NCPA - National Center for Policy Analysis

Obama's Dividend Assault

February 27, 2012

President Obama's 2013 budget is the gift that keeps on giving -- to government.  One buried surprise is his proposal to triple the tax rate on corporate dividends, which is higher than in his previous budgets, says the Wall Street Journal.

  • Mr. Obama is proposing to raise the dividend tax rate to the higher personal income tax rate of 39.6 percent that will kick in next year.
  • Add in the planned phase-out of deductions and exemptions, and the rate hits 41 percent.
  • Then add the 3.8 percent investment tax surcharge in the Affordable Care Act, and the new dividend tax rate in 2013 would be 44.8 percent -- nearly three times today's 15 percent rate.

Keep in mind that dividends are paid to shareholders only after the corporation pays taxes on its profits.  So assuming a maximum 35 percent corporate tax rate and a 44.8 percent dividend tax, the total tax on corporate earnings passed through as dividends would be 64.1 percent.

The plan gives new meaning to the term collateral damage, because shareholders of all incomes will share the pain.  Here's why.

  • Historical experience indicates that corporate dividend payouts are highly sensitive to the dividend tax.
  • Dividends fell out of favor in the 1990s when the dividend tax rate was roughly twice the rate of capital gains.
  • When the rate fell to 15 percent on January 1, 2003, dividends reported on tax returns nearly doubled to $196 billion from $103 billion the year before the tax cut.
  • By 2006 dividend income had grown to nearly $337 billion, more than three times the pretax cut level.

An American Economic Association study examined dividend payouts by firms and concluded that "the tax reform played a significant role in the [2003 and 2004] increase in dividend payouts."  If you reverse the policy, you reverse the incentives.  The tripling of the dividend tax will have a dampening effect on these payments.

Who would get hurt?  IRS data show that retirees and near-retirees who depend on dividend income would be hit especially hard.  But all American shareholders would lose.  Higher dividend and capital gains taxes make stocks less valuable.

Source: "Obama's Dividend Assault," Wall Street Journal, February 23, 2012.

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