Shrugging Off the Dividend Downer

"This is the answer for the economy, the stock market and for bringing back trust and fairness and faith to the system." -- Liz Ann Sonders, chief investment strategist, Charles Schwab.

Liz Sonders, among many others, has argued that eliminating the double taxation of dividends would have hugely positive implications for the stock market and the economy. So logic dictates that major setbacks on the path toward dividend reform would have negative implications.

But so far, Wall Street seems unperturbed by the possibility that President Bush's proposal for eliminating dividend taxes will be significantly watered down, if not altogether abandoned, by Congress.

One reason market participants aren't worried about tax reform is the current myopia about earnings, which has buoyed shares this week despite more lackluster economic data. Additionally, some contend the Street already "priced in" (or "out" in this case) the probability of only a partial cut in dividend taxes.

"When [Bush's plan] was first announced, it was a grandiose thing, the greatest thing since sliced bread," recalled Art Hogan, chief strategist at Jeffries. "Since then, the rhetoric turned south on the possibility of getting the plan rolled out. The market tried to get in front of it, and priced in disappointment."

Part of the market's backslide in early March reflected a realization that it was going to be hard for Bush to "justify increased military spending and tax cuts," Hogan argued.

If that's true, there's a somewhat ironic possibility of the market being set up for a positive surprise if Bush is able to wrangle even a 50% dividend-tax reduction out of Congress, much less 100%.

That's crucial because supporters say dividend-tax reform isn't dead, even if it's currently in dire straits.

Showdown on the Hill

Late last Friday, Senate Finance Committee Chairman Charles Grassley (R., Iowa) pledged to limit any tax cut to $350 billion, an act deemed necessary to convince fellow Republicans on the committee, Olympia Snowe (R., Maine) and George Voinovich (R., Ohio), to support the Senate's $2.27 trillion budget blueprint.

As a result, "the centerpiece of Bush's tax plan -- a proposal to eliminate the tax that investors pay on corporate dividends -- appears in deep jeopardy," The Washington Post reported.