President Barack Obama is determined to make the wealthy “pay a little more” in taxes. But if he gets his way one very important tax rate will triple overnight.
This increase is part of the “fiscal cliff” that has Washington and the markets so on edge as the so-called Bush tax cuts expire at the end of the year.
Most of the attention has been focused on the income tax rate. Unless Congress acts, all of the current income tax rates will rise to pre-2001 levels overnight. Those in the highest tax bracket will see their rate rise from 35% to 39.6%—a 9% increase.
But the Bush tax cuts also reduced the rate on dividends, which were taxed at the personal income level, to 15% regardless of income. If the Bush tax cuts expire, the dividend tax for high-income workers will return to 39.6%.
But that’s not all. The health care law imposes a new 3.8% Medicare tax on passive income, including dividends and capital gains. So the effective dividend tax rate for those at the upper end of the income scale will nearly triple, to 43.4%. Happy New Year!
And don’t forget that dividends have already been taxed as corporate profits—so they’re taxed twice.
Think tripling the dividend tax might, just might, have an impact on where people invest their money? Or whether they invest at all?
Ironically, dividend-paying stocks have been one of the bright spots for investors. That’s in part because interest rates have been kept so (artificially) low by the Federal Reserve Bank. Investors are understandably looking for better returns.
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.
Further, higher dividend taxes will likely cause companies to cut dividends in favor of deploying their cash in other ways, like re-purchasing their own stock. So individuals counting on their share of a company’s profits for their income—which they’d normally receive via a cash dividend—could find themselves out of luck.
Dividend taxes in the United States are already high. A study by the accounting firm Ernst & Young looked at the integrated cost of corporate taxes and dividend taxes. The study found the United States currently has the fourth-highest integrated dividend tax rate among the 34 Organization for Economic Cooperation and Development (OECD) nations. Without congressional intervention, U.S. dividend taxes will be “significantly higher than all other countries measured,” according to the study.
That will be particularly bad news for retirees, because many depend on dividends as a staple of their fixed incomes. According to the IRS, more than half of dividend payments go to Americans over age 65—and almost 75% go to those over age 55.
Even though the dividend tax hike has yet to take effect, there are already signs that it’s hurting American companies—and the stock market.
Analysts have cited numerous reasons for why the stock market tanked immediately after the election. One reason—and most likely the primary one—is the negative impact a tripling of the dividends tax will have on the market.
And while the dividends tax is the worst, the capital gains tax will also increase from 15% to 20%. Plus, we have to add the 3.8% Medicare tax for the first time ever, for an increase to 23.8%. To be sure, not nearly as high as the dividends tax, but a significant increase nonetheless.
President Obama must understand that not all tax increases and tax cuts are created equally; some will have very little economic impact, others will have a significant impact. While the income tax rate increases are important, and detrimental, they pale in comparison to the dividends and capital gains tax increases.
A dividends tax hike will take a big bite out of all Americans’ savings—even those who aren’t supposed to pay it. Regardless of what happens with the income tax rate battle, Congress and the president must stop the tripling of the dividends tax.