You’re right, Scylla.
The thing that has to be emphasized is that the bubble was all about this double taxation of dividends stuff. The problem is that Bush’s proposal doesn’t address the flip side: the perverse tax policy in relation to options. It’s when you put these two together that you get the combustible combination that created the Nineties whackiness.
According to current FASB rules, options need not be expensed. On top of that, the corporation gets a deduction against its corporate income tax when the option is exercised later, assuming it’s exercisable, of course.
Back in the day, yours truly received options. Not that many, but enough that it was worth it to me to think about what they were all about. The problem is, if you receive an option, dividends are your enemy, because the stock price is adjusted down every time a dividend is paid, which, if you’re holding a long term option, reduces your profit.
So if you’re an executive with lots of options in your pay package, you are being incentivized to keep those dividends as low as possible. The only way to keep the price rising and make that option pay well, therefore, is to keep those earnings coming.
In this way, we get the madness of the “earnings expectations” game that even today is still being played on Wall Street.
Of course, part of the reason for the relative incentives for dividends vs. growth stocks are the way they are is because the capital gains rate was lowered. And, this lowering of the capital gains rate was brought to you by…[Drum roll, please]…the very same people who now seem to have discovered the perverse incentives that have resulted and have concluded that we must get rid of the tax on dividends in order to save us from dangerous speculation!
How many years will we have to wait before they conclude that having the dividends tax rate at 0 and the capital gains tax nonzero is dangerously discouraging growth and instead encouraging a “live for today” strategy and thus we must, yes, must, get rid of that capital gains tax altogether?!
Oh, and the fact that all these changes in tax policies are a boon to wealthy folks? Well, that’s just a bizarre coincidence! (Just like it is a bizarre coincidence that a very dangerous dictator with very dangerous weapons who must be taken care of in the Middle East just happens to be sitting on top of the 2nd largest oil reserves in the world. Bizarre coincidences just sort of seem to pop up in the Bush Administration!)
jshore:
Cite?
The very same people? Could you name them for me because I don’t think this is true either.
is “they” the “same people” again? I don’t exactly who this “they” is but according to you they sure like to run down slippery slopes, don’t “they?”
If you say so.
Off-topic rant much?
Yes. More Bush bashing will raise the level of this debate.
You want a cite for the idea that a lower rate for taxation of capital gains over dividends will help create incentives for investment in stocks that go for growth in stock price over those that pay dividends?!?!
Or, could you just not think of anything else to say?
Why do you like to play dumb when backed into a corner. You know that what I am referring to is the fact that lowering the capital gains rate was a project of the conservatives…particularly the so-called “pro-growth” conservatives like Jack Kemp, the WSJ editorial page, and the other supply-sider types… for a long time (although it was also embraced by some moderates…and maybe even a few liberals…too). And, that these conservatives are now the ones pushing the dividend tax cut.
I suppose if you insist I could try to dig up a quote from someone like R. Glenn Hubbard supporting cuts in capital gains taxes…but why bother? I am trying to convince reasonable people here! You can believe what you want to believe.
Of course, one could say that the conservatives really feel that all such investment income should not be taxed and that this is why they are ratchetting down one and then the other. However, in that case, I would say that they should at least make the case honestly instead of relying on this relative incentives stuff.
Scylla: * One of the other arguments to repeal the taxation of dividends is to encourage a saner and more realistic stock market. […] One might suppose it would be a factor in reducing damaging bubbles of speculation like we recently just had […]*
pantom: *The thing that has to be emphasized is that the bubble was all about this double taxation of dividends stuff. […] In this way, we get the madness of the “earnings expectations” game that even today is still being played on Wall Street.
*
What puzzles me is, so many of the sources I see now deploring the '90s “bubble” and calling for an end to taxation of dividends in order to prevent future “bubbles” are the very same people who used to protest that the Big Bull stock market wasn’t a “bubble” at all! 
For example, I just got finished reading a fire-breathing article in Capitalism Magazine about how we desperately need to eliminate dividend taxation. Then I turned to some of their articles from1999 and thereabouts. Were they complaining about “damaging bubbles of speculation” and calling for policy changes to produce a “saner and more realistic stock market”? Apparently not:
“Madness of the ‘earnings expectations’ game”? “Damaging bubbles of speculation”? The good folks at CapMag and a number of other places apparently just never saw it coming!
For some real laffs, check out Wired articles of the same vintage: 
And plenty of other well-established economics pundits were saying the same sort of thing. James K. Glassman writing for the respected Heritage Foundation in 2000, anyone?
And what does the Heritage Foundation advocate now? “Policy-makers also should eliminate the “double taxation” of corporate income; taxing dividends at both the corporate level and the individual level discourages investment.” To help recover from what? “The stock-market bubble”, of course!
Folks, if so many august opinion-makers three years ago couldn’t even tell the difference between “a sane and realistic stock market” and “a damaging bubble of speculation”, why should we be so quick to believe that what they’re prescribing now is the right thing for the economy?
Your premise is simply false.
The degree to which a regular partnership (a “general partnership”) is deemed a separate entity is largely a function of state law. Many states (such as Texas) have long since adopted the Uniform Partnership Act, which deems such partnerships as entities distinct from their owners, with the right to sue and be sued, etc.
A limited partnership is also a distinct entity, as is a limited liability partnership (LLP). (Note a LP and LLP are different entities involving different rules regarding limited liability). To which we add the relatively new LLC form of business.
DCU: The degree to which a regular partnership (a “general partnership”) is deemed a separate entity is largely a function of state law. […] A limited partnership is also a distinct entity, as is a limited liability partnership (LLP). (Note a LP and LLP are different entities involving different rules regarding limited liability). To which we add the relatively new LLC form of business.
Okay, thanks! Then if these are all distinct legal persons with many of the rights of natural persons, why can’t we expect them to pay income taxes like natural persons? I can understand keeping a partnership or company tax-free if it has no legal existence except through its tax-paying owner(s), but seems to me that once it has rights of its own then it also has individual responsibilities, and I don’t see why paying income tax shouldn’t be among them.
Kimstu: the rationale is that an enterprise’s status as an independent entity is just an artificial construct to make life easier – it’s much simpler to just sue the partnership rather than specifically name each and every partner in your lawsuit, for example. But economically it’s just a conduit through which the owners recieve income.
Corporations really aren’t any different; the different treatment is largely a historical anomaly given the evolution of the corporate form. Sensible tax reform would remove the dividend tax at the corporate level so that the choice of business form would be “tax-neutral” – not colored by tax considerations.
DCU: the rationale is that an enterprise’s status as an independent entity is just an artificial construct to make life easier – it’s much simpler to just sue the partnership rather than specifically name each and every partner in your lawsuit, for example. But economically it’s just a conduit through which the owners recieve income.
But wait a sec, isn’t one of the major desiderata of such an entity considered to be the fact that it limits the owner(s)’ liability? And that therefore you can sue the entity only up to the extent of its “own” assets, not for any of the owner(s)’ other assets? That kind of sounds like having it both ways: we want the company to be a nominal, transparent, pass-through tax-free “conduit” when it’s earning income, but an independent separate legal person in its own right when it’s getting hit with a lawsuit. Seems to me that we ought to stick with one interpretation or the other.
There’s no inconsistency. Bubbles have always been with us. They seem to be a function of human nature. Everyone should read Extraordinary Popular Delusions And The Madness Of Crowds by Charles MacKay, which describes some fascinating historical examples. From his POV, even the Crusades were a kind of mass delusion, comparable to the Dutch tulip craze or the investment in non-existent New-World corporations in the 18th century. The 90’s tech stock bubble was simply the most recent of many.
Lower tax rates on dividends or on capital gains would allow investors to make greater returns, so they would encourage business expansion. Therefore such tax cuts would lead to rational growth in stock prices.
Not true. The employer and employee have the same limit on social security. They both have no limit on Medicare. See here.
Thanks amarone…I was also skeptical of that footnote of december’s. But, I’m glad that you tracked down the facts on how it actually works.
But this completely begs the question. If people are being irrational in their purchases or investments, you think the solution is to change the tax structure so that it is now more favorable for these purchases / investments? And, how does this prevent people from still irrationally buying / investing beyond the new rational point?
This seems completely silly to me and it is very different from the (at least more plausible) argument that is usually made that it is the relative change in incentives to buy growth stocks vs. dividend-paying stocks that will lead to more rational valuations.
Depends on the type of entity.
A normal partnership makes each partner joinly and severally liable for the debts of the partnership (some states require that partnership assets be exhausted before pursuing individual partners). This is so even in states that deem the partnership a separate and distinct entity from the individual partners.
A limited partnership has two types of partners, general partners and limited partners. GPs are on the hook as in a normal partnership. LPs are only liable to the extent of their investment. The key is that LPs cannot participate in the management of the enterprise – an exercise of control destroys limited liability.
A limited liability partnership (LLP) insulates each partner from liability for the negligence of his fellow partners. Each partner remains jointly and severally liable for the contractual obligations of the partnership. This is a common organizational form for professional enterprises such as law firms, who are typically required by their canons of ethics to use some form of partnership rather than incorporation.
Finally, an LLC essentially provides full limited liability for its members.**
Again, this is a convenience thing – it is much easier to sue the partnership than to sue each individual partner. Treating the partnership as a separate entity makes it easier for plaintiffs to sue because they don’t have to figure out who to name as a defendant.
Or consider contracting. Although even in states where the partnership is not a distinct entity any partner can bind the partnership, it’s much clearer that a contract is made with the partnership rather than with an individual partner if the partnership is treated as a separate entity.
kimstu, I can’t speak for all those guys; I got out in 1999 because I thought it was a bubble. Of course I can’t prove that, but honest to God, it really is true.
Anyway, I’ll go looking for a non-pay site that will have some facts on how dividends in relation to earnings didn’t move up much during the Nineties as options became more popular.
However, a lot of what happened at places like Enron happened because these guys had options that they wanted to keep in the money, and they would do just about anything to manufacture earnings to keep the stock price up so the options would be profitable.
This form of corruption simply wouldn’t be possible if we didn’t tax dividends, insisted on expensing options, and/or eliminated the deduction for the exercise of a profitable option by an employee, and eliminated the legality of a company match in stocks in a 401k that can’t be traded in for years. To me, it’s all a package deal, and it’s a package I’d like to see proposed and passed.
But the elimination of taxes on dividends is a vital piece of that whole package.
**
Yes. Please. Dividend paying stocks move in price as well as growth stocks, so I think any effect in this regard would be De Minimus.
No. I asked you for a cite because I believe your statement is wrong, and requires substantiation.
So they is Conservatives… Moderates… and liberals? Oh and the WSJ editorial page?
I’m not playing dumb. I just wanted to emphasize that your generalization is a false and silly one.
**
One could say that if one were interested in making meaningless and false blanket generalizations to attempt to polarize a complex issue.
I am not aware of any general conservative movement to completely repeal the capital gains. Perhaps you could show me this as well?
If you simply want to bash conservatives in general you should at least do so honestly without attributing straw-man positions to them.
Honestly, Scylla, I don’t understand how what I say is substantially different than your statement that
Would you care to explain what part of the logic in going from what you said to what I said is bothering you?
Well, I was just honest enough to admit that there were a few people who one might not characterize as conservatives who were in favor of the capital gains tax cut. [BTW, the WSJ editorial page is very supply-side “pro-growth” conservative in case it escaped you.]
Well, I don’t know about “any general conservative movements” but certainly there are conservatives who have already laid their cards on the table as being in favor of this. Here, for example is what some folks at the Cato Institute have to say
Here is another link to a press release by Zell Miller, the most conservative Dem in the Senate at least on tax issues who, joined by 3 Republicans, are forming a caucus specifically dedicated to eliminating the capital gains tax, the Zero Capital Gains Tax Caucus.
Honestly, I put that statement in as a defense of conservatives. I.e., while I had previously implied that conservatives might be motivated in large part to cut these taxes because they affect mainly the wealthy, I felt compelled to add that some would argue that they think taxes on investment in general are a bad idea.
jshore:
Of couse, but then I really would appreciate that cite.
The relative value of a speculative growth stock is already relative compared to a dividend paying security. The potential capital gain can be offset by losses, deferred, or otherwise mitigated, by a number of techniques already in existance. Therefore it is my strong suspicion that a further capital gains tax cut would not strongly effect that relative value, especially as long-term capital gains taxes are already fairly low on an absolute basis, IMO.
Dividends are taxed as current income which we can construe to be an onerous rate for most investors especially compared with long-term capital gains taxes.
So, lowering a rate that is already very low on a relative basis (and can be further mitigated) will produce a very small change in relative value compared with lowering or eliminating a rate that is very high on a relative basis.
Now, if you have a cite that speculates differently, I would like to see it.
I appreciate that. It seems to me that you are conceding that the capital gains tax cut was pretty widely endorsed and sponsored, and that your generalization otherwise was hasty.
I don’t understand what you’re saying. “pro-growth” is neither a supply-side, nor a conservative exclusive condition. At least I hope it’s not. I agree that I don’t see a lot of “recession is good,” “Negative growth,” or “Let’s Fuck up the economy,” type editorials in the WSJ, but then I don’t see them anywhere. I see that as a good thing.
Whatever it is that you are saying here, has escaped me.
Isn’t the Cato Institute more of a Libertarian sort of thing? I would hardly use them as an example of Conservative thought.
That is untrue. It appears you have misread your cite (if I was another poster I would here accuse you of being dishonest, but that’s another story.) Zell is joined by 2 Republicans, and another Democrat. Looks bipartisan to me. Again, I would hardly consider two Democrats and two Republicans agreeing on something as being representative of conservative thought in general, would you.
Frankly, a full repeal sounds like a Liberarian idea more than a conservative one to my ear.
IMO opinion the current capital gains tax structure is pretty good as it stands right now, striking a balance between creating revenue, and producing an incentive for investment. I think capital gains should be taxed, as they represent somebody making money.
Dividends do not. They represent a payout of an asset that is already owned. That this is an undeniable fact can easily be seen by the fact the the Specialist of an equity reduce the value of that equity by the amount of a dividend on the day it goes ex-dividend (in other words a stock’s price is automatically reduced by the amount of the dividend on the day it is paid.)
I can’t find a cite, unfortunately, so I did some calculations on my own using data from Standard & Poors, available on this site:
This is going to be anecdotal on the options side, but options did become very popular in the late Nineties. In my own company, we were taken over in 1998 by a company whose management was seriously into the “employee ownership” nonsense getting touted back then, which basically meant, in our case, stripping us of most of our benefits, stuffing the 401k with stock you couldn’t trade out of for years, distributing options to all employees, and turning a piece of year end bonus payments over a set limit into payment in discounted stock that couldn’t be sold for a few years, of course.
All of these practices are still going on. All of them are reasonably typical in large companies these days. In this way the stock price is supported, the company doesn’t need to report the options it gives out as an expense to shareholders when they’re issued, but when they’re exercised it can deduct it as an expense from its Federal tax return, while still not reporting the expense to shareholders. As I noted above, this is important in relation to dividends, because they are anathema to an options holder, as the terms of the option don’t usually include adjusting the price for the issuance of dividends.
Now the figures from the above site show that in the period from 1992 to 1996, the dividend payout ratio was 49.5%, using S&P’s “as reported” earnings, which is close to GAAP. This period encompasses the first half of the Nineties bull market, up until Greenspan’s infamous “irrational exuberance” speech of Dec 1996. During the bubble period, from 1997 to the first quarter of 2001 - I decided to cut it off there because earnings after that fell off a cliff - the payout ratio was 37.9%. My contention is that most of this is due to the unfavorable tax treatment of dividends.
So dividends are discouraged because they’re taxed, while options are encouraged because not only are they not taxed, they’re a deductible expense, for the corporation. The employee, of course, has to pay tax on the profit.
And of course interest on debt is deductible from the corporate tax return as well. So corporations are encouraged to
1 - issue options, which encourages fraudulent reporting of earnings, and
2 - issue debt, which can lead to bankruptcy when issued in large doses, of course,
3 - while being actively discouraged from paying a dividend.
And all the while they’re allowed to stuff 401ks with stock that could easily become worthless before the employee is allowed to trade out of it, and the likelihood of it becoming worthless increases as fraud is actively encouraged by the tax code. Ask any Enron or Worldcom employee about that piece.
At least if the stock in the 401k paid a dividend, there’d be a little bit of cash with which to buy dog food in your retirement. These days, it’s about the best a working stiff can hope for.
Wow, Scylla, you’re getting better. This time it only took like 3 posts to get you to explain what it was about my statement that bothered you! You know, when most people think a statement isn’t precisely correct, they explain why they think of it as not precisely correct rather than to lead the other person on a wild goose chase of guessing what you are objecting to. I don’t know why you do this, except perhaps to “score debating points”.
Well, you may be right that further cuts in capital gains taxes won’t have that much effect. However, let’s go back to my original statement for a second:
There are two things one might note about my statement:
(1) It doesn’t talk about further lowering the capital gains rate (although I do later some admittedly speculative comments that there will be a push for that down the road). It talks about the original lowering of the capital gains rate that had already occurred.
(2) I say “part of the reason”. If you think it is only a small part of the reason, then that is fine and you should make arguments to that effect. However, it doesn’t make my statement wrong and certainly doesn’t justify leading me on wild goose chase about back up my original statement.
Well, I still didn’t claim it was that widely endorsed. I don’t know what the vote was on it but my impression is that it got almost 100% support among conservatives, some support among moderates, and maybe a smattering among some who could be considered liberal.
My point is an attempt at a definition of a group of conservatives who tend to call themselves “pro-growth” and support basically supply-side / trickle-down type policies (along with smaller government). If you read the WSJ editorial page, listened to Jack Kemp, etc., it would be fairly obvious who I was talking about.
Sure, practically everyone is “pro-growth” but they don’t all define the best way to grow the economy to be the sort of supply side polices of the WSJ editorial page, The Club for Growth ( http://www.clubforgrowth.org/ ), etc.
Well, we can quibble about definitions til the cows come home. I think the distinction between the supply-sider / Club for Growth / libertarians are pretty slight although they could no doubt explain it to me just like the Spartacus groups and Trotskyist groups and the rest of them could explain the distinctions between their socialist/communist views.
Okay…my bad on the counting part. You are right, there was another “D” in there that I missed.
Oh come on, Scylla. Zell Miller is not very representative of the Democratic party…certainly not the liberal or even moderate wing. As I noted, he is probably the most conservative Democratic senator at least on tax issues and has been, I believe, the first (and one of only a handful overall) Democratic senators to support both of Bush’s tax cut plans.
Well, it seems to me that on economic issues, the distinctions here between conservative and libertarian get pretty subtle. It seems to me that many people on this message board tend to categorize themselves as conservative / libertarian. Those libertarians who dislike the conservative label usually seem to object to the religious right brand of conservativism on social issues, not to vast distinctions over tax and economic policy.
Well, I’m glad to hear you say it.
Well, there are all sorts of distinctions that can be made about all sorts of different taxes. And, as I have argued in other threads, I am openminded toward a policy of eliminating dividend taxes if it is coupled with a broader reform of corporate taxes to close loopholes and with some sort of other tax policies that get rid of the regressive nature of this tax cut. I haven’t found many supporters of the dividend tax cut who are too keen on these other ideas though.