Congress: Guilty as Not Charged

Email Print

As Congress grandstands and points its fingers at dishonest corporate
executives, I think we should examine what role Congress
itself played in the recent destruction of investor wealth.

Foremost, the double taxation of corporate dividends is an abomination
that Congress has written into the tax code.  In one bold step,
Congress could repeal this law, and, in a matter of weeks the market
would enter a long term and sustainable rally!

When a corporation like Home Depot makes a profit, they must pay
corporate income tax on that profit.  Then, as some of the
after-tax profit is paid out to the shareholders as a dividend;
the money is taxed again at the stockholder's personal income tax
rate.  Thus, Congress has rigged the game to where the government
is confiscating 50–70% of the wealth generated by corporations,
leaving little behind for individual investors.

Both Enron and WorldCom were highly leveraged.  Many corporations
in America today are highly leveraged.  Corporations are able
to deduct interest payments on their tax returns but not dividend
payments.  The banking lobby loves this!  Of course Federal
Reserve member banks desire that there be every incentive possible
in the tax code to get companies to borrow money. 

Corporations, seeing that the government takes 50-70% of the wealth
that they generate, will try to use the tax code to reduce their
burden.  Unfortunately, a number of companies borrowed enormous
sums of money, and invested that money in huge, low-return infrastructure
projects. WorldCom, for example, thought that by depreciating their
fiber optic networks and deducting large interest payments, they
could deliver a low tax enterprise that would grow in value and
deliver capital gains to their shareholders.

Capital gains are a more efficient way to deliver gains to shareholders
than dividends, as the tax rate is 20 percent versus 50-70 percent
on double-taxed dividends. When WorldCom's business went south because
of overcapacity and falling prices, management tried to hide
their mistakes of too much debt and poor capital expenditures, with

If corporations were allowed to deduct their dividend payments,
we would immediately see many hundreds of companies increasing the
dividend payouts to shareholders.  There would immediately
be less incentive for companies to borrow money and invest surplus
cash in boondoggle low-return projects.

Not that we should be concerned with this, but probably the government
would not lose any income either, as the income on personal returns
would increase, the deduction for interest expense would decrease
(poor banks), and finally, capital gains would increase as companies
that increased dividends would be rewarded with higher share prices. 

We could get back to investing the old-fashioned way, looking at
companies with secure and rising dividends.  Most companies
today would rather buy back stock with surplus cash, with hope of
a rising share price, than pay a dividend because a capital gain
is much less taxed reward for shareholders than a check in the mailbox.

Another reason to fix this disaster in the tax code is the coming
retirement of the baby boomers.  The baby boomers will need
their investments to provide them with income.  The payout
ratio and dividend yield on the market is pitifully low because
of the tax code. With higher stock payouts, there will be less wholesale
liquidation of stock portfolios to meet income needs of the boomers.

Finally, this tax code hurts the American worker.  Why should
companies locate manufacturing here when the government will take
so much of the earnings away from the risk takers who create the
company?  It is cheaper to manufacture in China and pay a flat
10% tax than to create new jobs taxed at a higher rate here at home.
China understands the importance of low taxes. Congress does not.
Does this seem as odd to you as it does to me?

24, 2002

Meixler [send
him mail
], a former Army officer, is an investment representative
for a nationally known NYSE member firm in Arizona.

Email Print
  • LRC Blog

  • Podcasts