Adding Up The Stimulus Plan

If there's one thing we're supposed to have learned from this year of business scandals and disasters, it's the danger of believing numbers that are too good to be true. The Enron and WorldCom implosions are about made-up math, as is the uproar over Wall Street's overly optimistic analysts. Yet despite these object lessons, it looks like we're about to get suckered by another combination of wishful thinking supported by nonsensical numbers.

I'm talking about the proposal to stimulate the economy by cutting personal income taxes on dividend income. Supporters include President George W. Bush, Charles Schwab, various business groups and such liberals as Sen. John Kerry. Cutting taxes on dividends is generally paired as an economic stimulator with a "tax holiday" that would eliminate payroll taxes on the first $10,000 of salary that people earn next year. Both ideas seem likely to be part of White House stimulus proposals. (A White House spokesman said last week that no decisions have been made.) But even though these items are often mentioned in the same breath, they don't deserve equal billing when it comes to stimulating the economy. That is, unless you're talking about stimulating the economy of the handful of households with significant dividend income.

You don't have to be an economics Ph.D. to see how a one-time reduction in Social Security and Medicare taxes could give the economy a shot of adrenaline. Much of the money--$765 each for employees and employers--would be spent quickly, particularly by lower-income households, which would get the bulk of the $101 billion windfall. (That statistic comes from the Brookings Institution, whose numbers I'm using throughout.) Employers would also save $101 billion, but are much less likely to run out and spend it. I don't know if this one-time tax holiday would work the way it's intended to. But it's got a lot better chance of stimulating the economy than reducing personal taxes on dividends.

For starters, the folks pushing this plan aren't talking about dividends from money-market mutual funds or bond funds. They're talking only about dividends that you get directly from a corporation, or the part of your mutual-fund distributions that are attributable to such dividends. Personal taxes on these amount to only about $25 billion a year, because many corporate dividends go to tax-exempt stockholders, such as pension funds and 401(k) accounts.

In a $10 trillion economy, $25 billion isn't all that much. Besides, most of the tax savings would flow to a relative handful of households--the top 2.3 percent pay 53 percent of dividend taxes--that aren't likely to spend the money quickly, and maybe not at all. What's more, it would take until 2004, when people file their 2003 tax returns, for most of the impact to be felt, in the form of lower checks to the IRS (or larger refunds).

So how would this stimulate the economy today? Watch this three-carom, wishful-thinking shot. Cutting dividend taxes would boost stock prices sharply. Higher stock prices make it cheaper for companies to raise capital. Cheaper capital leads companies to expand more than they otherwise would, stimulating the economy.

R. Glenn Hubbard, chairman of the president's council of economic advisers, has argued in the past that eliminating personal-dividend taxes would boost the stock market by 20 percent. This may be true in someone's computer model, but not in the real world. The White House wouldn't let me talk to Hubbard: "When the president makes a decision, we'd certainly be happy to discuss the reasoning behind the items, " a spokesman said. So we're on our own. Here goes. Stocks of U.S. companies are currently worth around $8.4 trillion. A 20 percent increase would be $1.7 trillion. Eliminating the dividend tax, as we've seen, would save taxpayers $25 billion. Do the math, and each dollar of tax savings is supposed to translate into $68 of stock- market value. In the dot-com days, you used to see ratios like that. But not now.

Current policy on dividends is flawed, because corporations pay dividends out of after-tax income, and recipients then pay tax on the dividends. By contrast, interest payments are tax-deductible. So companies have a predisposition to borrow, which often leads to problems. But the way to solve that problem, as Sen. Jon Corzine (former co-head of Goldman Sachs) says, is to make dividends deductible to companies. Not by making dividends tax-free to recipients. Pardon my skepticism, but cutting taxes on dividends is a Wall Street perennial. It used to dress up as "fairness." Now it's "stimulus."

I think the chances of dividend tax cuts restoring the economy to full vigor are about the same as a fat man's sliding down millions of chimneys and leaving presents behind. The difference is that Christmas is just one day a year, but eliminating dividend taxes would be forever.