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3 reasons to fear a dividend tax hike

President Obama has proposed raising the tax on capital gains and dividends from its current 15% rate to the same rates as earned income. Would it hurt more than help?

By MSN Money Partner Feb 28, 2012 8:32PM

This post is by Abram Brown of Forbes.com.

 

President Barack Obama's proposal to raise the tax on dividends should leave investors trembling. It has the ability to affect anyone with an interest in equities, from the executive in the corner suite to the grandmother who lives next door to you.

 

You pay 15% on dividends right now. Under Obama's plan, the wealthiest would see a personal tax rate of nearly 45%. And before a company gives a dividend, that money is taxed as corporate profit. Obama would like to lower the corporate tax rate to 28%.

 

So by the time the dividend reaches your bank account, it has been taxed twice.

 

The corporate-dividend tax hike is part of Obama's broader restructuring of America's corporate tax structure. As a whole, the plan would be a game changer for U.S. business. But the dividend tax increase is the plan's most striking element, since it's hard to identify whom it would help.

 

Here are three reasons to fear the Obama plan:

 

1. It could hamper the shelter behind dividend stocks.

 

A high-yield dividend stock can provide some comfort and stability in volatile times -- a period like the one we're in right now. (Post continues after video.)

If each new day brings a wild swing in the equity market, being able to count on a dividend can seem like a good way to take cover. Money managers can direct clients toward blue-chip companies with sizable dividend yields. Stalwart Coca-Cola just raised its dividend for the 50th straight year.

 

You don’t invest in these types of companies to make money through appreciation or trading, says Mark Lamkin, who manages $250 million at Lamkin Wealth Management. You pick these stocks for their security -- and their dividends. But if those dividends lose their value through higher taxes, these stocks lose their attraction.

 

2. It could increase market volatility.

To make up for what you lose in dividends, you'd probably start trading more. Greater volume can bring volatility. And don’t we have enough volatility as it stands?

 

It would also lead to some investors sitting out entirely, reducing the amount of available capital.

 

"As you increase tax on dividends, you discourage some amount of investment in stocks," says David Stowell, a former UBS managing director. "As you discourage investment in stock, there’s less money to fund companies to produce useful products, to employ people, and I think it really takes some money out of the economy. It certainly seems counterproductive to building a more robust economy."

 

3. It could hurt retirees the most.

 

Americans 65 and older accounted for 42% of dividend income reported to the Internal Revenue Service in 2008, the latest year available.

 

So when Obama suggests raising the tax rate on dividends, he's taking aim right at your retirement nest egg.

 

Your retirement portfolio probably has a lot of dividend stocks right now, because they're predictable. But with higher taxes, money managers would likely shift more toward growth companies and away from dividend-bearing stocks. This is all well and good until that growth stops, says David Armstrong, who manages $200 million at Monumental Wealth Management.

 

What would be likely to halt it? Well, if there was anything remotely like 2008 in the future, that would cause a pretty big jolt.

 

More from Forbes.com and MSN Money:

VIDEO ON MSN MONEY

41Comments
Apr 9, 2012 8:01AM
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Funny thing how the government can take NO risk at all but make a nice tidy profit on all the risk WE are taking, just by one stroke of this clown's pen saying we owe it to them. Sweet deal for sitting back and doing nothing!
Apr 9, 2012 9:53AM
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Yep, that's what we need in a bad economy, penalties on those that want to invest.
What we REALLY need is a government that spends less than it takes in and quits printing money like crazy.  $454,393,280,417.03 in payments on the INTEREST on the National debt for 2011.  How many programs, like healthcare, could be TOTALLY funded with that kind of money.  It is obscene, and the solution is to go after investors???


Apr 6, 2012 10:50PM
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Obama is like a pig - wants more , and more. He talks about the Republicans and the proposed budget plan as killing the seniors but his proposed tax rate increase will hurt the seniors and take away more from the seniors. Stop the lies and stop the out of control Government spending and taxes would not have to be adjusted- up.

Let the Federal Government employees and elected officials take a 20% pay cut immediately and pay part of the health insurance costs immediately. Maybe we could reduce some spending. All people must pay their fair share, Government Employees must sacrifice just like all ordinary working citizen. CUT WAGES AND BENEFITS AND ALL THE PERKS..

 

 

Apr 6, 2012 9:48PM
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another obumer idea gone bad

he needs to stop spending and start cutting and stop taxing us to death to pay for his bs ideas

Apr 6, 2012 10:17PM
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If he can't kill us with obamacare, he's going to starve us to death !!
Apr 7, 2012 2:02AM
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Here we go! Lower the corporate tax rate to the current effective rate after applying the "loopholes" and simplify the rules. Yes, a carrot for the corporations would help, but so would enforcement by the IRS when it comes to collecting any owed corporate taxes.

As for "interest" being taxed at a different rate as compared to "dividends", none of your investment principal in a bank account or certain interest bearing accounts is at risk. Contrast that to the fact that all of my investment in dividend bearing stocks or similar investment vehicles is at risk. I could loose part or all of my original investment. So, now tell me why my money that has already been taxed should have dividends taxed at a higher rate? Since I've already paid taxes on it, my dividend gains should not be taxed at all?
if my investment looses principal I don't think anyone is going to put their arm around my shoulder and say "it's alright, here's your money back from that poor investment" unless there was fraud proven by the SEC in a court of law. Remember Madoff? Not a lot of folks got their money back.

Exercise due diligence, and invest only in what you understand. LOWER the dividend tax rate now!
  
Apr 9, 2012 11:21AM
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Great idea Odumo.  Raise the tax on dividends so that seniors are discouraged from funding their own retirement.  Yeah, let everyone depend on social security and medicare for their future needs.  How in the hell do you plan on funding those programs, when the taxes the seniors already pay on dividends to fund those programs dries up under your brainstorm of an idea?  Remember, the problem with socialism is eventually you run out of other peoples money.  Raising the taxes on dividends will kill the economy and markets in more ways than one.  Go for it you jackwagon!
Feb 29, 2012 4:06AM
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Really, it seems as though every time BO wants to raise revenue he heads for the rich or seniors. No, it's not class warfare-----if it walks like a duck, wiggles like a duck, it must be a duck. Truth is, what BO does is so blatantly obvious the foolish part is trying to claim it isn't what it is? You can change the cover, but the book remains the same. BO is a socialist, was, is, and is going to be. His answer to all is government intervention. What did Reverend Jackson say----it's an honor to be the "food stamp" president----can't believe someone actually said that?? No doubt, there's folks who'll believe that.
Mar 1, 2012 3:29PM
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we need to get him and his cronies the hell out of DC.What money I do make,is on the dividends from the stock I own.Sure as hell can't make anything at the banks or CU'S

 

 

It just seems that you can't get a head,one step forward and two back

 

 

Mar 27, 2012 7:29PM
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 The 2003 tax cut on qualified dividends--- targeted to individuals, not corporations--- did nothing to encourage corporate dividend payouts or strengthen our corporate structure.  In fact as reported in a WSJ article dated 1/15/2010 "Dividend Stocks Get New Respect", our universe of corporations recently have been paying out 28.6% of profits as dividends compared to a 50 year average 47% payout ratio.  That’s a big step in the wrong direction.  We need a reversed tax incentive, cutting the corporate tax on dividends--- instead of giving the tax break to the corporate executive--- to spur corporations to pay higher dividends closer to the 50 year average 47% profit payout.  Letting the Bush tax cut on dividends at the individual level expire with a quid pro quo reduction of the corporate tax on qualified dividends from 35% to 20%, or preferably lower, would jump start this process.   Too many mature corporations today think of themselves as growth stocks and misallocate cash by hoarding it, over-compensating executives and funding risky mergers instead of paying decent dividends.  As a stockholder I don’t like the fact that general stock market returns have been static at best since 1999.   Real capital gains have been miniscule in this century.  Also, as a retiree, I prefer dividends for an income stream instead of hoping for illusionary capital gains.

Feb 29, 2012 2:35PM
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Ok. This is for all that don't understand taxing dividends. Your salary is taxed once. The effective tax rate on 75% of Americans is 12% or less. Since dividends are taxed at the corporate level that has an effective tax rate of 22% and dividends are taxed at 15% on individuals that means dividends get taxed at about a 28%-30% effective tax rate. That means dividends on individuals are paying much more of their fair share. Dividends should be tax free since it is already taxed.  
Feb 29, 2012 9:12PM
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How about transferring the tax break on dividends from the individual to the business side?  Reduce the corporate tax on dividends paid to a minimum of 15%, or better yet, 0%.  Treat dividends paid the same as interest paid at the corporate level.  A business tax deduction for dividends makes perfect sense.  If dividends become deductable, corporations will be encouraged to issue dividend paying stock in place of borrowing money.. Corporations then could strengthen their balance sheets and reduce risk by substituting equity financing for debt financing.  Assuming that the corporations pay dividends at at a rate comparable to the interest rate they pay on debt instruments, dividend payouts would go up.  Getting corporations to pay more dividends is supremely important.  The tsunami of baby boomers now retiring absolutely need better returns on their retirement assets, in place of low individual tax rates for the highest earners among them.

 

Mar 23, 2012 9:26AM
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Keep in mind what someone below touched upon - most moderate to moderatly high income brackets are already paying their normal tax rate on capital gains and dividends because most of their stock holdings are in 401(k)s and IRAs.  Under current tax law you are "penalized" to some extent for holding stocks in these instruments because income that would have been taxed at 10-15% if held outside of your retirement will be taxed at your marginal rate which will be much higher if you saved responsibly.  This somewhat dilutes the tax advantage of these plans.  As someone with a household income well into six figures, the majority of my wealth is in 401(k)s or IRAs.  My taxable stock holdings are minor in comparison.  I think most people would have a similar mix in their portfolio.  By the time you contribute enough to your employers plan to get the total match, then max out your Roth (for which the dividend/cap gain rate is irrelevant), most people will have little room left to purchase stocks in a taxable account.
Apr 9, 2012 12:09PM
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Don't worry, the government has probably thought through all the unintended consequences of the dividend action. They have many contingency plans to take your money if this one does not work.
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For Rich0000..........

You are very correct concerning the tax on dividends. That being said I would like to add a few more comments about taxable dividends. There are 2 types of dividends, qualifying and non-qualifying. Only qualifying dividends are taxed at the max rate of 15% while non-qualifying are taxed at the individuals tax rate. Also I am sure many of the people who are complaining about the tax on dividends are benefitting from the dividend tax rules. For those filing jointly do not pay any tax on dividends if their taxable income Line 43 on form 1040 or line 27 on form 1040A is $69,000 or less. Do not confuse Taxable Income with Adjusted Gross Income AGI. Taxable income is after all adjustments, exemptions and deductions are subtracted out.  Far too many people do not have any understanding of taxes and are happy to accept anything the news media puts out.   

Mar 23, 2012 12:05PM
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Somehow this article fails to note that President Obama's budget plan released in Fedruary calls for taxing dividends at ordinary income levels for individuals making more than $200,000 a year and couples making more than $250,000. The plan, returns the tax treatment of dividends back to policies in place before dividend taxes were cut in 2003. These dividend tax cuts since 2003 were unfunded and have directly contributed to the budget deficits  and the national debt since they were enacted.
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UPSTREAMVOICE........, thanks for your very thoughtful input concerning dividends and I think the comments are very appropriate for today's workers who have the luxury of 401ks and larger IRA contribution amounts. Being 77 years of age I am one of those who did not have a 401k nor large IRA contributions to IRAs. In most of my working days the maximum IRA contribution was $2,000 for the worker and $250 for a non-working spouse. I did take advantage of the $2,250 tax deferred contribution; however, I had to do additional things to improve my life style in retirement. One of which was invest in stable dividend paying stocks. While I am taking advantage of the lower tax rate on qualified dividends, which is computed on Taxable Income, my qualified dividends are computed into my Adjusted Gross Income (AGI) which causes 85% of my Social Security to be taxable.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Apr 9, 2012 12:19PM
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This guy is actually doing more damage to the USA and its "productive" citizens than all his predecessors combined.
Mar 1, 2012 12:30PM
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Most people saving for retirement or retired hold their dividend paying stocks in 401K, IRA, or related accounts, where contributions are not taxed going in, and all disbursals including dividend earnings are taxed at ordinary rates.  Obama's proposal to tax dividends outside tax sheltered retirement accounts at ordinary rates will have no negative effect on money going in or out of these retirement accounts because disbursals from these accounts are already taxed at ordinary rates, or are untaxed in the case of Roth IRA's. 

Also, retirement accounts are the most stable long term source of investment demand.  Arguably, contributions to these accounts will increase if non-retirement dividends are taxed at standard progressive rates; as investors will look for tax deferred growth potential instead seeking current investment income which no longer would enjoy a tax break.  

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