Senate Republicans draft dividend tax cut

WASHINGTON -- Republican tax writers in the Senate included a dividend tax cut in the first draft of their legislation, putting it a step closer to President Bush's outline for economic growth. Bush welcomed what he called "some progress" in Congress but argued for more.

"We need aggressive action out of the United States Congress right now," Bush told a business audience, reiterating his argument for complete elimination of taxes on stock dividends.

Finance Committee chairman Charles Grassley, R-Iowa, inserted a three-year version of the president's tax proposal to eliminate dividend taxes into his bill as a placeholder. In Grassley's version, taxes on dividends would be eliminated for one year -- in 2005. Taxpayers would get one-third of their dividend income tax-free in 2003, and two-thirds tax-free in 2004.

Republicans will have until Thursday's committee debate to rewrite the idea to make it fit in their $350 billion tax cut. The plan currently runs $65 billion over budget, and aides have identified at least $40 billion in revenue-producing ideas to offset the cost of the tax cuts.

Bush has pressed for a larger tax cut along the lines of the $550 billion level approved by the House, but did not specifically mention that level in a morning speech to the U.S. Chamber of Commerce.

'That's good news'

"We've got to do more. And that's the message I want you to take to the halls of the United States Congress," he told the chamber. Of recent efforts in both the House and the Senate to find some common ground, Bush said, "We've seen some progress...and that's good news. Both parties recognize that tax relief helps create jobs."

The House Ways and Means Committee debates its tax bill Tuesday, including a modified version of the dividend tax cut that gives tax benefits to a broader range of investors.

Committee Chairman Bill Thomas, R-Calif., opted to consider dividends in the same category as capital gains, which are taxed at a lower rate than dividend income. He wants to reduce taxes on both types of investment income to 15 percent, and 5 percent for low-income individuals.

Shareholders currently pay the same tax on dividends as earned income at rates as high as 38.6 percent. The new tax system will absorb $277 billion of $550 billion in tax cuts through the next decade. Democrats plan to make the dividend and capital gains policy the target of amendments to aim more of the benefits to middle-income taxpayers.

The remainder of the package would give individuals and families a $235 billion tax cut through 2013, reducing income tax rates beginning retroactively at Jan. 1 to accelerate changes already planned for later this decade. It would also increase other tax breaks for three years, raising the $600 child credit to $1,000 and expanding deductions for married couples and preventing 10 million people from being forced to pay the alternative minimum tax.

The package allows small businesses to write off $100,000 of investment from 2003 through 2007.

Senate Republicans, who control the chamber by the narrowest of margins, are under intense pressure to back the president and reduce taxes on dividends.

Bush set forth a $400 billion plan to cut the dividend tax, the centerpiece of his economic plan. The Senate limited its entire tax cut to $350 billion over the next decade and has struggled to combine a dividend tax cut with more popular plans to accelerate income tax rate reduction, boost the child credit and expand the standard deduction for some married couples.

Senate Republicans cannot fit the president's $400 billion dividend plan in their smaller tax budget. Even taking into account items that will offset the cost of tax cuts exceeding $350 billion -- a crackdown on corporate tax shelters and extended customs fees -- Republican aides estimate they have a $70 billion budget for a dividends tax cut.

Conservative Republicans want to reduce taxes on dividends to zero, even if it means gradually phasing in the policy and then letting it expire two or three years later. Senate vote counters say that approach may not have enough support to survive committee debate.

Sen. Olympia Snowe of Maine, a moderate Republican who holds a key vote in committee and floor deliberations, favors letting taxpayers exclude $1,500 of dividend income from taxation. She called the approach that phases in and then terminates the tax cut a gimmick that masks the policy's true cost.

Senate Republicans disagree over using the bill to give some relief to cash-strapped states. Snowe and Gordon Smith, R-Ore., want to give states $20 billion, half devoted to Medicaid.

Senate Democrats, who unveiled their recipe for economic growth on Tuesday, fashioned a smaller package and argued that Bush's costlier proposal would make huge expected federal deficits even worse.

"They call their tax cut 'robust.' In fact, it's just a bust," said Senate Minority Leader Tom Daschle, D-S.D.

The Senate Democratic plan would give state and local governments $40 billion. It also includes a one-time tax cut of $300 apiece for each working adult and up to two children in a family.

Additionally, the child tax credit, currently set at $600, would rise to $700 in 2003 and $800 in 2004. Other elements of the plan provide relief from the so-called marriage penalty, both for low-wage earners and for couples that use the standard deduction to calculate their taxes.

Overall, the plan is expected to cost $190 billion through 2013, offset by $38 billion in revenues generated by closing tax loopholes and raising customs fees.