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"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.

In a Rose Garden speech Tuesday, President Bush reiterated support for dividend-tax reform, stressing such measures are "more urgent today" than when first submitted to Congress in

early January.

The president pledged to push for his "pro-growth package

until it is enacted

" -- strong words from a president sporting historically high approval ratings. (Italics added.)

However, Bush followed his gauntlet toss with a concession, calling on Congress to pass "at least $550 billion" of his original $726 billion package, rather than the whole shebang.

"It shows

the administration is accepting the handwriting on the wall," said Greg Valliere, managing director of Charles Schwab's Washington Research Group. "The vote on Friday night was a real blow to Bush,

and maybe he's thinking if he shows some flexibility the Senate could as well."

In addition to Grassley's pledge, that handwriting includes the budget resolution passed by the House of Representatives, which allocates $550 billion for tax cuts vs. the $726 billion Bush requested and the House initially approved.

"The midpoint between the House and Senate is now $450 billion, which is probably the most

Bush can hope for," Valliere said. "You could do something on dividends, but I don't think he can even get half a loaf," meaning a 50% dividend tax exclusion. (Valliere

long argued a 50% reduction was the Bush administration's best bet all along -- if not its actual goal.)

Handicapping the Politicos

Chuck Gabriel, head of Washington research at Prudential Securities, speculated the administration might "try to offload some other nondividend related proposals into another bill -- ostensibly one that might be able to get 60 votes," in order to salvage dividend reform.

But that seems unlikely, given the president also called on Congress to accelerate tax relief passed in 2001, which was not due to take effect until later this decade, including raising the child credit to $1,000 from $600. He also asked for a tripling of the amount small businesses can deduct in the year they buy equipment, to $75,000.

Alternatively, Bush might reduce those nondividend proposals and ask for a 50% dividend exclusion, "and maybe do that for anywhere from three to five to seven years," Gabriel suggested.

Such a combinaton deal would allow Bush to employ the same strategy with dividend reform as with other taxes. That is, propose a "phase-in" for dividend reform now and after he's (presumably) re-elected in 2004, reiterate the mantra uttered Tuesday: "If the tax cuts are good enough three or five or seven years from now, they're even better today."

Although some additional tax relief seems a foregone conclusion, the strategist also observed "the only real metric is whether he turns the economy around, and we shall see about that."

Meanwhile, the rhetoric from various administration officials is that "we're going to keep pushing for the entire package," as Treasury Secretary John Snow said this week.

Schwab's Sonders, during a strategy group meeting with Bush and Snow earlier this month, asked the president specifically if he'd be satisfied with a 50% dividend-tax cut. "'If I wanted half, I'd have asked for half,'" she recalled the president replying. "I don't think they're done with the attempt,

although clearly this news is not great."

Such tough talk in the face of adversity has emboldened dividend tax reform proponents such as Frank Fernandez, chief economist at the Securities Industry Association, and another participant in the strategy group.

"I definitely don't think this is over yet, given we're talking about two votes," Fernandez said. "A lot can happen in the next 30 days. I can't handicap political prospects, but it seems people are counting this out well before its time."

"This is a political battle now,

but it stuns me it's so unpopular to do the right thing," Fernandez added.

However, private sector economists have done a much better job of describing the long-term structural benefits of dividend-tax reform, while the administration has tried to sell it as a short-term economic stimulus.

"I'd be hugely disappointed to not get anything on dividends," Sonders said. "Unfortunately, the chances of getting the full thing are fairly slim, but I'd like to think we'll get something."

On Wall Street, something is better than nothing, especially if expectations have been dampened, as is currently the case with dividend-tax reform.

Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.