Senate GOP Supports a Temporary End to Taxes on Dividends

Senate Republicans, struggling to salvage a main element of President Bush’s domestic agenda, on Tuesday embraced a proposal to eliminate taxes on dividends -- but only temporarily -- as part of a $415-billion, 11-year plan to jump-start the sputtering economy.

Even as Senate Finance Committee Chairman Charles E. Grassley (R-Iowa) unveiled the compromise, he also admitted that he did not yet have the votes to pass it through the Senate -- or even in his own committee, when it comes up Thursday.

Grassley’s political problem is a measure of the bitter divisions within the Senate GOP over Bush’s push to permanently abolish the tax on dividends. The dispute pits the party’s conservative majority -- which sees ending the dividend tax as the keystone of any new economic policy -- against a handful of Republican senators who do not believe the proposal is the best way to stimulate the economy and are worried about the effect on the burgeoning federal budget deficit.

In the House, meanwhile, the Ways and Means Committee on Tuesday voted 24 to 15, along party lines, to approve a $550-billion tax-cut bill that would reduce, but not eliminate, taxes on both dividends and capital gains.

The White House is showing increased willingness to compromise on the dividend issue, although Bush continues to press publicly for its elimination. A White House official, who asked not to be identified, said the administration was especially pleased with Grassley’s proposal because, by calling for elimination of the dividend tax even temporarily, it “embraced the fundamental principal” of the Bush plan.

Bush’s plan to eliminate dividend taxes would cost $396 billion over 10 years. Instead, Grassley proposed a $90-billion plan that would phase out the dividend tax over three years, eliminating it entirely in 2005 -- but only for that year. The tax would return in 2006 unless Congress voted to extend the repeal -- which Bush allies hope would happen.

White House press secretary Ari Fleischer hailed as “progress” the House proposal to reduce the dividend tax.

“There’s no question that the president is not getting everything he’s asked for,” Fleischer said. “But he’s getting, in both the House and the Senate proposals, a lot of what he’s asked for.”

Indeed, it is almost lost in the controversy over the dividend tax cut that both House and Senate bills would give Bush a version of each major component of his original $725-billion tax cut plan.

Both bills would accelerate income tax rate cuts scheduled to be phased in between now and 2006; both bills would make those rate cuts effective retroactive to Jan. 1.

Both bills would increase incentives for businesses to invest in equipment and other capital expenses, with special relief for small businesses. And they would speed up scheduled tax breaks for married couples and families with children.

The House bill, however, would cut off those popular family and business tax breaks after 2005 -- a provision critics said was a gimmick that masked the measure’s true cost. Even the bill’s authors acknowledge that these provisions likely would be extended beyond 2005.

Proponents of the GOP tax-cut plans said the legislation was needed to bolster the economy -- especially in light of recent reports of persistent joblessness.

“America’s economy is expanding, but obviously not as quickly as we would like,” said House Ways and Means Chairman Bill Thomas (R-Bakersfield). “Congress must take bold steps to spur economic expansion.”

Most Democrats have been backing a much smaller tax cut focused on middle- and lower-income taxpayers -- or no tax cuts. Critics say the GOP plans would drain the budget at a time of growing deficits and increasing demands for federal domestic programs.

“The truth of the matter is that this has nothing to do with the growth of the economy.” said Rep. Charles B. Rangel of New York, the ranking Democrat on Ways and Means. “But it has everything to do with getting rid of the resources that support the programs that a lot of people believe should be supported by this Congress.”

The House is expected to approve its tax-cut bill Friday. There is much more uncertainty about the fate of the Senate bill in the chamber’s narrowly divided Finance Committee. That panel consists of 11 Republicans, nine Democrats and one independent who usually votes with the Democrats.

The problem for Grassley is that most Republicans on the committee insist on some dividend tax cut. But all the Democrats, the independent and one Republican -- Sen. Olympia J. Snowe of Maine -- oppose the dividend tax cut.

The bill Grassley unveiled was a “placeholder” -- a draft that is the basis for negotiations until Thursday. As it stands, its $415-billion price tag is $65 billion over the $350 billion allowed by a budget resolution the Senate passed in April.

Grassley promised that by Thursday, he would propose offsets -- spending cuts or tax increases in other areas -- to bring the net revenue loss to $350 billion.

Snowe criticized Grassley’s proposal on the dividend issue as a “gimmick that cloaks the true cost” of the tax cut and said she could not vote for it. Snowe backs an alternative that would exempt from tax the first $1,000 in dividend income earned by an individual.

Montana Sen. Max Baucus, the ranking Democrat on the Finance Committee, opposes Grassley’s plan both because of its dividend tax cut and because it fails to include aid to financially strapped states.

Grassley said the demand for state aid is strong enough that he expects to add such a provision to the bill, despite opposition from several conservative Republicans.

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Times staff writer Edwin Chen contributed to this report.