Senator Peter Fitzgerald (R-IL), Chairman of the Subcommittee, will preside. The purpose of this hearing is to review how the elimination of taxes on cash dividends paid to individual investors may modify corporate behavior in a manner beneficial to individual shareholders.
Mr. Jeremy Siegel
Witness Panel 1
Mr. Peter Fisher
DEPARTMENT OF THE TREASURY OFFICE OF PUBLIC AFFAIRS EMBARGO UNTIL 10 A.M. Contact: Betsy Holahan April 8, 2003 202-622-2960 Testimony of Peter R. Fisher Under Secretary for Domestic Finance U. S. Department of the Treasury before the Subcommittee on Consumer Affairs and Product Safety of the Senate Commerce Committee U. S. Senate Chairman Fitzgerald, Ranking Member Wyden, and distinguished members of the Subcommittee, I am honored to testify before you in support of the President’s proposal to eliminate the double taxation of dividends. This proposal would strengthen our economy and create jobs by improving corporate governance and re-targeting investment to its most productive ventures. Corporate governance would improve because the proposal would better align executives’ interests with shareholders’ and encourage companies to disclose more clearly their cash earnings and taxes paid. Investment efficiency would rise because the proposal would reduce tax distortions to fundamental corporate decisions such as whether to repay shareholders or how much debt to raise. The result would be more investment, higher productivity, more new jobs and faster economic growth. At a time when too many people who want jobs can’t find them, and when economic growth around the world is slower than we should accept, the President’s proposal would be a welcome shot in the arm. In the past year, under Chairman Oxley’s and Senator Sarbanes’ leadership, Congress took a major step toward improving corporate governance in America. Investors have matched that with their own call for improved governance. Corporate executives, directors, auditors, and lawyers are already hearing and heeding the call for greater accountability. Better-run corporations make for more efficient capital markets and a healthier economy. But there is more to be done in encouraging the best conduct from corporate executives. Think of the headlines of the past couple years. Jobs destroyed by bankrupt firms that took on too much debt. Executives that “managed” earnings, inflating their companies’ stock prices and pumping up the value of their own stock options. “Corporate inversions” where companies moved to tax havens abroad. There are many forces responsible for these problems, but our tax code shares some of the blame. By taxing dividends twice, our tax code encourages companies to retain earnings instead of paying them to shareholders; to raise excessive levels of debt; to repurchase shares, often on a one-off basis, instead of issuing dividend checks; to dedicate some of America’s leading minds to tax minimization instead of job creation. There’s nothing wrong with debt or retained earnings or share repurchases. But there’s no reason our tax code should favor them, either. Eliminating the double taxation of dividends would reduce these biases against investing and creating jobs. A shareholder would no longer pay a second layer of taxes on dividends if the corporation had already paid tax on that income. If the company retained that income and invested it again, the shareholder would get an equivalent credit. This is a ripe moment to improve corporate governance by removing the tax bias toward debt and retained earnings. CEOs and capital markets are now acutely sensitive to the risks of managed earnings. Yet today, because of double taxation, only half of non-financial firms pay dividends. Without periodic dividends – unmistakable facts about cash flow – investors are basically left with earnings opinions. As Secretary Snow says, you can fudge earnings, but you can’t fudge cash. The President’s proposal would clear the barriers to companies that sought to mirror their earnings reports with dividend checks. The President’s proposal is bad news, too, for the attractiveness of corporate tax shelters, corporate inversions, and other tax minimization devices. The rationale for creating these devices would lessen, because an investor could only claim an exclusion on a dollar of dividends if the company had paid full tax on that dollar. The proposal’s second benefit would be boosting investment efficiency and thus job creation. Let’s be clear where jobs come from. New jobs come from investment – the willingness of investors and entrepreneurs to put capital at risk in a business venture. The President’s proposal is focused precisely on that point: at sharpening the incentives for investors and entrepreneurs to invest in the most productive ventures. And higher productivity means higher wages and a stronger economy for everyone. Taxing dividends twice means that we tax investment more heavily than any other major industrial nation. If investment is the blood of new jobs and growth, this is bad policy. The double taxation of dividends also distorts companies’ decision to retain funds versus returning capital to shareholders. Even if shareholders have more promising investment opportunities elsewhere, the tax code locks those funds up inside the company. That’s not good for shareholders, and it’s certainly not good for the economy. Each year American firms invest over $1 trillion in fresh capital and generate $700-800 billion in corporate profits. Think of the gains in capital utilization and job creation for everyone if we accelerate and re-target this entire investment process. The Council on Economic Advisors estimates that through 2004 the dividend tax cut alone would generate more than 400,000 new jobs, nearly a third of the total from the President’s Jobs and Growth Package. The Business Roundtable says it’s even higher, closer to half. Taxing dividends once and only once would convert directly into higher share prices. Private sector economists estimate that the President’s proposal could boost stock prices by 5 to 15 percent, delivering immediate wealth to a confidence-short market. Last, some ask why the President has not proposed eliminating the corporate income tax instead. The main reason is that doing so would violate the President’s principle that the government tax dividends once and only once. If Congress eliminated corporate-level taxation, many billions in profits, headed to tax-free entities or abroad, would escape any taxation at all. Much more revenue would be foregone. And the way would be kept open for the same kind of tax minimization devices that today’s tax code fosters and which the President’s proposal would cut back. On behalf of the Administration, I urge you to take this opportunity. Thank you. -30-
Witness Panel 2
Mr. Jeremy Siegel
Testimony of Jeremy J. Siegel Prof. of Finance The Wharton School University of Pennsylvania Before the Subcommittee on Consumer Affairs and Product Safety of the Senate Committee on Commerce, Science, and Transportation. “Promoting Corporate Responsibility through the Reduction of Dividend Taxation” April 8, 2003 I strongly support legislation leading to the elimination of the double taxation of dividends. There is no question that this legislation will have profoundly favorable effects on the corporate governance issues currently plaguing the market. Ending the punitive taxation of dividends will increase the credibility of firms’ earnings, reduce the amount of debt on balance sheets, and lower the number of options granted in lieu of cash compensation for employees. In short, this legislation will better align the interests of management with those of shareholders. In order to encourage cash dividend payments, I prefer that dividends to shareholders be deductible from corporate income, just as interest payments to bondholders have always been deductible. I believe that deductibility at the corporate level more directly incentivizes managers to pay dividends than exemption at the personal level. However, President Bush’s plan to exempt qualified dividends from personal taxes should also increase dividends and improve corporate governance. The fall in dividend yield In the United States, the after-inflation rate of return on stocks over all long-term periods has averaged between 6.5% and 7%. Yet there has been a dramatic change in the composition of this return over the past twenty years. From 1871 through 1980, the average dividend yield on stocks was 5%. This means that for over one hundred years, more than three-quarters of the total real returns on stocks came from cash dividends. But starting in the 1980s, and accelerating in the 1990s, the dividend yield plummeted. Currently, even with depressed stock market levels, the dividend yield on the S&P 500 Index is under 2%, a level that is less than 30% of the projected long-term real return on stocks. The principal reason for the drop in dividend yield is the double taxation of dividends. This encourages firms to distribute their profits by generating capital gains, which are taxed at a much lower rate rather than dividends that are taxed at investors’ highest marginal tax rate. Although this incentive to substitute capital gains for dividends was always present in the tax code, the shift away from cash dividends was accelerated by an SEC action in 1982 (Ruling 10b-18, amendment to the Securities Act of 1934) that made it easier for firms to use profits to buy back their own shares. This ruling, coupled with the double taxation of dividends and the increase in management stock options, described below, created the perfect storm that drowned the dividend yield. The ambiguity of earnings The shift to capital gains and away from dividends has led to a number of developments that hurts corporate governance and shareholders. Cash dividends are tangible and very well defined, but earnings are not. Although there are rules outlined in GAAP for computing “reported earnings,” management often chooses a more generous accounting convention, called “operating earnings,” that has no widely accepted definition. As a result, judging a firm’s value on the basis of earnings alone has been subject to increased error. Moreover, there are a tremendous amount of assumptions that go into calculating earnings. Even if the firm applies the strictest GAAP conventions, there are still arbitrary choices firms must make such as which schedules should be used to depreciate assets, what future return should be used to calculate pension plan assets, how fast and in what period revenue should be recognized, and what capital expenditures should be capitalized. It is much harder, however for management to deceive shareholders about the true state of profitability of the firm when most of the profits are paid out as cash dividends. This is because accounting profits that are not backed by positive cash flows are much harder to turn into dividends. It is unlikely that Enron or Tyco could have deceived investors and analysts as long as they did if they were distributing a large share of their purported profits to stockholders. It is well known that earnings numbers can be manipulated to show a brighter picture by tweaking a few assumptions. In the past, this was not such a problem since most of the real return was derived from cash dividend payments. But today, with returns relying on future earnings growth, trust in earnings is paramount. Unfortunately, the high profile earnings scandals have broken that trust. Eliminating the double taxation of dividends is one tangible action that could restore trust quickly. Deceptive Securities and Excessive Debt Since interest on debt is deductible, while dividends are not, it is in the interest of management to substitute debt for equity. Yet higher debt may harm a firm’s credit rating. This had led to the issuance of deceptive securities that qualify as debt for the purpose of tax deductibility yet are viewed as equity by the rating agencies. Enron’s incentive to manipulate its balance sheet was brought to light by the Wall Street Journal on February 4, 2002 in an article titled “How the Treasury Department Lost a Battle against a Dubious Security.” This expose showed how Enron employed a security devised by Goldman Sachs that, depending on who is looking, can be treated as either debt or equity. Goldman’s securities, or MIPS (Monthly Income Preferred Shares), incorporate the best of both debt and equity. When Enron reported to the IRS, MIPS would be referred to as debt and Enron could deduct an interest expense. But for rating agencies and shareholders, MIPS were referred to as equity. Is it surprising that Enron pioneered the use of these securities? Hardly. We now know that Enron took great strides to hide its debt from shareholders. Yet the use of MIPS was and still is perfectly legal. The U.S. Treasury disagreed with Enron’s use of these securities, and in late 1995 tried to crack down on what it considered to be abusive accounting practices. Unfortunately, an army of lobbyists successfully forced the Treasury to admit defeat in 1998 after a 3-year battle in the courts. And despite the US Treasury’s persistent attempt to shut this security down, almost $200 billion of these MIPS, whose existence is solely to circumvent the unequal deductibility of interest and dividends, are currently outstanding. If dividends were not tax-disadvantaged, MIPS would never have been invented as there would be no incentive for firms to hide debt as equity or vice versa. Maintaining the tax deductibility of interest payments while denying it for dividends has also induced management to use excessive debt in their capital structure. This means that if there is a negative shock to demand for a firm’s product (such as what is happening now to airlines), a highly leveraged firm will experience financial distress and possible bankruptcy. Tax deductibility of dividends would encourage more equity on the firm’s balance sheet and lower the probability of financial distress. Option Grants Finally, the shift from paying dividends to generating capital gains encouraged the proliferation of option-based compensation packages that are not accurately reflected in income statements and distort the decisions of management. Option values are only based on the price of the stock, not on the dividend. If management holds substantial options, it is against their interest to pay dividends, since the value of their options will only be enhanced by turning those profits into a higher price for the shares. Option holders also desire that the firm take on more risks than shareholders, since the gains in option price of an upside surprise are far greater than the losses caused by a downside surprise. If the payment of dividends were not tax-disadvantaged, I believe option grants would become a less popular form of compensation and would be replaced by either cash compensation or stock grants. The gains and losses realized in stock grants are identical to those of shareholders and help align the interests of management and investors. Summary In summary, corporate governance would be improved if this legislation is enacted. Investors would be better equipped to make investment decisions based on true profitability if firms were paying out more of their earnings as cash dividends. Firms’ capital structure would improve, and there would be better aligned incentives in compensation packages for management. While I think deducting dividend payments from corporate income best achieves these goals, the legislation we are discussing here today makes great strides towards the same ends.
Ms. Elizabeth Bull
Testimony of Elizabeth W. Bull Treasurer and Vice President, Texas Instruments Incorporated Before the Consumer Affairs and Product Safety Subommittee of the Senate Commerce, Science and Transportation Committee April 8, 2003 Mr. Chairman and Members of the Committee: Thank you for extending an invitation to Texas Instruments to address the President’s economic growth proposals and soliciting our ideas on growing the economy. The centerpiece of the President’s proposal is the elimination of double taxation on dividends and we strongly support that idea. We believe that ending this tax will promote consumer spending. More importantly, it will stimulate business investment by companies as well as personal investment by individuals, and ultimately, it will serve to encourage good corporate governance and accountability. Why better corporate governance? The plan will create more transparency, make corporate earnings easier to monitor, and place equity financing on more equal footing with debt financing. In doing so, it will reduce the opportunity for poorly managed companies to mislead their investors. Although the high tech industry in general has not traditionally paid dividends, Texas Instruments has issued quarterly dividends since 1962. Our goal has always been to create value for our shareholders. Paying a dividend requires financial discipline and accountability. We believe it sends a message to our shareholders about our financial health and the credibility and sustainability of our earnings. The deemed dividend provision of the President’s plan means that the plan does not favor only companies that pay dividends. In fact, it benefits almost any company that is consistently profitable and pays taxes. And, although it does not specifically penalize companies that choose not to pay a dividend, it forces those companies to make a better case to shareholders that any money not paid in dividends will be invested wisely within the company. It shines a strong light on corporate financial management and accountability. This is critical for many start-up and high tech companies where significant capital must be invested in R&D and plant and equipment. Indeed, dividends help investors keep track of companies in a way that was not generally appreciated or understood during the dot com boom and collapse. Corporations have routinely been permitted to hold onto their earnings because of the widely acknowledged inefficiency of dividends, due to double taxation. However, stockholders who cannot realize value through dividends must depend on continued stock price appreciation for their investment to grow. This increased pressure on the stock price has, in some cases, apparently led companies to engage in creative financial engineering and inappropriate managing of their earnings in order to manipulate the stock price. If this wasn’t bad enough, the double taxation of dividends creates a bias toward debt on the part of companies and their shareholders. Simply put, the repayment of debt financing is taxed only once (to the payee) while the repayment of equity financing, the dividend, is taxable to the corporation as well as the shareholder. The President’s plan will even the playing field between debt and equity financing, remove the bias, and ultimately result in lower levels of corporate debt. Companies with lighter debt burdens are better able to survive economic downturns. Under this proposal, companies will need to pay more attention to cash, how to manage it and how to invest it. Making companies better and more efficient at managing their money will have profound long-term benefits that will transcend any short-term economic or stock market boost. Ending double taxation on dividends will ultimately lead to a restoration of confidence in American companies and that, I believe, will lead directly to economic growth. Market forces should be allowed to govern a company’s decision about dividends rather than a law which, at the moment, clearly discourages them. If I have a key message for you today, this is it: the capitalist system is based on financial incentives. The Administration’s proposal to eliminate disincentives for dividends and wealth-creation and to embrace incentives which promote those objectives is right on target. Ultimately, this will transform behaviors for both companies and investors. This plan also would promote better debt-equity ratios. In fact, we can go beyond predictions and actually have some data points. A recent Money magazine article reported that when New Zealand repealed its dividend tax in 1988, debt-to-equity levels at 92 representative companies fell an average of 15%. If we could achieve that in this country, it would have tremendous positive consequences for equity markets. Likewise, when Australia repealed its dividend tax in 1987, the use of dividend-reinvestment plans – or DRIPs – grew from 2.5% of corporate capital raised to an almost unbelievable 33% within five years. This proposal will powerfully change investor behavior. With consumer spending accounting for two-thirds of U.S. Gross Domestic Product (GDP), it makes good sense to provide consumers with more purchasing power. Reducing their tax burden achieves this objective while also providing greater opportunity to make further investments. Likewise, robust business investment will drive economic recovery and job creation. Ending the double taxation of retained earnings and dividends will be a genuine incentive. I would be happy to take any questions. Thank you very much for this opportunity.
Mr. Charles Elson
U.S. Senate Testimony Corporate Governance and President Bush’s Corporate Dividend Tax Relief Plan April 8, 2003 Charles M. Elson Edgar S. Woolard Jr., Chair in Corporate Governance & Director, John L. Weinberg Center for Corporate Governance University of Delaware Traditionally, the tax on dividends with its resulting “double taxation” of corporate profits has been virtually universally considered an anomaly in the corporate law arena that created a distinctive bias against the use of the dividend as a way to distribute corporate earnings to shareholders. The present proposal to eliminate the dividend tax will certainly resolve this anomaly and eliminate the taxation barrier to dividend declarations. However, more importantly, the proposal has tremendous positive implications for corporate governance reform in this country and may act to create greater managerial accountability to shareholders and lessen the likelihood of the kinds of earnings manipulation that led to the numerous corporate failures of the past few years. By removing a critical, and some would argue artificial, barrier to dividend usage, this proposal will result in increased distribution of corporate earnings to shareholders in the form of dividends and collaterally create at least five differing, but significant improvements to US corporate governance and the protection and expansion of investor capital. 1. Dividends, which require regular tangible cash outlays by the corporation, create the necessity to generate tangible returns by a company, reducing corporate management’s ability and incentive to create fictitious earnings and returns based on the manipulation of accounting standards or outright fraud. 2. The financial discipline within the organization that regular cash distributions to shareholders requires will aid in the creation of a greater culture of managerial accountability to shareholder interests which will spur greater corporate productivity and real profitability. 3. Regular cash dividend payments, by reducing the now dominant retention of earnings by most companies, will remove the temptation presented by large cash positions to management in mature businesses to misspend capital in poorly conceived projects or simply expropriate those earnings in the form of exorbitant salaries. The capital that will be returned to the investors will find its way back into the investment pool and be directed to more meaningful and productive means. Investors have traditionally shown greater wisdom than most managers in the efficient deployment of capital. 4. Use of the dividend to distribute corporate earnings would dramatically change executive compensation structure and practice in the United States. The use of option-based compensation would decline significantly as the incentive for its usage by management would effectively disappear. Compensation would shift away from stock options, which have provided the incentive for earnings management and other forms of nefarious activity, towards restricted stock which most in the corporate governance community believe to be a better shareholder alignment tool and more effective incentive for prudent and productive management. 5. Through the regular cash distribution of corporate earnings, investors would gain greater liquidity in their investments and not be forced to sell their holdings as regularly to access their capital. Longer term investment would result. Additionally, if the sale of stock is the only way to access the return on one’s investment as under the current regime, one is dependent on the accuracy of the stock price to ensure an appropriate return. Unfortunately, stock price is affected by numerous factors, sometimes unrelated to a company’s performance, making the sale of stock a sometimes imperfect way of return on capital. A greater reliance on the dividend as a way to access return on investment would mitigate this problem. In summary, the corporate governance and investor protective aspects of the dividend tax repeal proposal are powerful and compelling reasons for its enactment. Its positive impact on the investing public far outweighs any short-term revenue consequences it may provide and will lead only to greater investment returns and greater consequent tax revenue in the future as corporate productivity and accountability are strengthened.
Mr. John Rowe
Testimony of John W. Rowe Chairman and Chief Executive Officer Exelon Corporation Before the Committee on Commerce, Science, and Transportation Subcommittee on Consumer Affairs and Product Safety United States Senate April 8, 2003 Chairman Fitzgerald, Members of the Subcommittee: I am John Rowe, Chairman and Chief Executive Officer of Exelon Corporation, a Chicago-based utility holding company. Our two utilities, Commonwealth Edison (ComEd) and PECO Energy, serve over 5.1 million customers in Northern Illinois and Southeastern Pennsylvania, respectively. Exelon also has one of the nation’s largest generation portfolios, owning or controlling the output from over 40,000 megawatts of electric capacity. Exelon’s Power Team affiliate markets the power from this generation in the 48 Continental United States and Canada. It is a pleasure to appear before you today to discuss promoting corporate responsibility through the elimination of dividend taxation at the shareholder level. Exelon’s Dividend Philosophy At Exelon, our core mission is “keeping the lights on” for our 5.1 million customers. At the same time, our Board of Directors has a fiduciary responsibility to grow the value of the company for our shareholders. In determining how to optimize the investment for our shareholders, we must balance our desire for long-term growth in the terms of appreciation of the stock price with the desire of some investors for a shorter-term return through dividend income. When Exelon was created in 2000 from the merger of Unicom, ComEd’s parent company, and PECO Energy, the Board of Directors made a decision to focus on total return to shareholders. Exelon’s dividend rate for 2002 represented about a 50 percent payout of the expected 2002 earnings per share from Exelon's regulated electricity delivery businesses. The Board has stated in regulatory filings that Exelon intends to grow the dividend to about a 60 percent payout of earnings from regulated operations based on cash flow and earnings growth prospects for Energy Delivery. Earlier this year, we stated in regulatory filings that Exelon intends to grow its dividend over time at a rate of approximately 4 to 5 percent, commensurate with long-term earnings growth. While specific demographic data for Exelon Corporation shareholders is not available, 70 percent of individual utility shareholders are 65 or older, and that the typical utility shareholder lives on a fixed income and has held stock for more than 9 years, according to recent surveys by the American Gas Association and the Edison Electric Institute. This shareholder profile is not surprising, since utilities have been viewed historically an attractive investment for investors interested in a stock with stable growth and a track record of issuing predictable dividends. As the industry has undergone deregulation over the last decade, that image has changed somewhat, with many companies focusing more on growth and less on issuing high levels of dividends. This change occurred not only as a result of the changes in our industry, but also as a result of the changing expectations of investors and the need for utilities to compete for capital with other industries which offered high-growth stocks but little return in the form of dividends. Utilities have responded to these changing dynamics in a variety of ways: some utilities – mostly in states that did not fully deregulate their retail electric markets – have continued to provide relatively high levels of dividend income; other utilities have cut their dividend and invested their retained earnings in a variety of businesses; others – like Exelon – have taken a hybrid approach, pursuing unregulated business lines as a means of growth, while relying on regulated business units to provide a steady stream of income for dividends. Our strategy for achieving the optimum balance for our shareholders was challenged during the late 1990s by individual investors and the investment community as a result of the tremendous run-up in the stock market. A handful of energy companies focused on aggressively pursuing growth in energy trading and non-core businesses as a means of driving up the price of their stock. While this strategy resulted in some truly spectacular results for some companies, the results were short-lived, and some of those same companies are currently in the midst of bankruptcy proceedings. Meanwhile, Exelon’s strategy has yielded impressive results that have been recognized by leading industry observers. Last month, Business Week named Exelon the best performing utility/energy services company for the second straight year. Exelon was also among the top 50 S&P Index companies for the second straight year in the Business Week survey, which rated companies based on growth in sales, profits and return to shareholders, performance over both one and three years, profit margins, and return on equity. Exelon was also recognized this year by Forbes, which named Exelon “Best in Breed” among energy companies. Promoting Corporate Responsibility Through Elimination of the Dividend Tax President Bush’s proposal to eliminate the taxation of dividends would provide significant direct and indirect benefits to the nation’s economy. The Council of Economic Advisors has estimated that eliminating the taxation of dividends would pump $52 billion into the economy annually. The President’s dividend proposal will not simply benefit the wealthy. Elimination of the dividend tax will benefit Americans from all walks of life. More Americans than ever – 84 million people representing over 50 percent of American households – own shares in public companies. According to Internal Revenue Service data, over 15 million individuals who claimed under $50,000 in income in 2000 received over $27.2 billion in dividends. In addition to the financial benefits, elimination of the dividend tax would have significant long-term economic benefits. Chief among these is the promotion of corporate responsibility, which will benefit investors – and all Americans – in a number of ways. First, eliminating the dividend tax would help restore investor confidence in the volatile stock market and promote corporate responsibility by strengthening the degree to which dividends are viewed as an indicator of a company’s financial health. Under the President’s proposal, the dividends would be exempt from taxation only to the extent that the company’s earnings have already been taxed. Dividend payment has long been an indicator of a company’s long-term stability. According to the Wall Street Journal, the price of dividend-paying stocks in the Standard & Poors 500 index fell 17 percent during first 9 months of 2002, while the price of non-dividend-paying stocks fell 39 percent. The President’s proposal will make dividend payment an even stronger indicator of financial health and will promote corporate responsibility by making companies declare the extent to which their dividends are paid from taxable earnings. Second, eliminating the double taxation of dividends will eliminate the current bias in favor of retained earnings and will require corporations to be more diligent in evaluating investments made with retained earnings. Under current law, many investors prefer growth stocks to dividend-producing stocks since capital gains are generally taxed at a lower rate than dividends, which are treated as ordinary income. Most economists expect corporations to reduce the amount of retained earnings because this bias will be eliminated. Since companies will have less excess cash on hand, companies will have to be more selective when investing that cash in new projects. For projects requiring financing beyond that available from a company’s retained earnings, the market will impose its own rigorous review of the venture, providing an added layer of scrutiny. In effect, the bias is favor of retained earnings is also a bias against companies that pay dividends, since many investors prefer companies that retain a higher portion of their earnings. This has significant implications for electric and gas utilities, which are facing the prospect of raising hundreds of billions of dollars for infrastructure investment in the next decade. It is important to note that the President’s proposal also includes provisions to prevent the current bias against dividends from becoming a bias in favor of dividend distribution. Specifically, the proposal allows for the adjustment of a shareholder’s stock basis to reflect retained earnings to the extent they have already been taxed. This provision ensures that the tax code is neutral in terms of dividends and retained earnings, allowing investment decisions to be guided by sound business principles rather than tax policy. It is essential that this provision be included in any legislation implementing the President’s proposal. Finally, since corporations must have taxable earnings for dividends to be tax-free, eliminating the taxation of dividends will decrease incentives for companies to engage in transactions whose only purpose is to minimize tax liability. This will shift the focus of both companies and investors to a corporation’s cash earnings, rather than book earnings. Why is this important? Since dividends can only be paid on a tax-free basis from cash, the payment of dividends will provide investors with valuable insights into the financial health of the company. While companies can engage in various transactions to inflate book earnings, the ability to artificially inflate cash earnings is limited. Since dividend payments cannot continue without adequate cash earnings, investors will be better able to determine the true financial health of a corporation. The President’s proposal could help avert future tax shelter crises such as the one that is the subject of the Senate Finance Committee’s hearing on Enron this morning. The Joint Committee on Taxation’s “Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues” consists of three volumes totaling nearly 2,700 pages. Among the findings was the fact that while Enron reported $2.3 billion in net earning from 1996 to 1999, the company reported tax losses of $3 billion during those years. During this same period, Enron paid out over $1.5 billion in dividends. Under the President’s proposal, none of these dividends would have been tax-free. Clearly, this would have set off alarm bells for investors. Conclusion Mr. Chairman, I realize that Congress has a number of competing budget priorities, and that some members view tax cuts to be undesirable at this time. Nevertheless, the elimination of dividends will have significant benefits in both the short-term and the long-term. One of the lessons of the last three years is that companies who put growth ahead of value ended up not getting either. The President’s proposal will encourage companies to be more responsible by focusing on activities that result in value, not merely growth. I strongly urge members of the subcommittee to support it. Thank you.