Though the news about the huge Microsoft dividend appeared several weeks ago while I was away, there’s still time, I hope, to share some observations that I haven’t seen in any of the material that passed through my email, listservs, and news subscriptions. Microsoft’s announcement of a $32 billion dividend, the largest ever, got attention.
Some folks focused on the inevitability of a huge dividend from a corporation that had accumulated huge amounts of cash. Others pointed out that the dividend creates an incentive for foreign owners of Microsoft stock to sell their stock, to avoid a 30% withholding tax on dividends paid to residents of countries other than those that have tax treaties with the U.S. providing for a lower rate (usually 15%).
The announcement also brought speculation about the impact of the presidential campaign. If John Kerry is elected and manages to abolish the special low tax rate for dividend income (something that is far from certain even if he does win), corporate officers and directors that waited until 2005 to cause increased dividend payouts to be made will face adverse shareholder reaction.
No one has said much about the accumulated earnings tax. Generally treated as meaningless by most commentators because almost every corporation can get into the “accumulated to meet the reasonable needs of the business” exception, it surely must come into play under these circumstances. Though it is possible that Microsoft has figured out ways to make its taxable income less than its cash flow, it surely has not reduced it to the point where there are no or little accumulated earnings in the company. Now, the declaration of this dividend is PROOF that the accumulation were not for the reasonable needs of the business because Microsoft is saying, in effect, that the business didn’t need the earnings. It will be interesting to see if the IRS picks up on this (especially if no one there reads this blog). Perhaps it will be more successful than was the Department of Justice.
Accumulated earnings taxes aside, the Microsoft dividend, and its taxation at low rates, highlights some of the failings of present-day corporate business culture. Let’s try this scenario:
A company invents an operating system unlike anything ever seen. It is almost perfect. It rarely crashes. It is secure against hacking, worms, and other intrusions. It is fast. It is easy to use. The company advertises this operating system, users speak of it highly, sales skyrocket, and the industry begins to suggest that the company branch into applications software. The company brings its expertise to bear on word processing, databases, spreadsheets, email, networking, and a long list of other applications. The programs are a hit. Competitors simply cannot deliver similar quality. Company revenues soar. The applications and the operating system are sold for a fair amount representing value. The company eventually pays out a huge dividend to its shareholders, who are taxed at low rates. After all, the company’s products energized the economy.
If that were the story, perhaps there would be some sympathy for the temporary stashing of cash in the company as it pondered other areas of technology in which it could make a similar high quality contribution, making talk of an accumulated earnings tax a bit silly. And if that were the story, perhaps there would be an array of arguments advanced to support the idea of taxing dividends at rates lower than other income.
Of course, that is not the story. Even if it were, we know that no one, back in the 80s, would have banked on dividends being taxed at absurdly low rates in the 2000s. Not only could no one have counted on such a thing, it would have been risky even to predict it other than as something in the “anything can happen” category of items ignored as silly.
No, the story goes as follows. A company takes an existing operating system and rushes it to market in order to get an advantage over another enterprise also fashioning a new operating system from the existing operating system. The company’s operating system is a kludge. It crashes incessantly. It is insecure. Later versions, spawned almost yearly if one counts service pack upgrades as new versions, add all sorts of needless complexity while opening up even more security holes. The systems are slow, and users complain. Attempts by users or other businesses to bring other operating systems to market are met with obstructions, some legal and some on or past the borderline. Manufacturers are arm-twisted into accepting the operating system because the company knows most end users lack the ability to replace it. Free copies are given to schools in the same manner as the soft drink sugar merchants put discounted vending machines in the school, both having learned lessons from the guy down the street from the school just past the “Drug-Free Zone Starts Here” sign. The company, bored with fixing the operating system, jumps into developing applications to compete with any other venture that manages to bring out something useful. The perfect word processing program is pushed aside with a lesser-quality pale imitation that is filled with security holes, a mind-boggling concept. Someone invents a great web browser and a campaign to drive it into oblivion succeeds even though the replacement is buggy and needs upgrade and revision almost every month. Someone else develops instant messaging and the company is on their backs the minute it seems there is money to be made. Others develop web search engine technology that works marvelously and the company announces it’s going into that area as well. In the meantime, its latest operating system, rid of some of the earlier flaws, generously advances new defects that defy explanation and that are passed off by the company as the fault of the users or others. As the money flows in from what clearly is a compelled monopoly, the efforts of the federal government and most of the state governments to bring the company into compliance with antitrust laws is thwarted.
Now, awash in cash from having shoved its less than adequate products into most of the nation’s homes and businesses, and a good portion of those elsewhere in the world, the company decides to funnel a huge amount of the cash to its shareholders. Yes, that’s us, if we own Microsoft stock (I don’t) or are in retirement plans that own the stock. But is that what we really want?
There are two things that Microsoft SHOULD do with its cash. Both rest on the principle that until a job is finished, and finished correctly, the anticipated profits ought not be spent.
First, all users of Microsoft products should be compensated for the time, distress, and lost profits caused by the numerous crashes, virus and other invasions, sluggish performance, and other damage generated by the flaws in Microsoft products over the years. I’m picking on Microsoft because it is awash in cash that reflects the burdens and costs it surreptitiously shifted to the consumer. Other companies do the same thing but they’re not awash in cash because if they didn’t shift costs to the consumers in terms of bad products, poor service, incompetent help line employees and other failings, they’d be out of business. Microsoft, it will claim, simply learned the lesson taught by the developers who made and make money building projects that leave infrastructure burdens in the form of traffic, congestion, demand for fire and police services and other costs on the taxpayers of the region. With all the economists in this country, you’d think somehow they’d get the point across that hidden and shifted costs ought to be taken into account. More, in a moment, on how.
Second, Microsoft should take this cash, for which it appears to have no use, and plow it into a total and complete redesign of its operating system. Microsoft claims it doesn’t do that because it would cost too much. Well, guess what? Microsoft has the wherewithal to pay those costs.
Before getting to the how, one more facet of this prism needs examination. Bill Gates announced that his $3 billion dividend (subject to $600 million less tax than it would have been in the absence of the “dividends are really special” low tax rate) will be contributed to the Bill and Melinda Gates Foundation, which already is the largest charitable foundation in the world. Sounds nice? Well, let’s face it. When foundations give money, they can attach conditions. Foundations CONTROL the use of their money. So while we hear about elections and voting, we don’t hear much about how corporations and their foundations are shaping policy and decisions while the Congress wanders aimlessly searching for ways to deal with the EU tax crisis, homeland security, intelligence oversight and many other serious issues.
The tax law, of course, exempts the foundations from tax if they jump through certain hoops. A tax-free institution, therefore, has even more economic muscle when it’s not Alex’s Lemonade Stand trying to eke by on the generosity of individuals, but is simply an extension of someone who has a lot of wealth acquired not through the free marketplace rewarding high quality products but gathered through intimidation, questionable business practices, and corporate behavior still being investigated by some brave state attorneys general.
The tax law has failed us. Not only has it prompted Microsoft to move its profits into charitable foundations and to shareholders taxed at rates more appropriate for the working poor, it has also failed to penalize Microsoft for having accumulated these profits in the manner in which it did. It also lacks any mechanism to reward quality and tax that which hurts society. If there can be taxes on environmental polluters, why not taxes on technological destroyers? Why not a system that records every Microsoft operating system crash, every security hole opportunity used by a hacker, and every productivity slow-down caused by bad programming, followed by a user fee imposed on Microsoft for the outrage of high priced products that deliver far less reliability than the $29 genealogy program or $19 html editor (which, by the way, is far superior to the junk churned out converting a Word document to html)?
Here’s why not. The typical person does not understand computers and think crashes are as normal as are automobile accidents (even though both are preventable and need not be accepted as unavoidable). Most people know little or nothing about programming, and thus are in no position to judge the defenses raised by those whose programming falls short because the dollar is considered more important than any other value. Most people know little or nothing about the tax law, how it affects dividend payment decisions, or how it is used to regulate (or not regulate) charitable foundations. So they don't know what to demand of their elected representatives (who themselves struggle to understand what's really going on), and thus suffer because "that's the way it is" and "what are you going to do?"
I have a nephew who is a certified Microsoft network engineer. He defends Microsoft with the same vigor with which I criticize it. He argues that Microsoft is doing a better job than anyone else. I respond that no one else is given much of a chance to do the job, and when they do find a niche and make it successful, Microsoft moves in quickly and rapaciously. Our debates could be endless, except that we’ve given up trying to change each others’ minds. I am resigned to the notion that someday Microsoft will pay yet another huge dividend, say, $50 billion, because it has accumulated yet another hoard of cash, from selling and monopolizing the sale not only of operating systems, word processing applications, networking software, email clients, and internet searches, but also robotics software, music downloads, cable television services, cell phone services, computer hardware, homeland security software, defense department databases, RFIDs, highway toll collection systems, GPS navigation services, and just about every other digital product or service on the market. Considering the extent to which technology has penetrated and will dictate even more decisions in education, health care, safety, entertainment, transportation, and manufacturing, it may be time to start collecting corporate logos for the collectors’ items they are bound to become.
And I will always wonder what the world would have been like had Microsoft waited to market its products until the products were essentially as fault-free as intensive cardiac care software systems. I wonder what would have been the impact on society, politics, and life had the increased productivity, the hack-free databases, the increased speed in delivery of goods and services, and the other benefits that should come from paying top dollar for software, been delivered. At least a $32 billion dividend would have been seen in the same light as a similar payout to the folks who cured cancer or developed an earthquake preclusion system.
