Senate Half-Measure on Tax Cut May Yield Few Dividends

Another battle over the elimination of the dividend tax was fought on the Senate floor Thursday, with another absurd result in a string of bizarre congressional decisions.

When the Senate narrowly passed its $350 billion tax-cut package late Thursday night in a 51-to-49 vote, it looked pretty much like what was expected -- an increase in the child tax credit and measures to phase out the marriage tax, for instance. There was one big exception: a three-year repeal of the tax on dividends.

While some Republicans are happy to get any dividend-tax relief, most Democrats and Washington observers expressed exasperation at the uselessness of a tax break with such a short "sunset," or expiration date, saying that it won't affect corporate behavior. And affecting corporate behavior, remember, is ostensibly the aim of such a break.

Montana Democrat Max Baucus, ranking member of the Senate Finance Committee, called the provision absurd and irresponsible. "It's a yo-yo tax provision ... now you see it, now you don't," he said. "You tell me if corporations are going to plan their dividend distributions around a tax break that expires after three years."

The dividend-tax relief would begin in 2003, with only 50% of stock dividends subject to tax. In 2004, 2005 and 2006, all stock dividends would be exempt from tax (provided the company has paid tax on the profits at the corporate level). But according to this Senate plan, in 2007 the exemption will expire and once again all dividends would be taxed at the individual investor's income tax rate.

"It's crazy tax policy," says Tom Oschenschlager, tax partner with Grant Thornton in Washington, D.C. "Even staunch conservatives who want the dividend-tax cut say that a three-year break won't help."

Eliminating the tax on dividend payments, the argument goes, will not only put more money back into investors' pockets, but also encourage them to buy more stock. That will give companies the capital (and the general sense of well-being) to expand their businesses, which in turn will create more jobs. But a three-year tax break will not likely alter anything.