There's a Triple Tax Increase in Your Future

July 5, 2012

The so-called Bush tax cuts are set to expire at the end of the year. That means that all of the current income tax rates will rise to pre-2001 levels overnight: the lowest rate will jump from 10 percent to 15 percent and the highest from 35 percent to 39.6 percent. Moreover, rhetoric from Congress suggests that Democrats will settle for nothing less than an expiration of those provisions benefitting the rich, says Merrill Matthews, a resident scholar with the Institute for Policy Innovation.

One of the implications of this policy change that receives less attention than it should is the effect of these taxes on capital gains and dividend payouts. Effectively, the expiration of the Bush tax cuts will triple the taxes on these forms of income overnight.

  • As a result of the Bush tax cuts, capital gains and dividends are taxed at a flat rate of 15 percent.
  • When the cuts expire, however, these forms of income will be taxed as if they are regular income, meaning that gains for the wealthy will be taxed at a rate of 39.6 percent.
  • Also, the health care law imposes a new 3.8 percent tax on passive income, including dividends and interest.
  • So the effective dividend tax rate for those at the upper end of the income scale would nearly triple, to 43.4 percent.

Democrats and the president justify this change in tax policy by arguing that it will only affect the wealthy, who are capable of giving more to government coffers. However, basic economic analysis allows us to see that many more parties than the wealthy will be harmed by this tax hike.

  • A study by the accounting firm Ernst & Young found that the United States currently has the fourth-highest integrated dividend tax rate among the 34 Organization for Economic Cooperation and Development nations.
  • Higher dividend taxes will make stocks that pay dividends less attractive to investors.
  • So those who currently hold dividend-paying stocks -- everyone from middle-class folks with 401(k)s to union pension funds to non-profit foundations -- would see the value of their investments decline substantially.
  • Hiking taxes on dividends would also be disastrous for retirees: according to the IRS, more than half of dividend payments go to Americans over age 65.

Source: Merrill Matthews, "There's a Triple Tax Increase in Your Future," Investor's Business Daily, June 19, 2012.

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