Jacob Levy criticizes the Senate’s proposed temporary tax cut on dividends.

The arguments in favor of repealing the dividend tax have to do with removing distortions from the capital markets and from the incentives faced by corporations, and with improving tranparency in corporate accounting. Removing distortions from the capital markets is a good thing for long-term growth…The desirable effects that it is supposed to have would all be defeated by a three-year sunset clause; corporations aren’t going to restructure their debt practices, their dividends vs. stock buyback practices, for such a short-term provision.

Levy argues that the Senate is confusing a temporary Keynesian stimulus with a supply-side tax cut. He says for temporary stimulus, a demand-side tax cut, such as increasing the personal exemption, would make more sense.

I would disagree slightly, in that there is a good argument that temporary tax cuts also are less effective than permanent tax cuts for increasing demand. The argument is that people tend to smoothe consumption, so that a relatively large part of a temporary tax cut will go into saving.

Overall, however, I agree with Levy’s point that a temporary dividend tax cut is a bad idea. Either double taxation of dividends is good policy or it isn’t. We should not legislate single taxation for three years followed by double taxation thereafter.

Virginia Postrel remarks,

The congressional process has taken a good idea for fundamental tax reform and turned it into short-term, wildly distortionary vote-buying with absolutely no economic rationale. It’s just one more example of why anyone with a brain inevitably develops contempt for Congress.

For Discussion. If you were President Bush, would you sign or veto a temporary dividend tax cut?