Arnold Kling  

Temporary Dividend Tax Cut?

Comment of the Week, 2003-05-1... Growth and Demographics...

Jacob Levy criticizes the Senate's proposed temporary tax cut on dividends.

The arguments in favor of repealing the dividend tax have to do with removing distortions from the capital markets and from the incentives faced by corporations, and with improving tranparency in corporate accounting. Removing distortions from the capital markets is a good thing for long-term growth...The desirable effects that it is supposed to have would all be defeated by a three-year sunset clause; corporations aren't going to restructure their debt practices, their dividends vs. stock buyback practices, for such a short-term provision.

Levy argues that the Senate is confusing a temporary Keynesian stimulus with a supply-side tax cut. He says for temporary stimulus, a demand-side tax cut, such as increasing the personal exemption, would make more sense.

I would disagree slightly, in that there is a good argument that temporary tax cuts also are less effective than permanent tax cuts for increasing demand. The argument is that people tend to smoothe consumption, so that a relatively large part of a temporary tax cut will go into saving.

Overall, however, I agree with Levy's point that a temporary dividend tax cut is a bad idea. Either double taxation of dividends is good policy or it isn't. We should not legislate single taxation for three years followed by double taxation thereafter.

Virginia Postrel remarks,

The congressional process has taken a good idea for fundamental tax reform and turned it into short-term, wildly distortionary vote-buying with absolutely no economic rationale. It's just one more example of why anyone with a brain inevitably develops contempt for Congress.

For Discussion. If you were President Bush, would you sign or veto a temporary dividend tax cut?

COMMENTS (3 to date)
Scott writes:

From a policy standpoint temporary tax cuts make little sense. We need permanent cuts for them to really grow the economy. From a political standpoint, a temporary cut is all that Bush can get right now. Anything else needs 60 votes in the senate and there’s no way to get that done – the Democrats simply won’t allow it.

Bush will and should take what he can get. He’ll be back again every year to renew and extend the temporary cuts. And those will get easier and easier to pass year after year.

Do we really think that the estate tax cut will be allowed to expire? Will future congresses allow the marriage penalty to come back after being abolished for a few years? I don’t think so.

David Thomson writes:

I feel it is incumbent upon me to throw a wicked curve ball over the plate. Is the tax cut really all that important? What about the near future increased oil drilling in Iraq? Won’t that alone be sufficient to significantly boost our economy? Might we actually be very close to an economic boom? Should I immediately seek residence in the closest loony bin, or am I truly broaching upon a subject which is in the back of everyone’s mind?

The war in Iraq was not directly about oil. Nonetheless, why be shy in admitting that this successful action will almost certainly improve the economies of most of the world?

Scott writes:

Allow me to take a swing at your curve ball. Oil production in Iraq should ramp up over the next few years to about 6 million BPD. It was running in the 1.5 to 2 MBPD range prior to the war.

Crude prices shot up in the 6 months prior to the war because of uncertainty. OPEC increased production, but the market drove the price up anyway. Prices started falling the day the war started and the uncertainty was resolved. In addition, the oil fields were taken pretty much intact. 20 years of deferred maintenance has taken its toll on the production facilities, but things will get better every month from here on out.

The longer term question of oil prices would seem to rest on how much of the Iraqi production comes out of other OPEC quotas. If quotas are adjusted to handle Iraq’s increasing production, then prices will remain in OPEC’s preferred range or $25 to $28. If not, then over production will drop prices and make them quite volatile. We could see $10 oil again.

As for its economic impact, the US economy is much less dependent on oil than in the past. Not because we use less, but because the rest of the economy has grown so much. During the first oil price shocks, it was 8% of the economy. Now, it’s less than half that. It’s noticeable, but it’s not that big a deal anymore.

For the developing countries, it will be more significant.

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