Somehow politicians occasionally come up with ideas that are supposed to have some particular effect, and in reality the opposite is true. Today was the first day of my Urban Economics class with Dr. Kelly Edmiston. Upon walking into the classroom, the first thing Dr. Edmiston announced to the class was that he wanted to talk about a particular aspect of Bush’s economic stimulus package before handing out the syllabus. The total cost of the proposed bill is about $600 billion over 10 years. $300 billion would go toward the elimination of the tax on corporate dividends.

The intended effect of the elimination of this tax is that it would increase consumer spending and corporate investment. According to Dr. Edmiston, Bush is wrong on both counts.

On corporate spending: an overwhelming majority of corporate stocks are owned by people who already have very high incomes. As income rises, the rate of savings increases and spending decreases. Therefore, a majority of the additional money “given back” to taxpayers or distributed in dividends would only wind up sitting in banks rather than providing an economic stimulus.

On corporate investment: there is a common misconception that when you purchase a share of stock in a company, the money goes to the company. This is not true. The money goes to the person selling the stock. Companies don’t receive money from stocks except in an initial offering. So while there remains the possibility that there will be an increase in the number of stock transactions, none of the money exchanged will actually go to corporations.

Meanwhile, the incentive structure will change. Under the current structure, capital gains are taxed at a lower rate than dividends are taxed. Therefore, corporations have a greater incentive to keep retained earnings and use those retained earnings to make further investments. Under the proposed structure, corporations will have a greater incentive to spend away their retained earnings by offering higher dividends. That is essentially a corporate disinvestment, rather than the investment that President Bush believes will happen.

A part of the stimulus package that Dr. Edmiston does like is the proposal to change accounting rules on depreciation. If equipment depreciates faster, then corporations have an incentive to purchase equipment more often. That’s an increase in corporate investment, and that will be good for the economy.