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 Home > News & Policies > April 2003

For Immediate Release
Department of Treasury
April 8, 2003

Eliminating the Dividend Tax to Strengthen the Economy
Testimony of Under Secretary for Domestic Finance Peter R. Fisher Before Senate Commerce Subcommittee on Consumer Affairs and Product Safety

Hearing: Promoting Corporate Responsibility Through the Elimination of Dividend Tax

Chairman Fitzgerald, Ranking Member Wyden, and distinguished members of the Subcommittee, I am honored to testify before you in support of the Presidents proposal to eliminate the double taxation of dividends.

This proposal would strengthen our economy and create jobs by improving corporate governance and re-targeting investment to its most productive ventures. Corporate governance would improve because the proposal would better align executives interests with shareholders and encourage companies to disclose more clearly their cash earnings and taxes paid. Investment efficiency would rise because the proposal would reduce tax distortions to fundamental corporate decisions such as whether to repay shareholders or how much debt to raise.

The result would be more investment, higher productivity, more new jobs and faster economic growth. At a time when too many people who want jobs cant find them, and when economic growth around the world is slower than we should accept, the Presidents proposal would be a welcome shot in the arm.

In the past year, under Chairman Oxleys and Senator Sarbanes leadership, Congress took a major step toward improving corporate governance in America. Investors have matched that with their own call for improved governance. Corporate executives, directors, auditors, and lawyers are already hearing and heeding the call for greater accountability. Better-run corporations make for more efficient capital markets and a healthier economy.

But there is more to be done in encouraging the best conduct from corporate executives. Think of the headlines of the past couple years. Jobs destroyed by bankrupt firms that took on too much debt.

Executives that managed earnings, inflating their companies stock prices and pumping up the value of their own stock options. Corporate inversions where companies moved to tax havens abroad.

There are many forces responsible for these problems, but our tax code shares some of the blame. By taxing dividends twice, our tax code encourages companies to retain earnings instead of paying them to shareholders; to raise excessive levels of debt; to repurchase shares, often on a one-off basis, instead of issuing dividend checks; to dedicate some of Americas leading minds to tax minimization instead of job creation. Theres nothing wrong with debt or retained earnings or share repurchases. But theres no reason our tax code should favor them, either.

Eliminating the double taxation of dividends would reduce these biases against investing and creating jobs. A shareholder would no longer pay a second layer of taxes on dividends if the corporation had already paid tax on that income. If the company retained that income and invested it again, the shareholder would get an equivalent credit.

This is a ripe moment to improve corporate governance by removing the tax bias toward debt and retained earnings. CEOs and capital markets are now acutely sensitive to the risks of managed earnings. Yet today, because of double taxation, only half of non-financial firms pay dividends. Without periodic dividends unmistakable facts about cash flow investors are basically left with earnings opinions. As Secretary Snow says, you can fudge earnings, but you cant fudge cash. The Presidents proposal would clear the barriers to companies that sought to mirror their earnings reports with dividend checks.

The Presidents proposal is bad news, too, for the attractiveness of corporate tax shelters, corporate inversions, and other tax minimization devices. The rationale for creating these devices would lessen, because an investor could only claim an exclusion on a dollar of dividends if the company had paid full tax on that dollar.

The proposals second benefit would be boosting investment efficiency and thus job creation. Lets be clear where jobs come from. New jobs come from investment the willingness of investors and entrepreneurs to put capital at risk in a business venture. The Presidents proposal is focused precisely on that point: at sharpening the incentives for investors and entrepreneurs to invest in the most productive ventures. And higher productivity means higher wages and a stronger economy for everyone.

Taxing dividends twice means that we tax investment more heavily than any other major industrial nation. If investment is the blood of new jobs and growth, this is bad policy.

The double taxation of dividends also distorts companies decision to retain funds versus returning capital to shareholders. Even if shareholders have more promising investment opportunities elsewhere, the tax code locks those funds up inside the company.

Thats not good for shareholders, and its certainly not good for the economy.

Each year American firms invest over $1 trillion in fresh capital and generate $700-800 billion in corporate profits. Think of the gains in capital utilization and job creation for everyone if we accelerate and re-target this entire investment process. The Council on Economic Advisors estimates that through 2004 the dividend tax cut alone would generate more than 400,000 new jobs, nearly a third of the total from the Presidents Jobs and Growth Package. The Business Roundtable says its even higher, closer to half.

Taxing dividends once and only once would convert directly into higher share prices. Private sector economists estimate that the Presidents proposal could boost stock prices by 5 to 15 percent, delivering immediate wealth to a confidence-short market.

Last, some ask why the President has not proposed eliminating the corporate income tax instead. The main reason is that doing so would violate the Presidents principle that the government tax dividends once and only once. If Congress eliminated corporate-level taxation, many billions in profits, headed to tax-free entities or abroad, would escape any taxation at all. Much more revenue would be foregone. And the way would be kept open for the same kind of tax minimization devices that todays tax code fosters and which the Presidents proposal would cut back.

On behalf of the Administration, I urge you to take this opportunity. Thank you.