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By Sheldon Drobny, CPA

Simplified pencil-sharpener:  Open window (A) and fly kite (B).  String (C) lifts small door (D) allowing moths (E) to escape and eat red flannel shirt (F).   As weight of shirt becomes less, shoe (G) steps on switch (H) which heats electric iron (I) and burns hole in pants (J).   Smoke (K) enters hole in tree (L), smoking out opossum (M) which jumps into basket (N), pulling rope (O) and lifting cage (P), allowing woodpecker (Q) to chew wood from pencil (R), exposing lead.  Emergency knife (S) is always handy in case opossum or the woodpecker gets sick and can't work.

Remember Rube Goldberg?  I recently wrote an article called The Rube Goldberg War On Terrorism, in which I pointed out that in the spirit of Rube Goldberg, the Bush Administration has chosen the wrong, far too complicated approach to solve a problem with a very simple answer.  Well, Bush and his political geniuses have done it again.  They have put together a stimulus plan that will not stimulate the economy, and which confuses tax fairness with tax incentives for business.

As a CPA with a tax specialty, I can speak credibly about this subject.  I can say without any reservation that the Tax Code has hundreds of unfair provisions affecting both the rich and poor.  Some of them are absolutely wrong and should be eliminated when we can afford to have a really solid revenue neutral tax reform bill.  Double taxation of dividends and the marriage penalty have been debated for decades.  But the supposed purpose of the tax changes proposed this week is economic stimulation.  Particularly, in the case of exempting dividends from taxation to shareholders, there is absolutely no benefit to businesses, and therefore to the economy, at all.  And there will be terrible unintended consequences to exempting dividends from taxation at this time.

First, a little lesson on corporate accounting, using Microsoft as an example.  Microsoft, whose largest shareholder is Bill Gates, has over $38 billion of free cash, and has never declared a dividend.  The reason investors buy growth stocks like Microsoft, the stocks that really "grow" the economy, is for capital appreciation, not for dividends.  If dividends are exempted from being taxable income to the recipient, Bill Gates has an enormous incentive to declare a dividend of billions of dollars, because he personally will receive the bulk of that dividend totally tax-free.  Up until now, Gates has had to sell his stock to get cash, and had to pay a 20% capital gains tax on the sale.  So instead of selling stock, Gates will declare a big dividend.  The Treasury will lose revenue from what would have been capital gains.  Other companies will be pressured to pay out all their reserves in dividends, as well.  Who knows how much of an additional revenue loss to the Treasury this provision may cause?  I suspect it will even be more than the administration’s projected $300 billion.

Continuing with the Microsoft example, the dividends exemption will in no way increase corporate earnings.  From an accounting point of view, it has the effect of contracting the size of the corporation, with no effect on earnings.  So instead of a stimulation to grow businesses, the additional incentive to declare dividends will actually decrease the company's free cash, thus preventing Microsoft or any other growth company from reinvesting its earnings into the economy for research and development and capital expenditures.  Is that what they call a stimulus package?

Now that Bill Gates, who is worth about $60 Billion, has another few billion dollars that he has received from his tax free dividend, what do you think he can do with this new windfall?  Does this give him an incentive to buy a new car—or anything else, for that matter?  Would his personal investments in the stock market increase because of this bonus?  If you were Bill Gates, would you put more money in an uncertain investment like stocks and bonds?  The truth is that most wealthy people are putting money into liquid fixed income securities, and are waiting for the economy to recover—only then will the stock market become an attractive investment.

Giving more cash to the rich from dividends does not increase corporate earnings.  Giving tax savings to business increases corporate earnings dollar for dollar.  That is where the stimulus package for businesses should go.

Sophisticated investors know that the value of most stocks is based upon a multiple of earnings.  For example, the Dow Jones Industrials Index is measured by the performance of the top 30 companies.  The value of the Dow as measured by a multiple of earnings is approximately 20.  In other words, for each additional $1 of earnings, the stock's value goes up 20 times.  If those companies in the Dow Index were to benefit by a combined tax reduction of $50 billion, the value of those companies would increase by $50 billion x 20, or $1 trillion.  That is real economic stimulus, which would immediately increase the value of the stock indexes.

So if you want to increase corporate earnings to stimulate the economy, the easy approach is to give tax savings to corporations, which will immediately increase corporate earnings.  But that's just too simple and direct for the Bush Team.  Whoever is running their tax and fiscal policy must know these facts, and can only have chosen to ignore them for ideological reasons.

The Democrats’ response is not much better.  Although it puts more money into the pockets of the working middle class, it is not nearly enough to make a difference to the economy.  While I agree that the Social Security tax is one of the most oppressive taxes upon working people, their relief package should be much higher.  These are the consumers, who have kept the economy going, and they should be given much more of a tax benefit.  The Democrats should be bold enough to suspend all decreases in the tax rate for the wealthy, to fund this necessary benefit to working people.  Instead of griping about the unfairness of the Bush proposal, they should do something significant for the working class that consistently votes for them.

I propose a $1billion rebate to the working class only, completely offset by an increase in the upper tax brackets.  For every rich voter, there must be at least 50 working class voters.  The Democrats would even endear themselves to some of the White Male Reagan Democrats who are members of the working class.  And they would lose very few votes from the wealthy.

But my proposal is too simple and direct, so Rube Goldberg got it right again.  People will gravitate to the stupid, complex approach when the simple one is right before their eyes.

When will our representatives learn that nothing is so invisible as the obvious?  And when will we be able to expect our leaders to start using that knowledge?


Sheldon Drobny is co-founder of Air America Radio, providing talk radio for the majority of Americans.

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Last changed: December 13, 2009