WASHINGTON (AFP) - President George W. Bush's proposal to scrap taxes on dividends is a potential boon to Wall Street, but could also reshape the investment landscape, possibly hurting the bond market and other vehicles, analysts say.
The elimination of taxes on dividends paid to investors is the centerpiece of Bush's 674 billion dollar economic stimulus proposal, and the most expensive element, costing an estimated 364 billion dollars over 10 years.
Administration officials said that doing away with such taxes would reduce the cost of capital and be especially beneficial to senior citizens. White House Council of Economic Advisors chairman Glenn Hubbard said plan could boost the stock market by seven to 10 percent.
Abby Joseph Cohen of Goldman Sachs acknowledged that such a move "should boost equity valuations" but said there are many unknown effects on the investment landscape.
"The proposed change in dividend taxes cannot be viewed independently. Indeed, further increases in the federal budget deficit, should they result, might tend to boost interest rates, hurting equity valuation through the discount rate," she noted.
"Some may also argue the proposed federal policy stimulus package could be offset by higher taxes likely to be imposed by state and local governments."
The move could make tax-free municipal bonds less attractive, forcing higher interest rates, and hurt other types of bonds and real estate investment trusts.
Hank Gutman, former chief of staff of Congress' Joint Committee on Taxation, said pressing companies to pay out more dividends could be detriment to product research and development.
"In the past, business has not been terribly in favor of (dividend paying) because they view it as pressure to distribute earnings that they want to retain for investing," Gutman said.
First Albany chief investment strategist Hugh Johnson said the prospect of the abolishing dividend taxes had been anticipated by investors for weeks, lifting the utilities, telecoms and basic materials sectors while capital has flowed out of municipal bonds and other instruments.
"I hate to tell you, but a good deal of the seven to 10 percent increase already has taken place and I'm not sure how long it will last," he said.
Johnson said he believes the asset shifts are likely to be short-lived because he doubts that Congress will pass the entire package.
Brookings Institution senior fellow Bill Frenzel said it is hard to gauge the impact of the possible change on the stock market, given the mercurial nature of the market.
"I don't disagree with (Hubbard's) conclusions, but the market has made a long and, successful life of fooling me," Frenzel said.
Bank One chief economist Diane Swonk expressed concern that, if passed, the plan might create an unwise preference among investors for companies with high dividends, calling dividends "a weird animal."
"In a sense when a company gives you back money in the form of a high dividend, they are telling you they don't have any better ideas about what to do with their money," Swonk said. "Are those always the companies we want to reward?"
The Bush plan has been sharply criticized by Democratic members of Congress from California's Silicon Valley, where many local technology companies do not pay dividends and have been hard-hit by the economic downturn.
On the other hand, analysts said passage of the plan could inspire major shifts in the fiscal priorities of high-technology and other corporations and might prompt some cash-rich technology companies to begin paying dividends.
For instance, Oracle announced that it would consider paying a dividend if the plan is passed in its current form.
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