Dear Mr. Berko:

I think the president’s proposal to eliminate the tax on dividends is a great idea. It makes sense to me even though I only earn about $200 in dividends each year. It seems that this proposal has created a fight in Washington and many people are getting vocal and even physical about it.

Would you please unemotionally explain the pros and cons of this proposal without favoring either side of the argument? What do you think the chances are for this law to pass?

V.R., Johnson City, Tenn.

Dear V.R.:

Certainly, the most controversial proposal within the president’s new tax plan is to make stock dividends 100 percent tax-free for investors. But this is not a new idea.

I recall way back in December 1992, just a few weeks before the first Bush administration gave the Clintons the keys to the White House, that the Treasury Department made several bold suggestions to revamp the tax code. One of those recommendations was to exempt the payment of stock dividends from taxation.

This idea, which has gained a lot of political currency in the past few years (even Federal Reserve Chairman Alan Greenspan likes it), has been under bombardment. As certain as Satan is evil and satin is smooth, it will undergo major surgery in Congress. One rather blustery member of Congress told me: “This is an abomination, and the president is under the influence of evil guidance.” There are strong feelings on this subject, and both sides of the tax table are right.

For the tax year 2000, according to the port side of the table, there were 92.8 million people earning less than $50,000 who filed tax returns. Just about 17 percent of those people, or 15.6 million, received $27.2 billion in dividends, which comes to $1,742 per taxpayer. However, the remaining 77.2 million taxpayers did not receive a dime in dividend income and are not included in that average dividend income number.

But, there are 2.7 million taxpayers who earn more than $200,000 a year, and 89 percent of them, or 2.4 million out of 2.7 million filers, received dividends averaging $26,900 a year. Certainly most of us can understand why the port side of the table is so vehemently opposed to this proposal, arguing that it favors only the wealthy. Can you disagree?

Now the starboard side of the table tells us that taxes on profits are already paid at the corporate level, so taxing those distribution (dividends) amounts to double taxation. That makes sense. The starboard side also tells us that if dividends were not taxed, it would become much smarter to raise capital by issuing common stock rather than bonds.

Issuing bonds rather than equity to finance expansion lowers corporate taxes because the interest payments are deductible at the corporate level. It can easily be argued that the elimination of the personal dividend tax might promote a more efficient corporate financial structure, which would encourage increased corporate investments. That makes “cents” to me, too. Issuing bonds for expansion often inflates a company’s debt-to-equity ratio and can create instability in a down market. That makes good sense, too.

Both port and starboard are right as rain, and two rights don’t make a wrong. So what do we do when both sides are inarguably right?

Well, my Uncle Cosmo once told me that the best way to settle some arguments is to offer a solution that pleases neither party. That’s what Congress will do – compromise. The compromise that might emerge will allow investors to exclude up to a certain dollar amount of annual dividend income from tax liability.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or visit his Web site at www.berkoradio.com.