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?
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:
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???
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..
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.
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.
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.
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.
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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