President Bush’s proposal to eliminate dividend taxation for investors as part of his sweeping economic stimulus package unveiled last Tuesday is expected to have significant benefits for the energy industry, notably natural gas and electric utilities, said energy analysts and industry groups.

Under the current system, individual investors who receive stock dividends are taxed on the proceeds at whatever their income tax bracket is, while corporations pay a 35% tax when issuing their dividends. The Bush proposal would end this system of double dividend taxation, providing relief to individual investors.

The administration is calling for $674 billion in tax cuts over a 10-year period, with $364 billion to be earmarked for ending the dividend tax on individual investors. An estimated $20 billion is expected to be spent on eliminating the tax in the first 16 months.

This action will provide “financial relief” to senior citizens over the age of 65, many of whom own stock in gas utility companies, said the American Gas Association (AGA), which represents gas distribution utilities. “Dividends have always attracted these investors to energy utilities delivering natural gas, as nearly every investor-owned utility member of AGA pays regular dividends, and many have done so for over 50 years,” the group noted.

In addition to benefiting existing investors, the AGA believes the Bush plan will attract new investors to dividend-paying companies such as gas utilities, which it says would reduce the cost of raising capital for utilities to build needed new distribution infrastructure. “Natural gas utilities must invest $100 billion over the next 20 years to help build the 255,000 miles of distribution pipeline infrastructure necessary to meet growing consumer demand for natural gas.”

Merrill Lynch analyst Steven Fleishman warned, however, “the tax change is not a done deal and it remains very possible that the tax reduction could end up being short of full elimination.” Before the tax package was issued there had been reports that dividend taxes would only be cut to the level of capital gains tax rates. If the tax on dividends is completely eliminated, Fleishman said, after-tax yields for persons in the highest (38%) tax bracket would rise by 1.7 percentage points. That would be on top of the 4.5% he estimates as the average dividend currently paid by utilities.

But Williams Capital analysts, Christopher Ellinghaus and Ida Fiumefreddo, called the Bush proposal “terrific news for income investors and utility investors,” and added it was “just what the doctor ordered for the utility sector.”

UBS Warburg analysts, led by Ronald Barone, also said they see the proposed dividend taxation changes as a “positive catalyst” for the energy utility group. However, given the lackluster market and credit uncertainty, “we continue to have a cautious stance on overall natural gas and electricity utility underlying fundamentals, with our top picks including: Equitable Resources, Dominion Resources, Entergy Corp. and Kinder Morgan Inc.”

The administration’s proposal is good news for energy companies that have had a “good track record of paying dividends,” agreed Martin Edwards, vice president of legislative affairs for the Interstate Natural Gas Association of America (INGAA).

Given the president’s desire to “get his economic stimulus plan done quickly” and through Congress, Edwards said he doubted that any attempt by industry groups or companies to get energy issues attached to the initiative would succeed on Capitol Hill. “It’s difficult to put energy issues on the fast track.”

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