Tax Relief's in the Wind, But Will Markets Get a Lift?

Author: Charles V. Zehren

Published: December 22, 2002

Tax relief is sure to head the agenda next month as President George W. Bush's new economic team moves into place and the Republican-controlled 108th Congress convenes.

So what sort of cuts can investors expect Congress to consider, and will the proposals potentially help or hurt the overall stock market averages?

Two areas under consideration as part of the administration's soon-to-be-released $300 billion economic stimulus package are a reduction in the taxation of dividends and an increase in the maximum deduction for capital losses. In the weeks ahead, you'll probably be hearing a lot about how the White House intends to propose both measures to a relatively receptive House and Senate.

But keep your hope in check. For there's a good chance these proposals may fall by the wayside as the president and Congress struggle to mix and match various spending priorities with other politically sensitive proposals like making the 2001 individual income tax cuts permanent, instituting a payroll tax holiday, creating marriage penalty relief and repealing the estate tax.

As you follow events, keep in mind that this game is about politicians wanting to bolster our confidence in them - and in the stock market. If the economy and stock market rebound, tax relief would probably go by the boards, just as it did in 1992.

"These investor-related items are expensive to deal with, and they're not the only tax items under consideration," warns Eugene Steuerle, an economist and tax expert at the Urban Institute in Washington. "How much Washington will do will be affected by budget limits."

Investors could receive a tremendous windfall if the cuts go through. On the other hand, the amount of federal tax receipts Bush and Congress may be willing to forgo could be trivial. "The situation is fluid," Steuerle said. "It all depends on what else happens with the budget and other tax proposals."

Ending Double Taxation

The buzz you've heard about "double taxation" refers to dividends being taxed the first time on the corporate level as profits. Then dividends are taxed a second time as personal income when received by investors. Despite what you'll hear from some Wall Street lobbying groups, there's no way Washington will eliminate the tax on dividends altogether, because that would mean a budget-busting loss of at least $25 billion in revenue. Instead, the debate likely will center on how much the tax on dividends should be reduced and who will get the benefit - individual investors or corporations.

Now, maybe you haven't heard, but corporate America isn't politically popular these days. So the betting is that the White House and Congress will move to reduce the burden on individual investors, not on companies.

This could mean a combination of reducing the tax rate on dividends from the current maximum of 38.6 percent, increasing the total tax exemption on some dividends, or awarding investors a credit for the taxes already paid by the corporation that issued the dividends.

In citing the salutary effects of dividend tax relief, supporters say it would help the overall market by automatically increasing the value of dividend-yielding shares. And by making dividend-yielding stocks more attractive, analysts say, retirees would have a steady source of income to supplement Social Security payments and savings. A related chart by Standard & Poor's lists examples of companies sporting robust dividends. Once dividend tax relief becomes law, backers say, companies would be under pressure to husband their money and stop blowing cash on executive perks as they strive to issue bigger payouts, attract more investors and bolster their stock price. The proponents argue that eliminating double taxation could even force companies to be more conservative, reduce their reliance on debt, increase equity financing and eschew risky accounting schemes.

"As a result of the corporate scandals, a lot of investors want companies to start sending money their way and stop retaining it in the corporation," said Jere Doyle, of Mellon Private Wealth Management Group in Boston. "When investors look at the outlandish pay and retirement packages for some of these CEOs, they should be asking themselves why they aren't getting that money" in dividends, he said. "If there is that much money in the corporation to spend on that, I'd be asking, 'Where's my piece?'"

Capital Loss Deductions

The way things have stood since 1977, deductions to offset losses in the stock market have been capped at a puny $3,000. Losses over that amount can be carried forward for a 10-year period, but at far too slow a rate, critics say.

So it wasn't surprising that discount brokerage titan Charles Schwab got Wall Street's attention at last July's White House economic summit in Waco, Texas, when he proposed raising the limit to an eye-popping $20,000 annually. The president jumped on the idea, at least in concept. And congressional Republicans and Democrats, anxious to curry favor with shell-shocked investors, followed suit, proposing plans to raise the deduction to more modest levels ranging between $5,000 and $10,000.

But talk among the politicians about increasing the level of the deduction quieted after estimates came in showing that doubling the deduction to $6,000 would cost the increasingly cash-strapped federal government $1 billion a year in revenue.

Advocates say raising the limit could help boost the wider stock market averages by giving individual investors the confidence to go long knowing they can offset a bigger portion of their losses. Yet, other analysts fret that raising the limit would lower the averages as investors sell to take advantage of the bigger deduction. Meanwhile, back on Capitol Hill, even some Republicans fear that raising the deduction for stock market losses would be portrayed as a sop to the rich.

All this has me thinking that it's unlikely we'll wind up with a significant increase in the deduction for losses.

Indeed, in a Dec. 16 letter to Bush, the Securities Industry Association didn't even list upping the deduction as one of its priorities, instead emphasizing dividend tax relief - without saying whether it should be for corporations or individual investors - and increasing contribution limits on individual retirement accounts and 401(k)s.

"I get a lot of calls from clients on changing IRAs and repealing the estate tax, but I haven't gotten one call on raising the limit," Doyle said. "People have lost tens of thousands of dollars in this market, and bumping the deduction up to $7,000 is not a big item for them."

Sadly, in this market, that's a drop in the bucket.

Paying Dividends

If Washington ends the double-taxation on dividends, holders of some high-yielding stocks could benefit. Here's a list of stocks yielding at least 3.6 percent, twice as much as the average annual yield of stocks comprising the S&P 500 Index.

Company Stock Symbol Yield

Amsouth Bancorp ASO 4.8%

Associated Banc-Corp. ASBC 3.6

Bank of America BAC 3.6

Chelsea Property Group CPG 5.5

Cooper Industries CBE 3.8

El Paso Energy Partners EPN 9.4

FPL Group FPL 3.8

Hospitality Properties Trust HPT 8.4

Hudson United Bancorp HU 3.6

Kinder Morgan Energy Partners KMP 6.8

National City NCC 4.4

Olin Corp. OLN 5.1

Provident Financial Group PFGI 3.6

U.S. Bancorp USB 3.6

Union Planters UPC 4.6

Vornado Realty Trust VNO 7.3

Weingarten Realty WRI 6.0

* Dividend yield arrived at by dividing the annualized dividend per share by the stock price.

SOURCE: Standard & Poor's Corp.