The magical disappearing tax break may be a fine way for the Senate to conjure up something of a compromise, but the effect it will have on the economy is more a matter of smoke and mirrors.
When the Senate voted last week to approve a $350 billion tax cut, it included some revenue-raising (read: tax increases) to offset the cost of eliminating the tax on dividends -- a provision for which President Bush desperately lobbied. To minimize the cost of the president's proposed $400 billion dividend cut, though, the Senate also limited the dividend tax relief to a three-year period. "It doesn't make a lot of sense," says Jim Cusser, who manages a $1.5 billion bond portfolio for Waddell & Reed and has long advocated for the elimination of a tax on dividends. "Any temporary tax reduction typically goes to savings. But this way the president gets a legislative victory, although it won't do what he intended it to do." According to the Senate's latest proposal, only half of dividends distributed in 2003 will be taxed; in 2004, 2005 and 2006 no dividends will be taxable at the individual's level. In 2007, though, the break expires, or reaches its sunset, and the tax law reverts back to its current state -- in which all dividends are taxable at the individual's ordinary income tax rate. Congress has taken to phasing in tax breaks and adding these sunset provisions in an effort to hide the true cost of budget expenses -- such as tax cuts. And the 10-year projections that are so common in Washington these days are really nothing more than an outgrowth of that same desire to delay the real accounting of a tax cut. "In the early 1970s we had one-year budget forecasts," says Stan Collender, managing director of Fleishman-Hilliard's federal budget group. "That went to two years when Congress realized all they had to do to get the amount they wanted was to push past the standard projections. Two years became five, and five became 10."