As the fine print of President Bush's dividend-tax-cut plan got a closer reading by economists and others Wednesday, technology companies found more to like -- while some financial advisors said the proposal could create a record-keeping nightmare for investors.
The plan to eliminate federal taxation of dividends initially had been viewed as problematic for many tech companies because few of them pay dividends to shareholders. Instead, many tech firms say they need to retain all of their earnings to fund research and expansion.
If dividends are tax-exempt for shareholders, tech companies could feel pressure to return at least some profit to investors.
But as part of the Bush plan, Treasury officials said they would propose that companies give shareholders a credit for earnings that could be paid as tax-free dividends but instead are retained for expansion. The credit would allow shareholders to reduce any net taxable capital gain if or when they sell their shares.
Greg Jenner, deputy assistant Treasury secretary, said the credit is needed to make sure that tax policy is neutral with respect to dividends -- in other words, that the law neither discourages dividend payments nor pressures firms to pay them.
Although a dividend tax exemption would be expected to encourage many companies to raise dividends or to begin paying them, the Bush administration hasn't billed the idea as a prod to do so. Rather, the administration said it was tackling the long-criticized "double taxation" of dividends: Companies owe taxes on earnings, then shareholders owe taxes on any dividends paid out of earnings.
By allowing retained earnings to be credited against investors' future capital gains, the Bush plan would make it easier for cash-rich tech firms such as Microsoft Corp. and Cisco Systems Inc. to justify not paying cash dividends, experts said.
"It's designed to level the playing field" among companies that pay dividends and those that don't, said Richard Berner, an economist at Morgan Stanley in New York.
"If it's real, it's a definite help" to Silicon Valley, said Richard Carlson, an economist at Spectrum Economics in Mountain View, Calif. But he and others said there is a potential downside: The record-keeping aspect of the tax-credit idea appears to present "an accounting nightmare" for companies and shareholders, he said.
"You're adding a lot more complexity to the tax code," said Ethan Harris, an economist at brokerage Lehman Bros. in New York. For investors trying to keep track of their cost basis of shares for tax purposes, "it sounds like a mess to me."
Treasury's Jenner disputed that the record keeping would be troublesome. He said companies would tell investors at the start of each year what they had received in tax-exempt cash dividends and what amount of their share of profit was retained and could be credited against any future capital gains.
Also in the fine print of the Bush plan is a provision to withhold the dividend tax exemption in cases where a company manages to pay no federal tax for a given year but still makes dividend payments to shareholders.
That would penalize shareholders of firms that avoid taxation through skillful accounting.
Some types of companies automatically would not qualify for the exemption. For example, real estate investment trusts are structured to pay out all of their net earnings in dividends to shareholders each year. Because the firms don't incur federal tax, their dividends would remain fully taxable to investors.
Many financial experts said they still expect that a dividend tax exemption, if passed by Congress, would drive more institutional and individual shareholders to demand higher dividend payments from companies they own.
In the wake of last year's high-profile accounting scandals, investors who are suspicious of companies' financial results will be more comfortable believing the numbers if they are accompanied by substantial dividend payments, said Allan Rudnick, a principal at Kayne Anderson Rudnick Investment Management in Los Angeles.
"We've always viewed rising cash dividends as a sign that a company's cash flow is really there," he said. "You can fake reported earnings, but you can't fake dividend payments."
Some economists also contend that the corporate capital spending and merger binges of the late 1990s squandered company earnings that would have been better used if they had been returned to shareholders.
"Every manager thinks he's a genius," said Robert Shiller, an economist at Yale University. "It would be better if they'd pay out earnings as dividends. Then the investors can give it back to them if they want."
Jenner said that by requiring companies to tell shareholders each year how much of their potential dividends were retained, the government would make it easier for shareholders to see what they're missing. "They could say, 'Hey, I'd really like this tax-free cash. Why am I not getting it?' "