Right Plan at the Right Time
www.washingtonpost.com By Stephen Friedman Sunday, January 12, 2003; Page B07
Last week the president announced a comprehensive plan to strengthen America's economy by raising our potential for long-run growth while providing near-term lift. It is a robust plan and, judging from the favorable response it is receiving from many economists and business leaders, it's what our economy and markets need at this time.
The economy has survived extraordinary shocks in the past few years: a dramatic market decline beginning in March 2000, followed by a recession, the Sept. 11, 2001, attacks and disclosures of confidence-shaking abuses by some corporate leaders. Yet thanks to the economy's resilience and to sound policies of the administration, growth has resumed, although not with the momentum we need.
Most private forecasters expect business investment to improve this year, and with it the job creation needed to reduce unemployment. The consensus is that we will have a rising rate of GDP growth over the course of 2003, and strong growth in 2004.
Still, we face serious challenges. Many who want to work cannot find a job. Many employers lack the confidence to invest, expand and create new employment opportunities. Concerns about future terrorist attacks, the possibility of war and rising oil prices brought about by disruptions such as those in Venezuela could undermine public and business confidence. If the recovery in business investment is delayed or anemic, the economy's ability to generate new jobs will be hampered. If families, feeling the wealth reduction of recent years, shift to a more cautious stance, they will pull back on spending.
That's why the president's plan is timely and essential. My Wall Street experience taught me to measure potential risks as well as likely returns, and this plan provides the economy with the growth insurance it needs at this time. It asks Congress to speed up the future tax relief promised to Americans in 2001 by accelerating marginal rate reductions; and it includes additional relief for middle-income families by reducing the marriage penalty, increasing the child tax credit (and accelerating payment of the increased amount) and expanding the amount of income taxed at the lowest -- 10 percent -- rate. Thus, for example, a family of four with earnings of $40,000 per year will be able to keep about $1,100 more of its money.
Upon passage, the Treasury Department will make withholding changes, so Americans immediately will be able to keep more of their paychecks. For the past two years, the household sector has held up while business investment slumped. The president's measures will help ensure that the household sector stays strong and will help families replenish savings. Also, small-business owners taxed on a "flow through" basis will keep more of their profits to reinvest, expand and create jobs.
The president's plan would also abolish the double taxation of dividends. Under current law, an investor's after-tax return from a dividend shrinks to as little as 40 cents for each pretax dollar earned by the paying corporation. As a matter of principle, the president believes it is unfair to tax earnings twice, a principle most Americans surely agree with. But abolishing the double taxation of dividend income is also good policy, for three other reasons.
First, it would eliminate what economists and scholars across the spectrum have for decades considered to be a distorting element in corporate finance. The United States is one of only three of the 30 Organization for Economic Cooperation and Development nations that offer no relief from this double tax. Double taxation of dividends creates a bias toward corporate borrowing, because the interest on debt is tax deductible, whereas dividends are at present neither deductible nor exempt from tax at the recipient level. Sound management and market forces -- not the tax code -- should govern decisions on whether to raise debt vs. equity capital and whether to retain earnings, buy back stock or pay dividends.
Second, this reform would make the fundamental financial health of firms more transparent. In the '90s there was a great deal of pressure to book manufactured earnings, and this hurt investor confidence. If a company pays regular dividends, investors will have checks in their hands and can be confident that profits are real.
Reaction from business people I talked with this last week indicates that the president's proposal could also lead many companies to start paying dividends or increase their existing dividend payouts if they don't have compelling uses for all their retained earnings. This would be a boon to the economy and to the more than half of all American households that own stock, directly or through pension plans. Investors can decide whether to spend this additional money or choose among the most attractive investment opportunities. Senior citizens, who receive half of all dividend income, will be important beneficiaries of this reform.
In fact, abolishing the double taxation of dividends will help all Americans -- not just stockholders -- and that's the third and most important reason it is good policy. To the extent that money paid out in dividends isn't spent on consumption, it doesn't get put under a mattress. It gets invested someplace. Over time, this reform will lead to a better allocation of capital, as money flows to the places where it will have the highest return. That leads to greater capital stock -- an economist's term that really means workers will get better technology and tools to do their jobs -- resulting in higher productivity and higher income for working families.
By putting more money in people's hands and providing more incentives for work and entrepreneurship -- while making the tax code fairer -- the president's plan will encourage consumer spending and business investment, boost confidence in our markets and promote job creation.
The writer is assistant to the president for economic policy and director of the National Economic Council.