Stimulus for Lawyers

SYNOPSIS: The Bush dividend tax cut plan makes the tax code a lot more complicated

My colleagues on the editorial page dubbed the Bush administration's proposal to eliminate taxes on corporate dividends "The Charles Schwab Tax Cut." Indeed, the idea seems to have originated in remarks Mr. Schwab made last summer in Waco. But a closer look suggests that it should actually be called the "Tax Complication Act of 2003": it will do little if anything to create jobs in the economy as a whole, but will be a bonanza for tax lawyers and accountants.

In fact, even some of the lobbyists you would have expected to cheer the plan now believe that it is so complex as to be unworkable.

By now you've probably read a lot about the economics of the administration's plan; all the criticisms are true. The plan has nothing to do with stimulus, since less than a dime on the dollar will arrive in the next year. Its benefits are almost ludicrously tilted toward the very, very affluent. (Exercise for readers: Explain how the administration can claim that the average family receives a $1,083 tax cut, when 80 percent of families will receive less than $1,000, most less than $300.)

But you may not be aware of the huge technical problems with the plan's centerpiece, an end to taxes on dividends.

The slogan was simple enough: "No more double taxation." Corporations, it was said, pay taxes on their profits so let's not tax the same income again, when it's paid out as dividends. But the slogan was simplistic. On one hand, in our loophole-ridden system many profitable corporations pay little or no profits tax (and the new plan, by the way, will still leave corporations eager to exploit every loophole they can). On the other hand, retirement accounts, which receive most of the dividends paid to middle-class investors, are already sheltered from taxes.

A simple end to dividend taxation, then, would be a blatant giveaway to the rich: it would allow some wealthy investors to pay no taxes at all. That's too much, even for the Bush administration.

So the actual plan is much more complicated: Dividends will be tax-free only if the company that pays them is deemed to have paid sufficient profits taxes.

That's only a minor complication, but it gets worse. Companies that reinvest their profits complained about the plan. So there's another fix: when companies choose not to pay the allowed amount of tax-free dividends, the dividends not paid will be counted against capital gains for stockholders, reducing their taxes when they sell the stock. This makes sense, sort of; but it means that individual taxpayers will have to maintain elaborate records, and it also opens substantial new possibilities for abuse.

Are you confused? So are the experts.

For 90 percent of Americans, none of this matters, because they will get little or nothing from the dividend tax exemption anyway. But among the minority who might expect to gain, many will find their tax cut chewed up by fees for lawyers and accountants.

The really big question, however, is what this will do to tax collection.

Bear in mind that the I.R.S. is already severely overstretched; for years Congress has starved the agency of resources, and officials privately concede that it is doing an increasingly poor job of policing tax evasion. Yet if a dividend tax exemption will make it complicated to file taxes, it will also make it harder much harder for the I.R.S. to enforce the rules. Tax lawyers are already devising schemes to exploit the many new loopholes the plan would create.

So here's a prediction: If the dividend tax exemption is put into effect, the rules that supposedly prevent abuse that prevent wealthy individuals from avoiding any taxation at all will be subject to extensive evasion. Will the I.R.S. get the resources it needs to police that evasion? Don't be silly. So both the true budget costs of the plan and its tilt toward the wealthy will be bigger than even the harshest critics now assert.

It's tempting to attribute this mess to sheer incompetence: George W. Bush liked what Charles Schwab said, and nobody dared tell the emperor the truth about his wardrobe. But maybe the mess is deliberate. Is this just another clever step on the way to a system in which only the little people pay taxes?

Originally published in The New York Times, 1.14.03