Don’t Let the Sun Set on U.S. Saving and Investment

The Hill
By Mark Bloomfield, Esq.
November 16, 2005

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The tragic result of violent hurricanes and the nation’s ongoing efforts in Iraq have led to record-level spending from Capitol Hill, leaving many pondering ways to finance our domestic and international commitments. Some lawmakers have proposed curbing important tax reduction policies that help investment and productivity flourish. Congress must not lose sight and should remain committed to the sound policies that drive the U.S. economic engine and make it a global competitor.

As Congress grapples over tax and spending proposals to finance the challenges of war and Mother Nature’s aftermath, it must remain steadfast in committing to growing a strong and vibrant economy. One paramount step to such growth is to extend the 15 percent tax rate on dividends and long-term capital gains through the end of 2010 as a part of the 2006 budget-reconciliation package.

Extending the 15 percent rate would demonstrate that the U.S. Congress is serious about providing certainty for savers and investors and could help stabilize financial markets. Failure to do so this year could send negative signals to investors about the nation’s long-term commitment to lower rates and result in significant downward pressure on an already unstable market.

Globally, an extension would facilitate stronger U.S. savings and investment rates, which are lagging dramatically behind international competitors. The federal tax code and regulatory structure have long hindered U.S. economic growth and eroded our international competitiveness. The United States taxes new investment more heavily than most of our international competitors. High tax rates on dividends and capital gains raise the cost of capital for new investment and hamper economic growth. Unlike the United States, many countries offset the double taxation of corporate income (the income is taxed at the corporate level and again when distributed in the form of dividends) by providing either a lower tax rate on the dividend income received by a share-holder or by providing a corporation with a credit for the taxes paid on dividends distributed to their shareholders.

U.S. tax rates on long-term individual capital gains were among the highest in the world before rates were reduced in 2003. Increasing the rates from their current levels would put America at a competitive disadvantage relative to our up and coming global competitors such as China and India.

The 2003 cuts in tax rates on dividends and capital gains were enacted to reduce the double taxation of corporate profits, equalize the taxation of returns on capital investments and decrease the tax burden on individuals who invest in corporate equities. Academic research on the early impact of the cuts shows that the rate reduction has prompted numerous publicly traded companies to raise or initiate regular dividend payments.

A 2004 report from the prestigious National Bureau of Economic Research (NBER), which involves the best of American economists in academic research with policy implications, is right on point. It found that, after a continuous decline in dividend payments over more than two decades, total regular dividend payments have increased by nearly 20 percent since the beginning of 2003, precisely the point at which the lower tax rate was proposed and subsequently applied retroactively. The authors also report that their data “strongly suggest that the 2003 tax reform induced a large, widespread set of firms to initiate regular dividend payments or to raise the payments they were already making.” Further, the NBER report found that this is “unprecedented in the record of publicly traded U.S. corporations.”

Data from Standard & Poor’s show that since the dividend tax cut was signed into law on May 28, 2003, publicly traded corporations making up the S&P 500 alone have increased their dividend payments 626 times through July 29, 2005; in fact, many companies have raised their dividends a number of times over the 25-month period. In dollar terms, dividends by S&P 500 companies have averaged nearly $46 billion per quarter since the reduction in the dividend rate cut was enacted — a 21 percent increase from the quarterly average of the 10 years preceding the cut.

All Americans who own dividend-paying stock, not just the wealthy, benefit from this dramatic increase in dividend payments. In addition, the cuts in capital gains rates encouraged investors to realize gains, which release capital for economic growth and greater employment — a vital long-term solution to challenging times today.

If the United States is to meet the challenge of maintaining strong productivity growth, new investment is needed. “Sunsetting” the 15 percent tax rate on dividends and capital gains at the end of 2008 could have negative impacts on U.S. saving and investment, adversely affect the economy’s long-term outlook and reduce the attractiveness of the equity investments that help fuel innovation, economic growth and prosperity.

Bloomfield is president and CEO of the American Council for Capital Formation (www.accf.org), a nonprofit, nonpartisan organization dedicated to the advocacy of tax and environmental policies that encourage saving and investment.