Greg Mankiw on Obama’s Dividend Income Tax Proposal

Greg explains the politics:

Four years later, however, Senator Obama enters the picture with, apparently, a different point of view. He has not been coy about wanting to use the tax code to redistribute income more aggressively. He has proposed modest tax cuts (about $1,000) for numerous middle-class Americans, cuts to be financed by much higher taxes on the richest few percent of the population. When all of Senator Obama’s proposed tax increases on the rich are added up, the top marginal rate on wage income would be nearly 50 percent. But for dividend income, Senator Obama has proposed only a modest increase in the top tax rate, to 20 percent from 15 percent. That is, the personal income tax would continue to tax dividends at a far lower rate than ordinary income. This decision must surprise many of his Congressional supporters. But it should be making President Bush smile. In light of Senator Obama’s stand, the politics of dividend taxation may take some surprising twists. Senator John McCain wants to maintain the current tax rate of 15 percent on dividends (while cutting the corporate tax), but it is a good bet that if Senator McCain is elected president, while Congress remains Democratic, Congress won’t give the Republican president what he wants. They would instead let the Bush tax cuts expire, returning the dividend tax for high-income taxpayers to about 40 percent. By contrast, if Mr. Obama is elected, Congressional Democrats will be less likely to balk at his proposed 20 percent dividend tax rate and thus embarrass the new president from their own party. This leads to one of the great ironies of the political season. On the issue of dividend taxation, Barack Obama may be the candidate with the best chance of preserving George Bush’s legacy.

Earlier in this op-ed, he made the case why dividend taxation had distortive incentive effects and then stated this about the 2003 debate to reduce the dividend tax rate to 15 percent:

Many Democrats pointed out, correctly, that the most immediate beneficiaries were rich. The poor don’t own much dividend-paying stock. Middle-class families hold more equities, but they often do so in retirement accounts, which are already tax-preferred. Wonkish arguments that a better allocation of resources would improve the overall economy were dismissed as “trickle-down economics.”

The improvement in incentives might have had a small benefit to the overall economy but the fairness issue is still a critical one. But maybe President Obama can achieve improvements in tax progressivity at lowers costs to efficiency.