A Cut in the Capital Gains Tax Rate-
We Just Got One; More on Bush Tax Plan
by Gary D. Halbert
January 14, 2003
IN THIS ISSUE:
1. The Stealth Tax Cut The Media Missed.
2. "Excludable Distribution Accounts" (EDAs).
3. More Analysis Of The Bush Tax Plan.
4. Who Are "The Rich?" You Might Be Surprised!
An Overlooked Benefit In Bush's New Tax Plan
As expected, the Democrats and the media have gone ballistic over Bush's latest tax plan. By now you've heard all the sound-bites: "tax cuts for the rich," "favors the richest 1%," "shot in the foot, not the arm," "soaring deficits," etc., etc. In particular, the Democrats have the most heartburn with Bush's plan to eliminate the tax on dividends.
Yet there is one provision in the Bush tax plan that the Democrats and the media have largely missed. It's called the "Excludable Distribution Account" (EDA), and it will amount to a cut in the capital gains tax rate. Let me explain.
When Bush and his tax planners decided to go for eliminating the tax on dividends, they realized that, if successful, this could lead to a boon for companies that pay dividends, while it would be a disadvantage to the many companies who don't. Small, fast-growing companies, which make up the bulk of the economy, don't typically pay dividends; they plow after-tax profits into reinvestment to grow the business.
The Bush administration decided to level the playing field for small, growing businesses. Here's how it works. Under Bush's new plan, after companies pay their taxes, they can put what remains of their profits (retained earnings) into an EDA. If the company doesn't pay that money out in dividends, but keeps the profits for its own use, the shareholders get a tax break.
A Specific Example To Illustrate How EDAs Work
Let's say you bought ABC Corp. at $10 a share. Over the next year, ABC does well, sets up an EDA and puts the equivalent of $2 a share in it. Because ABC has done so well, the stock price has risen to $20 a share. If you decided to sell ABC at $20 a share, you would have to pay a 20% capital gains tax on the $10 gain, or $2 per share in taxes.
But under the Bush plan, you would be allowed to subtract the EDA value of $2 per share from your $10 gain for tax purposes. In other words, you would only pay taxes on $8 per share, not $10. In this example, the capital gains tax would only be $1.60 per share ($10 - $2 = $8 X .20 = $1.60). That's a 20% cut in the capital gains tax rate. If ABC had done even better, say $3 per share in profits in the EDA, that would be a 30% reduction in the tax rate.
Or, let's say you buy XYZ Corp. at $100 a share, and it puts $6.50 in an EDA in the first year. In the same year, its stock rose to $110. In this case, if you were to sell it, you would only pay taxes on a gain of $3.50 per share.
According to the Wall Street Journal's (Jan 9) analysis of EDAs, even if you don't sell your shares at the end of the year, you get to increase your cost-basis by the amount of the EDA. In the case of ABC above, your cost basis would increase from $10 to $12, and it would continue to rise in future years, assuming ABC continues to increase its EDA.
This is good news, both for companies that don't pay dividends and for investors. These companies are encouraged to make profits and retain earnings, which is good for the economy. And because they are not at a disadvantage to companies that do pay dividends, they will be attractive to more investors. Caveat: once again, we don't have many details on the EDA, so as more info becomes available, we may find it is not as significant as it seems initially.
Are The Bush Tax Cuts Fair?
After my brief analysis of the Bush tax plan in last week's Forecasts & Trends E-Letter, I received many comments from readers, both for and against the plan. I also received a few e-mails from readers who scolded me for using the administration's "average" benefit numbers. They pointed out the obvious, that such estimates could be skewed toward the richest Americans, and still show to be reasonable in the average.
You will recall that I noted last week that the White House had not revealed how the tax cut estimates were calculated, and that they were the only numbers we had to work with at the time. Now that we know more details of the plan, it is easier to see exactly how the tax cut provisions will affect "regular" families.
The bottom line is that the Bush tax plan benefits those who actually pay income taxes, and families with children at lower income levels.
The Tax Foundation, a Washington, D.C.-based non-profit group, recently prepared an analysis of how the Bush tax cuts would affect families with children at different income tax levels. The results are very revealing and can be found at the link following this article. Here are three examples.
They found that the median family with two children earning $67,000 per year would receive a tax cut of $1,133 this year, eliminating 22% of their current tax liability. A family with two children earning $40,000 per year would get the same amount and see 96% of their tax liability erased. A family with two children earning over $200,000 would see only 9% of their income tax liability erased.
One of the most interesting notes that I found in the survey said that families earning below $35,000 per year were not included in the analysis because the tax cuts enacted in 2001 had already effectively eliminated all of their income tax burden.
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More Class Welfare... I Mean Warfare
Of course, the Democrats have had a field day with Bush's tax plan because they do not concentrate on the percentage of tax relief, but rather the dollar amount. In the examples above, the family earning $40,000 and our median family earning $67,000 per year both get a total tax break of $1,133, while the family earning $200,000 receives a tax break of $3,077, or almost three times as much.
So, while the percentage relief is skewed in favor of the little guy, the total dollars still favor the upper income taxpayers.
Never mind, of course, that the family earning $200,000 - three times as much as the family earning $67,000 - will have to pay over 8 times as much in income tax than the family earning $67,000, this according to The Tax Foundation's latest analysis.
The Democrats' plan, on the other hand, puts a $300 check in the hands of everyone ($600 per couple), whether they paid taxes or not. I'm sorry, but this seems more like welfare than sound tax policy.
Of course, the Democrats believe that putting cash in the hands of families who really need it will result in consumption, since they are more likely to spend the money than save it for a rainy day or invest it. On this, I'll have to side with the Democrats. Lower-income families, especially those with a couple of school-aged children, will have plenty of places for $600 to go.
However, this same family would do better under the Bush plan even if they earn an income that would have previously exempted them from taxes. That's because they get the extra $400 per child in tax credits. Two kids equal $800 in additional tax credits, and this is better than $600.
Two-parent families with one child would not fare as well under the Bush plan as with the Democrats' plan, since they would only get one $400 child tax credit. However, the ever-growing single-parent households would fare better even with one child, since the $400 credit would be more than the Democrats' $300 check to a single taxpayer.
A Question Of Perception
Obviously, whether one supports the Bush tax plan, or not, depends upon their perception of what it does for them. However, the liberal media is pulling out all of the stops in an effort to paint the Bush tax plan as nothing more than a boost for the rich. One good example was a recent New York Times article that distorted the impact of the tax plan on a family cited as an example. As a result (and somewhat predictably), the head of the family in the NY Times article said he was "not impressed by the President's tax plan," a perception primarily based on the fact that the family had no significant stocks, so the dividend exclusion would not benefit them.
However, the Washington Times ran a subsequent editorial criticizing the Times for not informing the family that the other provisions of the Bush tax plan would have shaved 30% off of their 2003 tax bill. Well, the New York Times surely can't let a few facts get in the way of a really good quote now, can they? (You can get all of the details of the original New York Times editorial and the real effects on this family in the Washington Times in the links I've provided below.)
This is just one example of how the liberal media is seeking to force a perception upon the American people. I don't mind if people disagree with my position, as long as their disagreement is based upon facts. I am an independent and call things the way I see them, so I get e-mails from liberals about being too conservative, and sometimes even from conservatives who think I'm not nearly conservative enough.
However, it really burns me up when I see the talking heads on TV intentionally slanting the news and/or leaving out key facts and/or flat out lying in order to create a perception!
The Bottom Line On Any Tax Reduction Plan
Let's cut to the chase. Whether you are a conservative or a liberal, there are a few basic points that really aren't debatable; they're just facts.
The top 50% of taxpayers paid 96% of all income taxes in the 2000 tax year (latest official data available from the IRS).
Another fact of life is that many lower-income Americans not only pay no income taxes, but may actually qualify for tax credits that mean they get a refund over and above their tax savings.
Considering that the bottom 50% paid only 4% of all income taxes, and of that group, many paid no taxes at all, it is very difficult for any tax reduction plan not to favor people who pay more taxes.
Note that I did NOT say it is "impossible" to have a tax reduction plan that favors the lower income people. There are some liberals who believe that the top 50% should pay all income taxes, not just 96%. There are others that believe the top 40% should have to pay all the income taxes, with the bottom 60% paying nothing.
Sorry folks, but to me it looks like those on the lower end of the income scale have already received plenty of relief. It's time to start providing a few benefits to those who are carrying the load.
[And to pre-answer some of your e-mails, I know I'm just talking about income taxes and not Social Security Tax. However the Social Security Tax, as well as the entire Social Security System, is a whole different story, one that I'll be glad to tackle in a future issue of the Forecasts & Trends E-Letter.]
Two Irreconcilable Positions
In essence, it comes down to the economics of politics. The conservatives believe in providing tax breaks to those who actually pay taxes. They believe those with higher incomes will invest money from tax breaks in established business, or start new small businesses. In turn, this investment will go to purchase plants, equipment and inventory that will, in turn, create jobs and opportunities for everyone. This willingness to invest "risk capital" is the basis upon which capitalism is built, and like it or not, it is what has made this country great. Unfortunately, this process is a slow one, since it takes a while for investments to be made and work their way through the system.
The liberals, on the other hand, do not believe in this model. Instead, they believe in the Keynesian view of the government providing the necessary stimulus through spending programs. In the current case, they believe the $300 per taxpayer checks will be spent, thus increasing consumption to kick-start the economy in the short-run. This is possible, but the Bush tax rebates in 2001 ($300-$600) didn't exactly send the economy soaring.
As a general rule, you are not likely to reconcile these two polar economic opinions. You may find someone converted from one to the other on occasion, but these two theories tend to mix like oil and water. So, you're not likely to see anyone put them together and explain the US or global economy.
It All Goes Back To Politics
We must all realize that both plans were developed under the supervision of politicians, with their own respective re-election plans in mind. The Democrat plan has some legitimate provisions that would be good for the economy and small business in the short-run, but it fails in terms of true tax reform.
The Bush plan, on the other hand, has some very good provisions that would be good for business and the economy in the long-run, but is also geared toward supporting the stock market, which has now been politicized (much to my chagrin).
While I have spent a lot of time explaining my previous explanation of the Bush Tax Plan, now that we have more of the details, let me remind you that I am not at all certain that we need ANY stimulus plan for the economy to keep growing. As much as the Dems would have us believe otherwise, 3% growth in 2002 is not too shabby.
As I stated last week, if I had to pick one of the two, I'd pick the Bush plan, but by the end of the year, we may find that we needed neither, at least in terms of the economy.
I do think the elimination of the tax on dividends is a good idea and one that is long overdue. The liberals would have us believe that only the "super-rich" receive dividend income, but this is NOT true. As you can read in the link below from The Tax Foundation, 45.8% of all tax returns claiming dividend income in 2000 came from those making $50,000 a year or less. The liberals never quote this figure. Imagine that! In fairness, however, it is true that the wealthy pay a much larger percentage of total dividend taxes than those earning $50,000 or below.
And Finally, Who Are "The Rich" Anyway?
If you make $28,000 a year, do you consider yourself rich? What if you make $55,000 a year, are you rich? Okay then, what if you make $92,000 a year, are you rich? I doubt that many in any of these income brackets consider themselves rich, especially if they have kids.
However, if you make $28,000 a year, you are in the top 50% of taxpayers; $55,000 puts you in the top 25%; and $92,000 puts you in the top 10%, the so-called "super-rich."
The liberals NEVER quote these figures either. They know that most people making $28,000-$55,000 do NOT consider themselves remotely to be rich, nor do many who make $92,000. These folks would be appalled if the liberals were to call them rich people, so they don't.
