Senate Lawmakers Debate Dividend Taxes

House and Senate tax writers rejected a complete elimination of taxes on stock dividends (search) — the centerpiece of the president's recipe for economic growth — in favor of less ambitious plans.

A Senate agreement to give stockholders at least $500 in tax-free dividends won the support of GOP moderates worried about growing deficits, improving the prospects for a scaled-back version of the president's tax cut. Conservatives said they will try to enlarge the dividend tax cut during later debate.

The Senate Finance Committee (search) on Thursday debated the legislation, which also includes $20 billion in aid to fiscally strapped states.

Chairman Charles Grassley, R-Iowa, cautioned lawmakers not to concentrate on "who gets what," but instead on the tax cut's ability to create jobs and expand the economy.

Sen. Max Baucus, D-Mont., said the dividend component skews the benefits to wealthier taxpayers. "All should benefit, not just a special elite," he said.

The plan to cut taxes $350 billion through the coming decade faces dozens of amendments emphasizing Democratic priorities, such as unemployment benefits.

But the bill now enjoys the support of moderates on the committee after Chairman Charles Grassley, R-Iowa, included $20 billion in state aid and agreed to rewrite the largest and most debated proposal the president offered — a $400 billion plan to eliminate taxes on dividends.

"The agreement seems to be what I've been hoping for — a robust tax cut that gives the economy a needed shot in the arm without shooting the deficit in the foot," said Sen. George Voinovich, R-Ohio.

Adopting an idea put forward by moderate Republican Olympia Snowe of Maine, who refused to support earlier versions of the bill, Grassley agreed to exclude $500 in dividend income from taxes. That will eliminate dividend taxes for 86 percent of corporate shareholders.

To retain support of conservatives who opposed that approach, taxpayers with more than $500 in dividend income get an extra portion tax-free. For about five years, 10 percent of additional dividend income will be tax-free. For the following five years, 20 percent of dividend income will be free of taxation.

The legislation will offset the cost of the dividend tax cut, more than $80 billion over a decade, with increased revenue, including money from closing corporate tax shelters and extending customs fees.

"We've designed a limited dividend proposal, which will establish the basis for long-term economic growth, paid for with legitimate offsets," Snowe said.

The rest of the bill will increase the $600 child tax credit (search) to $1,000 and reduce taxes for married couples. Small businesses would be able to write off $75,000 in expenses. All the tax cuts continue through 2013.

The bill would cut taxes by more than $430 billion, but the net cost to the Treasury would be $350 billion.

House tax writers also decided to speed up income tax rate cuts planned for later this year. But other benefits, including the $1,000 child tax credit and tax cuts for married couples, end in three years to keep the cost of the legislation within a $550 billion budget.

The single largest portion of the House bill lowers the top tax rate for stock dividends to 15 percent from 38.6 percent. It treats dividends like capital gains and lowers the tax rate for both.

The House plans to debate its legislation Friday.