Commentary: Why the Dividend Tax Cut Adds Clutter to the Tax Code

By Peter Coy

Rich or poor, Americans agree on one thing about the U.S. tax code: It's too complicated. Each April, the 1040 form and its slew of schedules reduce people to tears. Unfortunately, President George W. Bush's bid to eliminate double taxation of corporate profits would make matters worse. It would add paperwork and open new loopholes. "Simplification always gets put at the bottom of the heap," gripes Leslie B. Samuels, a tax attorney at Cleary, Gottlieb, Steen & Hamilton in New York City.

The complexity might be acceptable if the changes brought enormous benefits. But even the plan's main author--Columbia University economist R. Glenn Hubbard, the outgoing chairman of the President's Council of Economic Advisers--predicts that the overall Bush tax plan will boost growth by only 0.2% a year while swelling the budget deficit. The Administration might produce fewer tax headaches and still achieve its aim of a fairer tax system by, say, fixing the alternative minimum tax, which was intended to apply to the rich but is socking millions of middle-class families. Or, if its goal is to spur long-term growth, it could permanently accelerate depreciation of business investment.

The President's plan is clean enough in concept. It asserts that corporate profits should be taxed once and only once. So if a company pays $35 in tax on $100 of profit, shareholders should not have to pay tax on the remaining $65 of profit, whether the money is distributed to them as a dividend or is retained by the company, which would help increase the stock price and add to shareholders' eventual capital gains.

But the idea leads to endless complications in the real world. Already, colorful phrases like "basis clawback" and "cumulative net basis bumps" are entering the tax lexicon. On Jan. 21, the Treasury Dept. had to issue a 12-page "technical explanation" with clarifications and adjustments. Now, airlines and other money-losers will benefit from a change that preserves some tax advantages for companies with net operating losses.

The heaviest paperwork will be keeping up with constant changes in the "basis" of a stock--the price shareholders are presumed to have paid per share. "We're crying in our beer here," says Gayllis R. Ward, senior vice-president for investment tax services at Fiduciary Trust Co. International, a New York money manager. It's not conceptually difficult, but then again, neither was the hugely expensive fix for the Y2K glitch, says Stephen J. Tall, a Fiduciary senior vice-president. He estimates it could take 18 months to write and test software to handle the changes if the bill passes.

Others are more optimistic. Securities Industry Assn. Chief Economist Frank A. Fernandez says the new information can be conveyed fairly easily if the Treasury sets things up right. Some also argue that variations of the Bush plan work well in other countries. Actually, they don't. Germany, Britain, and Japan are moving toward the current U.S. approach, and Italy and France are considering doing so.

The likely macroeconomic impact of the Bush tax plan may be up for debate, but there's little question about its impact on the complexity of the Internal Revenue Code: negative.

Coy is Economics Editor.

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