Relevant and even prescient commentary on news, politics and the economy.

I spent a few hours reading Eric Alterman’s What Liberal Media. As others have said, it’s good. Buy it and read it.

So far, it’s clear and convincing. (Of course, I started out with the belief that its fundamental premise is true). I hope to add some further commentary over the next week. But first, more dividend taxes (Monday).


I’ve developed what I fear may be an unhealthy addiction to tracking views of my blog, though I think it will pass with time. In any event, I see that I turn up on Google as the 9th most relevant hit for the search “bush’s tax consumption regressive”. That puts me one ahead of a Washington Monthly story by Robert McIntyre, but behind TAP, Slate, One Term President, and (yikes!)Free Republic.

Excitedly, I thought “what do Freepers think about this?” I hurriedly read the article and thought to myself, “hey, this is a pretty accurate discussion of the issue. Now I’ve got to link and endose Free Republic”.

Oops. is the Detroit Free Press, not Free Republic.


Dividend Taxes Part II: Options, Dilution, and Share Buyback Primer

For those familiar with dilution and share buybacks, much of this post will be old news (but do read the last paragraph), but I want to make sure that the readers understand the lingo before I start tossing it out.

Earlier, I mentioned that there are a few things companies can do with their profits. They can save them as cash, they can reinvest them (e.g., infrastructure or acquisitions), or they can give the money to the owners of the firm, shareholders.

There are actually two ways that firms can give money back to shareholders, the most obvious is to pay dividends in the way described in this post. The second way they can give money to shareholders is for the firm to buy back outstanding shares of the firm. A share buyback is just dilution working in reverse.

Dilution occurs when a corporation gives out options that are then exercised. An option gives the option-holders (usually employees) the right to buy shares in the company at some future time at a fixed price. Generally, when the market price rises above the option price, holders of options can realize a profit by exercising those options. Specifically, the profit is (Market Price – Option Price)*#Options. That’s great for option holders, but not so great for the other shareholders, because now their shares become a little bit less valuable. Go back to the example from my earlier post:

If there are 20 million shares of AB Tech outstanding, then that $4m has to be split $20 million ways, meaning each share represents the right to $4,000,000/20,000,000=$.20. AB Tech will pay this out as a dividend of 20 cents per share. If you own 10,000 shares of AB Tech then you get a check for $2,000.

If AB Tech option-holders exercise 4 million options prior to the dividend payment, the same $4m has to be split 24 million ways. This reduces the per-share payout to $4m/24m=$.167, a dividend of 16.7 cents per share. The shareholder who holds 10,000 shares now only gets $1667, not $2000, in dividend payments because his stake was diluted. To prevent dilution, companies often buyback outstanding shares, to keep the total number of shares outstanding roughly constant. Slate’s Daniel Gross is pretty good on this, here’s the relevant quote:

”Intel spends about $4 billion each year on its own shares, while it pays out just $530 million a year in dividends. Dell last fiscal year spent $3 billion on stock buybacks and paid no dividend.”

A final point on dilution. Suppose there were no options exercised, but AB Tech buys back 4 million shares. Then the same $4m gets split 16m ways, a dividend of 25 cents per share. This would increase the 10,000 share-holder’s payment from $2000 to $2500. Because each share is worth more when there are less of them, their price will go up. Shareholders can make a profit by selling those stocks at the higher price. So when AB Tech buys back outstanding shares, it is putting money into shareholders’ pockets. So at the end of the day, share buybacks work much like dividend payments: they take profits from the firm and give them to shareholders. Another way to think of buybacks is that they are dilution in reverse.

So how does a firm decide whether to put profits in shareholders’ pockets, and if so, whether to do it via share buybacks or dividend payments? (And why should we care?). A large part of the equation is tax treatment. Short term capital gains (gains realized from the price of the share increasing) are taxed at 20%. Dividends are taxed as personal income, at rate between 0 and 36%. Depending on the income-profile of shareholders and the extent to which their holdings are in retirement accounts, buybacks may impose less of a tax burden than dividends.

This is getting us close to the important point about dividend taxes: they do discourage firms from distributing profits to shareholders. And, as it turns out, when firms don’t distribute profits to shareholders they quite often do very silly things with the money. When this happens, it’s bad for the firm, bad for the shareholders, bad for the employees of the firm, bad for the stock market, and bad for the economy. More to come.


I’m getting (relatively speaking) a lot of traffic from Alas A Blog today, who writes

Angry Bear is a brand-new economist-blog, and it looks like it’ll be worth reading. (One thing, Bear: please choose a different color for your outgoing links!).

Following the author’s (Ampersand) tip, I ended up on a two hour quest to optimize the color scheme. The process was made more difficult by my lack of knowledge of the details of html. I’ve also learned that the html I do know is now “deprecated”. Sounds bad doesn’t it?


A deprecated element or attribute is one that has been outdated by newer constructs. Deprecated elements are defined in the reference manual in appropriate locations, but are clearly marked as deprecated. Deprecated elements may become obsolete in future versions of HTML.

Yikes! Not just obsolete or outdated, deprecated!

I’ve used up my blog time for the day on playing with the blog template. More on dividend taxes over the weekend.


Dividend Taxes, Part I: A Primer; Double-Taxation

A primer (skip ahead if you know this):

Dividends are profits that are distributed to shareholders. If Angry-Bear-Tech (AB Tech) makes an after tax profit of $10m this year, the CEO and the board must decide what to do with that $10m. Some of it, say $1m, we may keep as cash, a rainy day fund. Some of it, say $3m, we spend on improving our infrastructure. We spend another $2m to acquire Honey Bees Inc.. That leaves us with $4m. One of the things we could do with this is distribute that $4m to the owners of the firms, the shareholders. Why would we do this? In principle, the Board represents the shareholders and will, acting in the shareholders’ interests, say give the shareholders that money! If there are 20 million shares of AB Tech outstanding, then that $4m has to be split $20 million ways, meaning each share has the right to $4,000,000/20,000,000=$.20. AB Tech will pay this out as a dividend of 20 cents per share. If you own 10,000 shares of AB Tech then you get a check for $2,000. Under current tax laws, that counts as income on your 1040, so you will have to pay taxes on that $2,000.

Of course, AB Tech’s pre-tax profits were above $10m, roughly $13m. So that $13m was taxed once and it brought the total down to $10m. Then it gets paid out as dividends, where it is taxed again as personal income. If the average tax rate of AB Tech shareholders is 25% then that $10m becomes $7.5m of after-tax income. At the end of the day, $13m in pre-tax corporate profits becomes $7.5m of after-tax profits in shareholders’ pockets. This is an overall tax rate of (13-7.5)/13=.423, a 42.3% effective tax rate on income received via corporate profits.

So is the problem really that dividends are taxed twice? All sorts of income are taxed twice. It’s taxed when I get my paycheck and then it’s taxed when I buy gasoline. It’s taxed when I get my paycheck and then taxed again when my landlord receives it as income. Should we really be counting the number of times something is taxed? What if it were taxed twice at very low rates? Is that better than taxing it once at a high rate? That part of the discussion is just silly.

Returning to the example above, do you really think the advocates of eliminating the dividend tax would be happy if the corporate income tax rate were increased to 42.3% (with no dividend tax)? Then the income would only be taxed once!

Another point rarely mentioned by the pro-cut side: if you own stocks in a 401(k) or Traditional IRA, then your dividends are not taxed when you receive them, but rather when you retire and draw upon the funds (this is tantamount to paying a lower rate. Paying taxes 10 to 30 years from now is a lot better than paying them right now). Dividend income from stocks held in a Roth IRA are never taxed. I’m not sure what proportion of stocks are held in these vehicles (, but it is a substantial amount, probably in the neighborhood of 10-20%.

One more point for the time being, but there’s more to come. If you make less than $85,000 per year, as 80% of all households do, then it’s a pretty safe bet that the vast majority of your dividend income is in retirement accounts. The same is true, though to a lesser extent, for the 95% of households that make under $150,500 per year (see Money Income in the United States, 2001, p. 19). So for the majority of the population, dividends are not taxed or are highly tax-advantaged, so there is not really much of a double taxing.

So of the myriad intricacies and oddities in the tax code, this is the one we have to fix right now? Because it’s the one that causes about 5% of the population to pay an overall tax rate around 42% on income received from corporate profits?

But there are legitimate reasons why the dividend tax is problematic, but they are more subtle than “double taxing bad”, andthus not widely invoked by the proponents of eliminating the tax.


Just turned on the TV and, flipping through the channels, I come across Bush giving a speech on the economy (I believe he’s in Georgia). The first thing I heard of note was “There’s a blue chip forecasts by economists that predicts growth this year of 3.3%–and that’s positive.” I’ll give him the benefit of the doubt and assume he meant that in the “good news” sense rather than the “greater than zero” sense of the the word “positive”.

But then what do I hear from the President?

“”This [tax] plan is fair and it is balanced”

Hmm? Who is writing Bush’s speeches and where do they get their news? It’s not my place to say…I report, you decide.

Just about to sign-off when I heard this: “Ten million seniors rely on dividend income to make sure their quality of life is strong”. See my earilier post.

Most of the speech was on the need for immediate tax relief and a push for dividend tax cuts, then a section on Iraq. I’ve made references to an upcoming dividend tax post, and it’s still upcoming.


The Much Ado About Nothing? Post

For many years, there was a third rail of politics: Social Security. Simply put, don’t f*** with the Grey Lobby. They vote and they have money (and they don’t like it when you try to take it away). The stock market boom of the late 90’s came close to changing the calculus—giving seniors 20% annual returns on their money would be giving them more, not less, money. Clinton flirted with, but never really jumped onto, the privatization train. Bush on the other hand was a strong advocate of privatization—remember his complaints of how bad a deal a 2% rate of return is for seniors? Of course he forgot to mention that that was, essentially, a risk-free rate of return.

Turn the clock ahead to 2002, by which time 2% looked pretty good, and Republicans are running away from claims that they ever favored privatization of Social Security. Josh Marshall was pretty good on this one. So I think it’s pretty reasonable to say that messing with Social Security recipients’ income is once again politically dangerous. Think also of the variety of more recent references to how eliminating the dividend tax would benefit seniors.

What does this have to do with Consumption Taxes?

Social Security benefits are subject to less income taxes than other sources of income. There’s a very concise summary at Brookings; here’s the important part:

“Benefits are only subject to tax if this expanded income measure exceeds $25,000 (single) or $32,000 (married filing jointly). Above these thresholds, up to 50 percent of benefits are included in taxable income if the income measure is below $34,000 for singles or $44,000 for joint filers. For those with higher incomes, legislation enacted in 1993 increased the maximum inclusion rate to 85 percent of benefits…By design, more beneficiaries will be subject to tax over time. The Congressional Budget Office estimates that only about one-third of beneficiaries were taxed on at least part of their Social Security benefits in 2000.”

Eliminating income taxes on seniors would generate less savings for them precisely because they pay so much less in income taxes than the under-65 population. They do, of course, consume—that’s half of what retirement is about, right? (Presents for the grandkids counts as consumption).

I just don’t think the political will or audacity exists to implement this. Add to this the black-market problems that would surely arise with a combined federal and state tax that, conservatively estimated, would have to exceed 25%, and it’s a no-go.

Yes, a carefully crafted set of tax exemptions could alleviate the disparate impact that a consumption tax would have on seniors. Similarly, a well-crafted set of exemptions could also make a consumption tax progressive (CalPundit makes this point correctly). But, a few points are in order:

  1. Almost nothing about using exemptions in the consumption tax made it into the Economic Report of the President (on page 196, the authors mention possibly retaining favorable tax treatment of nonprofits)
  2. The only compelling case for a consumption tax is its theoretical simplicity. As soon as you start talking about favoring seniors, nonprofits, making the rate increase with the value of the sale, exempting some goods and services, applying regional adjustments to adjust for regional price and income variation, continuing to encourage the social goal of home ownership, favoring families with children, the popular R&D credits… it starts to look a lot like the current tax code morass.


P.S. Is it really much ado about nothing? I don’t think so. It’s telling that this proposal made it as far as it did. Now if I could just figure out what it tells me.

P.P.S. The fonts appear to be under control!

Calpundit has the heads up on this one, though he highlights a different quote.

“The White House team is saying that the Fed chairman has lost sight of the broader thrust of the president’s tax proposals. They claim that Bush has started a major revamp of the tax system, from one that taxes investment and savings, to one that taxes consumption [emphasis mine]. Rather than make one massive effort to achieve that goal, they say, Bush is chipping away at the problem, with the abolition of the double taxation of dividends and the institution of new tax-advantaged savings plans. They say that these are the first steps on what will be a long road. As the Financial Times perceptively notes, ‘Little by little, [the administration] has headed towards the distant dream of some Republicans: a tax system based on consumption.'”

Calpundit muses accurately “And on a related note, is it just my imagination or is the Standard really a more interesting, more unpredictable, and basically more honest conservative magazine than National Review? It seems that way to me.”


P.S. is not intended to be “consumption tax central”, I just happened to start this blog as the issue was picking up steam. Soon, I’ll have thoughts on dividend taxes and why they are bad (it’s not the intrinsic unfairness of double taxation)–and no, that statement doesn’t mean that I favor the Bush plan.