View Full Version : The Dividend Tax Bill Arrives

29th April 2010, 02:35 PM
The Dividend Tax Bill Arrives

Democrats would nearly triple the top rate.

As the big tax increase day of January 1, 2011 approaches, the Democrats running Congress are beginning to lay out their priorities. Get ready for bigger rate increases than previously advertised.

Last week the Senate Budget Committee passed a fiscal 2011 budget resolution that includes an increase in the top tax rate on dividends to 39.6% from the current 15%—a 164% increase. This blows past the 20% rate that President Obama proposed in his 2011 budget and which his economic advisers promised on these pages in 2008.

(See "The Obama Tax Plan," August 14, 2008, by Jason Furman and Austan Goolsbee: "The tax rate on dividends would also be 20% for families making more than $250,000, rather than returning to the ordinary income rate.")

And that's only for starters. The recent health-care bill includes a 3.8% surcharge on all investment income, including dividends, beginning in 2013. This would nearly triple the top dividend rate to 43.4% in Mr. Obama's four years as President. We suppose the White House would call this another great victory for income equality.

But the driving impulse here isn't equity. It's money. According to the static revenue estimation rules that Congress lives by, maintaining the current 15% tax rate on capital gains and dividends will "cost" the government $347.7 billion over 10 years. The Congressional Budget Office hasn't broken out how much the higher 39.6% dividend rate alone would yield in revenue, but a reasonable guess is $200 billion. Congress simply wants that cash.

But this revenue estimate assumes businesses and investors are dumb and dumber. Dividends which are payouts from business earnings are already taxed once at the corporate rate of 35%. The individual dividend tax is a second levy on that same income, and at a rate of 43.4% would take the total tax on each dollar paid in dividends to something like 60 cents.

You can expect fewer businesses either to offer or increase dividend payouts, which means less dividend revenue for the government than that $200 billion guesstimate. The punitive tax rate on dividends combined with the deductibility of interest on borrowing also increases the tax code's bias toward debt over equity. But aren't we supposed to be living in a new era of healthy deleveraging?

Washington's perverse revenue estimation rules also increase the policy bias toward higher rates. The dividend increase to 39.6% (from 15%) is built into current law as the Bush tax rates expire, and so the current budget baseline assumes that revenue increase of roughly $200 billion. This means that any rate increase lower than 39.6% "costs" the government money under budget rules, and thus Democrats must come up with some offsetting tax increases or spending cuts to make up for the lost revenue. So under this Beltway math, even a dividend tax rate increase to 20%, or 28%, counts as a revenue loser.

All of this increases the likelihood that the Senate budget resolution dividend tax rate of 39.6% will become law next year. The millions of Americans who receive dividend income—most of them not rich— need to begin adjusting their investment strategy accordingly. And don't forget those Obama campaign promises from 2008.

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