Why defend dividends?
Published in MarketWatch
WASHINGTON (MarketWatch) — Last month, Apple Inc. paid out nearly $2.5 billion in dividends to its shareholders. For now, recipients of the technology giant’s prosperity will be subject to a tax rate of 15%, as dictated by the Bush-era tax cuts.
But with those rates set to expire at the end of the year and a Congress focused on a major election in November, the future of taxation on savings and investment remains a mystery. Congress should act now to alleviate the uncertainty.
Without action from Congress, the top rate on dividends (now 15%) will expire at the end of this year, and revert to a staggering 43.4% (39.6% plus the health care surcharge of 3.8%) raising taxes by almost 190% for millions of Americans. Capital gains tax rate will rise to 23.8% (20% plus the healthcare surcharge).
Battle lines have been drawn. Several weeks ago, the Senate approved a tax cut extension bill by a vote of 51 to 48 that maintains current income tax rates but allowed them to rise on income above $200,000 individual/$250,000 family. The House responded by voting 256-171 to extend all current tax rates across the board.
Neither the House nor Senate versions of the Bush tax cuts are expected to pass the other chamber of Congress. The votes are really more symbolic steps that members of Congress want to take back to their constituents they face back home during their August recess.
Why defend dividends? Dividend income has been one bright spot for American investors during the recent recession and the sluggish economic recovery. Stocks that pay dividends had a more stable performance in the market. Companies that continually raised their dividend not only have outperformed the broader index, but have done so with less risk.
In addition, according to the latest S&P Dow Jones Indices announcement, U.S. stocks boosted their dividend payments in the second quarter of 2012 by $12 billion, pushing the payout to an all-time record. Investors received a 14% boost in dividend cash payments in the second quarter of 2012.
Contrary to what many might say, dividend beneficiaries are far from just being wealthy Warren Buffet one-percenters. According to a recent Ernst & Young Report, 25.4 million tax returns included qualified dividends in 2009, representing $123.6 billion of qualified dividends (which are ordinary dividends that meet specific criteria to be taxed at the lower tax rate, currently 15%, rather than at higher tax rate for an individual’s ordinary income).
Tax returns with qualified dividends came from the following:
- 63% are from taxpayers 50 and older
- 32% are from taxpayers age 65 and older
- 68% are from returns with incomes less than $100,000
- 40% are from returns with incomes less than $50,000
Raising taxes on dividends would disproportionately hurt many older Americans who are dependent on stable dividend income to supplement their retirement incomes.
Higher rates on dividends will also have a significant impact on the industries that are currently driving our economic recovery. Capital-intensive industries, such as electric and natural gas utilities, tend to have above-average dividend payout ratios. Many of these companies raise the capital needed for key infrastructure investment through debt and equity financing. Capital requirements are expected to increase each year due to growing demand, changing combinations of power sources, aging infrastructure and evolving environmental regulations.
For example, higher levels of investment are needed by U.S. utilities in order to meet demand.
According to an American Society of Civil Engineers (ASCE) report this year, “The aging of equipment explains some of the equipment failures that lead to intermittent failures in power quality and availability…The capacity of equipment explains why there are some bottlenecks in the grid that can also lead to brownouts and occasional blackouts.”
As of Dec. 31, 2011, 56.6% of U.S. shareholder-owned electric utility capital is financed by debt and 42.8% by equity. Raising the tax on dividends could decrease the capital available for many sectors such as utilities and increase the use of debt financing, leading to a riskier economy.
Given the slowness of U.S. GDP growth and the high unemployment rate policymakers need to be sure that changes in the tax code will help, rather than hinder, economic growth. Any tax increase in this current economic environment would have unwanted consequences. A recent study done for the American Council for Capital Formation by Dr. Allen Sinai of Decision Economics Inc. analyzed the possible impact of letting all the Bush tax cuts expire as well as just dividend and capital gains tax rates. The results, in both cases, show that the tax increases would harm the U.S. economy and provide no relief on deficits and debt.
The income that savers receive from dividends like Apple (as well as from capital gains) is already taxed twice, once at the corporate level and again at the individual level. Raising the tax rate from the current top rate 15% for individuals will slow the U.S. economic recovery and job growth.
Dr. Pinar Cebi Wilber is an economist for the American Council for Capital Formation , a nonprofit, nonpartisan organization promoting pro-capital formation policies and cost-effective regulatory policies .