So, we're just one day away from electing our commander in chief, and many find themselves wondering just what in the heck the leader of the free world is going to do for their nest eggs.
With that in mind, let's take a look at a few key tax issues that are facing these candidates, our nation, and our portfolios.
Icon of the free world, and double taxation
In all likelihood, Sen. John Kerry, if elected, will attempt to push Congress to repeal the reduced tax rate on dividends, along with nearly all of the tax cuts associated with the 2003 Job Growth Tax Relief and Reconciliation Act. I have nothing against Mr. Kerry in general, and I'm not making a political statement here for, or against, either candidate. But personally, I think this is a horrid idea.
Certainly, as the author of the Fool's dividend-oriented newsletter, Motley Fool Income Investor, I have an obvious bias toward dividends because of the enhanced risk-adjusted returns and the market efficiencies that they provide. But the true reason that I dislike this potential repeal is that these cuts were a step towards fundamental tax reform and the elimination of the double taxation that runs rampant throughout our current tax code.
Frankly, it is my belief that double taxation is wrong, period. As such, if the elimination of double taxation created revenue shortfalls, which it almost certainly would, I would gladly pay larger sums of a legitimate tax rather than pay any sum of what should be an illegal one.
Consider that the vast majority of companies out there that we invest in -- from General Electric (NYSE:GE) to PepsiCo (NYSE:PEP) to Bank of America (NYSE:BAC) -- pay taxes on their earnings. It doesn't matter whether the company ultimately retains those earnings or pays them out as dividends -- in either case, they've been taxed.
Now, further consider that the money you earn and ultimately invest in these companies has also already been taxed (assuming you're not investing via a regular IRA). Why then should dividends or capital gains be taxed at all?
OK, even if we concede that we're not going to see an elimination of such taxes anytime soon, does the idea of taxing dividends at a rate that's different than that of capital gains make any sense? I say the answer is an emphatic "no," but -- despite the fact that I just spent several paragraphs expressing my feelings on this subject -- it may surprise you to learn that my real point in this article is that (gasp) this issue really doesn't matter.
That's right, the repeal of the dividend tax and the other 2003 tax cuts as a means of reducing the federal budget deficit is akin to attempting to put out a house fire with a turkey baster. In spite of what we're hearing from our presidential candidates and their minions, the numbers we're talking about here are virtually inconsequential in relation to our deficit, and I'll explain why.
The tax dance cometh
According to the recent figures provided by the Congressional Budget Office (CBO), the federal budget shortfall will amount to $422 billion for 2004. In addition, relying on its current taxation estimates and economic projections, the CBO forecasts a total budget deficit of $2.4 trillion in 10 years. That may not sound so bad given the expensive outlays required to fight terrorism and the relatively fragile economic environment we've experienced.
However, here's the real pickle, ladies and gentlemen: That figure doesn't include the massive projected shortfalls in our Social Security and Medicare programs. Want to toss those figures into the mix and see what we're really facing? To be honest, I don't think you do, but I'll tell you anyway. Including those unfunded obligations, we're looking at a deficit of more than 70 trillion greenbacks, no matter how you slice it. I'd say that's a notable increase -- something that I would have liked to have heard a little more about during one of those presidential debates.
Will you take a convenience check?
So, let's see. We the people owe about $70 trillion on our U.S. Express credit card. But how long will it take us to pay our balance in full? Well, it's not a pretty picture.
We the government brought home a paycheck of about $2 trillion last year -- not a bad day's work, to be sure. But this means -- if we dedicated every dime in our red, white, and blue wallet to paying this bill -- it will take us 35 years to pay off our U.S. Express card.
Clearly, our presidential candidates must recognize the fact that a few bucks of extra dividend taxes are not going to fix this problem. Addressing this situation is going to require a fundamental overhaul of the Social Security and Medicare programs. Beyond that, a complete overhaul of our current tax code and heavily scrutinized future spending is also a likely necessity.
In other words, the government may have to actually do what the private sector and individual citizens have always had to do: focus on reality and find a way to deal with it. Unfortunately, no one is really telling that story, so it's difficult to judge which candidate has the greatest potential to fix this problem for us.
The spin
Instead, we hear things like, "The rich don't pay their fair share!" It's catchy, it's got a beat, and you can dance to it, but is it really true? Let's take a look at what the U.S. Treasury says. As of 2001, the top 4% of earners in this country paid half of total federal individual income taxes. The top 50% of earners paid 96% of total federal individual income taxes. Hmmm.
Given that, I don't think anyone can make a credible argument that the "rich" aren't paying their fair share of this country's tax burden. However, as ironic as it sounds, our multilayered tax code actually provides -- and indeed encourages the use of -- legal means that allow wealthy Americans to substantially reduce their effective income tax rates to levels that are far below the average paid by middle-class taxpayers.
Of course, one could point out that these tax loopholes and incentives are available to lower-income taxpayers as well, and that is certainly true. But wealthy Americans who pay large sums for professional tax advice -- because of the fact that they have more to gain -- are generally the only ones taking full advantage of these opportunities.
The Foolish bottom line
So, what does it all mean? The plain truth is that we're not likely to see decisive action from either candidate that moves us toward the fundamental reform required to truly address our deficit situation. But that doesn't mean there's nothing we can do.
A major step forward is simply being aware of the problem. We have to get past the campaign spin and demand that our representatives start addressing the true economic realities facing our country.
Again, while the repeal of the dividend tax cut would be disappointing, it's largely inconsequential if for no other reason than it is set to expire in 2007 in any case.
Because of the strategy's compelling low-risk/high-reward attributes, I employed a dividend-oriented investment strategy with great success before the 2003 tax cuts. And I'll be using a dividend-oriented investment strategy -- hopefully with continued great success -- after the 2003 tax cuts are no more.
Though I don't think that anyone truly wants to see the return of policies that stifle saving and investing -- such as double taxation on dividends, higher taxes on capital gains, and reinstatement of the marriage penalty or higher estate taxes -- we may have bigger fish to fry in this election. Unfortunately, though folks continue to jest, "It's the economy, stupid," I believe we're facing our fair share of challenges on many more important fronts these days.
Still, I'm confident that, in the end, Fools will conquer all. Now get out there, vote, and make a Foolish difference!
Mathew Emmert, chief analyst of Motley Fool Income Investor , is traumatized by chad dimples and once got lost in a voting booth, but he will overcome his fears and vote in this year's presidential election. He owns shares of General Electric and PepsiCo. The Fool has a disclosure policy .
