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Author: boad Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35361  
Subject: Bonds and Bush Proposal to End Dividend Taxes Date: 12/7/2002 3:46 PM
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As widely report, there is speculation that the Bush Administration will eliminate "double taxation" of dividends -- either at corporate or individual level.

Here's one story:
http://business-times.asia1.com.sg/innews/story/0,2276,66126,00.html

Whatever ones views of tax cuts, some concerns about this specific proposal:

1. If done at individual level, one newsletter writer chortled, ""This would destroy the municipal bond market and would cause more money to pour into the stock market." Won't destroying the municipal bond market have serious downside -- e.g., taxpayers (i.e., us) will have to make up any funding slack?

2. Whatever the problems with tech companies, technology -- information technology, biotech, materials science, etc. -- is the driver of our brand of economy and standard of living. Many of these companies retain earnings to grow (as does old economy companies like Berkshire Hathaway--WEB authorized a dividend once and said never again). Would this proposal help cut off funding of innovation that is fundamental to our brand of economy? Is this some kind of government anti-industrial policy?

3. Would this proposal be necessarily a plus for blue chips, rather might investors go after stocks with really high dividend yields like royalty investment trusts (e.g., ERF) and business development companies (e.g., ALD)?

4. About 75 percent of dividends go to people with incomes over $100,000. If looking for proposals to stimulate demand, wouldn't better to target people with marginal propensity to spend?

5. Do we want the government in the business of goosing the stock market? Manipulation in plain sight! Didn't government manipulation of the Japanese stock market smash its credibility?
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Author: brucedoe Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5557 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/7/2002 6:50 PM
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You don't understand. The purpose of exempting dividends from taxation is to increase the riches of the wealthy. They always want more. Has nothing to do with the rest of us, though we may or smay not benefit to a small degree. Afterward the great corporate America was built under the double taxation standard, and "retaining earning to stimulate growth of the company" is a rather recent event. I first heard about it in the 1960s. The trouble is, CEOs waste a lot of money when they have too much around (think of all the good will being written off these years). They huge amounts of money that companies like Microsoft have squirreled away is indicative (1) that they can't find good investments with which to use the money and (2) they would rather be a bank than pay a dividend.

brucedoe

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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5560 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/7/2002 10:07 PM
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Boad,


You're asking good questions, probably a lot better than the politicians, who I presume are looking for a quick fix for stock market losses.

I'll share my thoughts—I don't have answers.

1) I don't get the chortle about muni bonds. What affect encouraging more companies to pay dividends will have on bond yields is an interesting question. Most companies, though, aren't profitable enough to be offerring dividend yields big enough to compete with bond yields, even with current low bond yields. And, if people buy stocks to get the yields, as stock prices go up, dividend yields go down. Dividends take some of the risk out of the stock market, but not enough to make it a substitute for bonds, especially if a lot of people buy stocks again in response to the dividends. I don't see why munis would be in particular trouble, as opposed to other bonds. But, you're right, if people stop buying munis (or treasuries, for that matter), other sources for funding would be necessary.

2) Absolutely fundamental question. I've been arguing that supply-side economics needs to be reexamined objectively. The stimulus to growth and innovation that comes from pushing the investment (supply) side of capitalism is crucial, especially providing working capital to legitimate start-ups and other companies pushing the envelope (whether in technology or just good entrepeneurship). The issue I've been raising is when is enough? I think the investment banking scams were enabled by too much capital being available than could be put it to good use as working capital by genuinely innovative companies. I also think a lot of successful companies retained earnings that they squandered on worthless acquisitions, bad investments, and wasteful spending on executives and their luxuries that would make the pork barrel kings on Capitol Hill look like misers. Now, as a consequence, we're sufferring through an almost complete loss of VC investment in legitimate innovators, and established companies have reduced capital spending, including on improvements that could greatly enhance efficiency—some have even cut back on R&D, which also happened in the '70s, after another bear market, with disasterous results. What we need is a common sense balance. We need plenty of working capital available when it can be used, but if companies can't use the money, it is better to return it to shareholders than to blow it on confetti. This is why the call for dividends is a retreat from the supply side, probably a necessary one, but you won't hear those who cloak themselves in the mantle of supply side admit it.

3) A lot will depend on what dividend proposal is enacted. There is no good excuse for exempting stock dividends from taxes for individuals, while taxing interest and dividends from more conservative investments. I would think a more plausible proposal is to tax corporate profits after they issue dividends, and let tax payers pay taxes on the dividends they receive. Even if the other approach is taken, if people buy high yield stocks, the yields will go down.

4) Actually, since middle class investors tend to have most of their stock investments in retirement plans, increased dividends would help them proportionally more than the wealthy who have a higher percentage of holdings in taxable accounts, but of course, any proposal that focuses on stocks helps the wealthy more than anyone else. As to what stimulates the economy best, demand side stimulus—government spending to create (meaningful) jobs, tax cuts aimed at spenders not investors—always has a stronger short term effect. However, this runs directly counter to everything the Bush administration and many Republicans in Congress claim to believe in (those of us who read actions not lips don't necessarily take these claims at face value).

5) The government interferes with the stock market all the time. What do you think Uncle Alan does with his interest rate wand (while professing to pay no attention to the stock market)? Why do you think we have long term and super long term capital gains taxes, if not as a feeble attempt to control traders and a more successful attempt to get even reluctant investors to buy stocks? What about allowing companies to put large portions of their own stock into 401ks, which is not allowed in traditional pension plans? Anyway, if anyone is guilty of smashing the credibility of the US stock market, it's not government: it's corporate executives and accounting firms and investment banks and brokerages, aided and abbetted, of course, by politicians who they had in their pockets. For most stock markets around the world, lack of credibility comes from within; unfortunately, the US markets are no longer any different, if they ever were.

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Author: iamdb Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5566 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/7/2002 11:09 PM
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Loki,

Regarding point 1 of your response: "I don't get the chortle about muni bonds",
as I understand it, without tax exemptions, munis would need to pay dividends more competivitve with corporates, making it more costly to raise money for public works. But of course you already know that, so I must be missing the point.

db

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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5567 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/7/2002 11:21 PM
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"I understand it, without tax exemptions, munis would need to pay dividends more competivitve with corporates, making it more costly to raise money."

db,

Where did it say anything about eliminating the tax exemption for munis? Did I completely miss it? Wouldn't stand a chance of being passed—a lot of irrate state and local officials pulling the plug on their favored suns and daughters in DC come next election.

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Author: reikiman Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5568 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/7/2002 11:36 PM
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They huge amounts of money that companies like Microsoft have squirreled away is indicative (1) that they can't find good investments with which to use the money and (2) they would rather be a bank than pay a dividend.

I think you mis-understand why Microshaft has squirreled away that large amount of money.

It is because they are a convicted proven monopolist, in posession of an illegal gotten and maintained monopoly, and there's a buncha lawyers on their tail looking to exact a few $$$'s of justice. Like any company facing a huge judgement, they're stashing away a fund to potentially pay that judgement without immediately threatening the company. Sound business sense, but it would make even more business sense for them to learn some simple business ethics so that they wouldn't be facing such penalties int he first place.

- David


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Author: iamdb Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5569 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/7/2002 11:56 PM
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Loki,

Wouldn't eliminating the tax on corporate dividends be essentially the same thing, i.e. level the playing field so muni dividends would have to compete with corporates to be attractive? I surely must be missing something.

db

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Author: reikiman Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5570 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/8/2002 12:02 AM
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I don't quite understand either ...

To me, if I buy a stock I'm always nervous the company is going to die. Muni bonds are far more stable than that.

- David


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Author: kentm401 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5573 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/8/2002 6:46 AM
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I believe that Lok has "got it"...dead on...<g>

Anyway, if anyone is guilty of smashing the credibility of the US stock market, it's not government: it's corporate executives and accounting firms and investment banks and brokerages, aided and abbetted, of course, by politicians who they had in their pockets. For most stock markets around the world, lack of credibility comes from within; unfortunately, the US markets are no longer any different, if they ever were.

we have met the enemy and they are us......55% of all US households own equities either directly or indirectly through tax deferred retirement accounts & plans. "We", as an investor class, over the last 30 years, "bought into" this market skam, bigtime, and now the "chickens are coming home".

BWDIK

KBM (just another "chicken")

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Author: kentm401 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5574 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/8/2002 7:07 AM
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Not Lok....but

Wouldn't eliminating the tax on corporate dividends be essentially the same thing, i.e. level the playing field so Muni dividends (siq Interest) would have to compete with corporates to be attractive? I surely must be missing something.

db


My own answer is prob. not. It's the "double Taxation" of corporate div. issue, that I would prefer Congress to change, not the direct "taxation" of dividends at the recipient (taxpayer) level. This would "level the playing field" on a corporate valuation basis, perhaps in the eye of the investment (community), IMO shifting the "valuation" of an investment from "Phantom Wealth (aka Capital Gains), to "Valuation" of an investment to "Real Returns", or an accual Rate of Return on the investment paper, in the form of dividends or/and interest. A complete shift in investment valuation psychology IMO.

IMO, Muni bonds (interest) would not be effected in any way, and the "spread" between them, Dividends & Interest) would still be driven by the non-taxable features (that and credit worthiness) of Muni bond issues. Corporate dividends, should not in any way directly affect Muni bond issues, other than in the way we model or value the cash flows of respective investment grade "paper".

As a ST stimulus to the markets, removal of the taxation on dividends at the investor taxpayer level, is just "bad Treasury policy", IMO. But it does make sense at the corporate level. Of course, "politically", my opinions do not "fly".

Since Carl Rove now "runs the economy", based on his political judgments relevant to the next election cycle, in my cynical mind, we will get exactly, what I "don't want".

KBM (Cynics R US)

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5575 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/8/2002 8:28 AM
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There's a whole bunch of ways to do this--some better than others depending on the goal.

1. It wasn't too long ago that the first $400 of dividends was free from Federal taxes. That's not a bad way to help the little guy, but of course it would have almost no impact on Fools saving/investing for retirement.

2. The proposal in Business Week would let corporations deduct 20% of their dividend distributions from income taxes. This might encourage them to pay more dividends. (That's especially attractive with low growth giants like food companies. You'd rather see them pay dividends that spend the money on fancy building and perks.) This sounds like the old trickle down theory the Republicans seem to favor.

3. Making dividends tax free or single taxed would be nice, but note we have a few of those already--partnerships and REITs. Those are investments that require payment of UBTI taxes if held in an IRA account (when payments exceed $1000).

No easy anwer here. Taxes are always complicated.

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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5576 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/8/2002 9:53 AM
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db,

Kent summed up my views of the muni thing. I just don't see how most companies can issue dividends with competitive yields, except maybe to short-term munis. And if there are some high dividend stocks, such as REITs, investors will flock to them so fast, their prices will go through the roof, driving down yields.

I also agree with Kent (my wording) that the Shrub administration has no economic policy, no real sense of cause and effect on the economy of any of its proposals, and has no interest in anything but helping the crony capitalists that got it elected and pulling the wool over everyone else's eyes with short term feints.

Doiing something with double taxation by letting companies pay dividends before they are taxed (or some reduction formula) makes sense. Prioritizing stock dividends over interest and bond dividends by making them tax free to individual tax payers is just an attempt to get people to buy stocks and inflate the stock market in ways that are unsustainable. I ain't buying.

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Author: boad Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5578 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/8/2002 2:47 PM
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Lok, you probably know most of this, but here's a bit more info about 
what may enter into an asset allocation decision between munis and 
dividend-paying stocks.

My original point 1:

1. If done at individual level, one newsletter writer 
chortled,  "This would destroy the municipal bond market and would 
cause more money to pour into the stock market."  Won't destroying the 
municipal bond market have serious downside -- e.g., taxpayers (i.e., 
us) will have to make up any funding slack?

Well, this point was also subsequently made on the Rukeyser show 
Friday night on CNBC, and is a question about asset allocation 
decisions by individuals:  will individuals who invest in munis now 
find some stocks more attractive?  After all, unlike most other bond 
markets which are dominated by institutional investors, 75% of munis 
are held by individuals.  Also, although munis are the second largest 
bond market -- after Treasuries -- with $1.7 trillion in outstanding 
obligations -- the market is pretty illiquid (i.e., people hold onto 
them--for reasons described below).  And munis are pretty riskless 
since insured for default.  Munis are also "individual investor"-
friendly as issued in units of $5,000.  And because interest is paid 
every six months, muni holders have to put that money somewhere.

Some stocks have pretty decent returns: Check out preferreds, or 
REITS, and, here's a just couple of others that come to mind: ConAgra 
(CAG) is yielding 4.08%; Allied Capital, the business development 
company, 9.79%; EnerPlus Res Fund, a oil/gas royalty trust, over 13%.
Of course, as you point out, if people piled into these stocks, the 
yields go down.

But when it comes to investment returns, how much an investment earns 
is secondary to how much you earn after taxes.

Here's a description from Quicken on the interplay of tax bracket and 
municipal bond returns.
http://www.turbotax.com/articles/TaxBenefitsofInvestinginMunicipalBonds.html

Municipal Bond Yields
As you move to higher tax brackets, you get even more benefit from the 
tax exempt status of municipal bonds, so the real yield is even 
greater than the income you receive from the bond.  Imagine a 
situation in which a municipal bond offers a 5.4% yield.

If you're in the 27% federal tax bracket, the 5.4% yield has a taxable 
equivalent yield of 7.4%.  In other words, you need to get a 7.4% 
yield from a taxable bond to equal the 5.4% payout of the municipal 
bond.

If you're in the 30% federal tax bracket, the 5.4% municipal bond 
yield is the equivalent of 7.7%. 

If you're in the 35% bracket, your yield is 8.3%. 

And if you buy a bond issued within your state, you can usually shield 
the income from your state income.

Recall how the tax brackets work (adjusted gross income; joint 
return; cut roughly in half for singles):

$0-$12,000            10.0%
$12,000-$46,700       15.0%
$46,700-$112,700      27.0%
$112,700-$171,950     30.0%
$171,950-$307,050     35.0%
$307,050 and up       38.6%

These are of course marginal brackets.  The first $12,000 for all is 
taxed at 10%; the $59,250 increment from $112,700-$171,950 at 30%, etc.

So basically, an individual is not even interested in munis until 
joint AGI is about $47,000, and gets more interesting after that.  And 
this is just the Federal take; obviously shielding income from State 
income taxes is a big incentive as well.

Now, I haven't looked for data on ownership of munis by income 
bracket, but I guess it's mostly folks in the upper brackets -- who 
have a long-term investment plan, understand tax-efficient strategies, 
and a comittment to preservation of capital.  (I was reading 
a bio of John Maynard Keynes, who when building his fortune through 
speculation was a wildman, but after making his pile, became quite 
conservative in his investments.  Another point:  TMF seems to have a 
mission of bringing commerical financial planning to the masses--not a 
bad idea.)

I've posted a couple of messages about the distribution of income in 
the U.S.  Most recent link:
http://boards.fool.com/Message.asp?mid=18252084

These messages had implicit (if not stated) value for understanding
the wider investment environment.  After all, in the US all wealth is 
essentially owned by individuals, and individuals, or their agents 
(institutional investors, mutual funds -- and asset allocation 
decisions between stocks and bonds (and maybe some futures and 
currencies in managed accounts for the bold) undoubtedly move markets.

Now, if Federal government started exempting dividends from income 
taxes, for certain high net-worth individuals who buy munis dividend-
paying stocks might look more attractive, particularly since also 
offer a potential capital return.  Of course, that total return bears 
more risk than munis themselves.  The answer to this question is not a 
matter of logic, but a math model.



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Author: Lokicious Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5581 of 35361
Subject: Re: Bonds and Bush Proposal to End Dividend Taxe Date: 12/8/2002 9:14 PM
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Boad,

You certainly provide us with a lot more to think about than some flippant remark from an "investment professional." I wish I had faith the politicians would do some calculations and look at implications before leaping.

When I've looked at munis for myself, I've generally found that my 30% bracket is the break-even point for munis vs investment grade corporates. The cut-off point would be a lower bracket vs. treasuries.

I still think when you consider the universe of stocks, the number with high yields (and moderate risk), especially when the yields go down as people flock in, wouldn't destroy munis. But the question of what impact making stock dividends tax exempt would have on all types of bonds is very legitimate, and even if it is as little as boosting bond yields by 1% to make them more competitive, that matters a lot.

I also think the point you made about supply side principles is crucial—if people flock to high dividend stocks from companies that have little need for new equity capital, is that going to make it harder for innovative companies in need of working capital to obtain further equity funding at acceptable levels of dilution? Are young companies who make legitimate use of stock options to attract talent they could not pay competitive wags for going to suffer, because the prospects for strong capital apprecitation of the stock are going to be limited until the company reaches the dividend paying stage (I'm talking young companies with something special, not pump and dump scams)?

By the way, I think there are just as many questions about increasing the tax loss against income proposals—not going to help people with losses in 401Ks, not going to help the retirees who got out of the market with long term capital gains from decades of investing, just with a lot less money than they planned on having, and probably going to precipitate another market crash as those who haven't harvested their losses have a new incentive. I'm sure that Charles Schwab benefitting from the increased turnover has nothing to do with his championing this idea.



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