyond 2007, would raise the 10-year size of the tax cut from $350 billion to $660 billion.
As written, the amendment would cut revenues by $124 billion, $44 billion more than the bill's original dividend provision. To make up the difference, the amendment would scale back relief of the so-called marriage penalty and provisions designed to encourage investment by small businesses.
Democrats have sharply opposed efforts to eliminate the dividend tax, saying benefits would go largely to the nation's wealthiest taxpayers while doing little to boost the economy.
Baucus said the provision also strays far from Bush's call to end the double taxation of dividends. Bush has repeatedly said it's "fair" to tax corporate profits once, but unfair to again tax the same money when distributed to shareholders as dividends.
Baucus said the proposal would exempt dividends from taxation even if a corporation had never paid taxes on the earnings.
Any Senate tax bill will need to be reconciled with the $550 billion package that cleared the House earlier this month. That bill scaled back Bush's call for full elimination of the dividend tax, instead cutting the capital gains tax rate and the income tax rate on dividend income to the same 15 percent rate.
House Speaker Dennis Hastert, R-Ill., expressed skepticism Thursday about the temporary nature of the Senate dividend provision.
"Most capital gains are long-term investments. That is what we want people to do. If the dividend is 50 percent and then nothing, and all of a sudden it is back to 100 percent or whatever it is, my feeling is that it does not solve the problem," Hastert told reporters, emphasizing that he hadn't discussed the proposal with Bush.
Tonic for the stock market?
The White House and Republican leaders have argued that eliminating the tax on dividends is crucial to boosting the stock market and improving corporate governance.
Proponents have argued that the proposal could boost the market by anywhere from 5 percent to more than 20 percent.
Skeptics question whether the proposal would have any significant effect. A recent study by the consulting firm McKinsey & Co. predicted the plan would be unlikely to have a lasting impact on the market because the key market players -- tax-exempt institutions and individuals with shares in tax-exempt accounts -- are already shielded from taxes on dividend income.
The Senate bill includes $20 billion in aid for cash-strapped states, a measure that has angered some conservative Republicans but has also served as a potential enticement to some moderate Democrats, including Nelson, to support a bigger tax cut.
An effort by Democrats to double the amount of aid to $40 billion was defeated.
William L. Watts is a reporter for CBS.MarketWatch.com
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