While many are applauding President Bush's $674 billion economic stimulus package, it is expected to have very little impact on the mutual fund industry, and some even think it could actually hurt certain areas of the market.

According to the White House, 35 million American households receive taxable dividend income that and will directly benefit under the proposed plan. And more than half of these dividends go to seniors, many of whom rely on a steady stream of dividend income.

Investors who receive dividends are, in effect, taxed twice. The IRS taxes a company on its profits, and then it taxes the investor who receives those profits as dividends. According to the White House, for every dividend dollar, as little as 40 cents actually reaches shareholders.

"Under the president's plan, company profits will still be taxed--but only once," reads a statement on the White House' Web site.

The Investment Company Institute immediately threw its support behind the plan. "The mutual fund industry supports the president's efforts to provide investor relief from double taxation and commends him for recognizing the important role investors play in revitalizing the economy," said Matthew Fink, ICI president, in a statement.

Fink also said the institute will work with the government to increase contribution limits for IRAs and employer-sponsored retirement plans, to press for "catch-up" provisions for those age 50 or older, and work to allow permanent tax-free treatment of qualified withdrawals from 529s.

"These significant provisions, if enacted, will directly benefit middle-income Americans," Fink said.

However, not everyone thinks this legislation will help the average fund investor. Grace W. Weinstein, author of JK Lasser's Winning With Your 401(k) and Complete Idiot's Guide to Tax-Free Investing, said that she doesn't expect the legislation to have much of an impact on the individual fund investor since most funds are in qualified plans.

Some also question the timing of the move. The theory is that the elimination of the double tax will stir demand for dividend-paying stocks, prompting more companies to offer them. Critics say that investors may now be looking for growth rather than dividends, since the worst may well be behind us.

The number of dividend-paying companies in the S&P 500 dropped from 96.7% in 1990 to 74.8% in 1999, according to Factset Data Systems of Greenwich, Conn. (see MFMN 4/3/00). Additionally, dividend rates are dwindling. The current dividend yield is 1.7%, less than one-third of the rate of the bear of 1982.

Furthermore, many in the real estate investment trusts (REIT) business fear that this specialized sector of the fund market - which pay generous dividends and are not subject to the double tax - will be put at a disadvantage by the president's relief plan.

By the same token, the insurance industry isn't happy with the plan, either, since it doesn't contain lifetime annuity payouts, which the industry has long campaigned for. In fact, the American Council of Life Insurers is considering lobbying once again to fully remove taxes on annuities, in light of the broad economic plan, according to an ACLI spokesman.

But many don't think the plan will pass as is. Corporate America currently has "a perverse incentive to add debt," according to Don Cassidy, senior analyst at Lipper of New York. "If you get a deduction for dividends paid, you probably issue more stock and less debt."

The big question right now is whether Bush will be able to sell Congress on "total repeal" of dividend taxes, considering the current deficit, Cassidy said. "It makes more sense at the corporate level, but it may be more popular if it were [eliminated] at the individual level."

"I suspect they may do some sort of a partial or block exemption so it doesn't help the rich too much, or phase it in," Cassidy continued. "As to the funds, it'll probably slightly help already-popular funds. If [the government] reduces the corporate tax, it encourages dividend payers to pay a little more because they have more money lying around. It's a more direct effect if it goes the way I think it will go"

However, Cassidy suspects that it will sway toward the individual side because it would "cost less and have a better political feel."

Tony Rosso, a partner in the tax department of Chicago-based law firm Chapman and Cutler, said that the proposal looks pretty simple at this point in time. "If you, as an individual, get a dividend, then you don't have to pay a tax on it, period. So it would seem relatively straightforward."

However, in effect, the proposed change is not so simple, he said. There needs to be clarification on a number of points in the legislation in order to tell what the real effect on the industry will be.

Rosso said that mutual funds are treated as regulated investment companies for tax purposes, in general. "I'm assuming they will deal with it in a pass-through sort of way," he said of the funds and dividends. In the end, it may well be a lot more complicated than it looks now.

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