Most people know that the U.S. government is rapidly approaching the edge of a fiscal cliff that will raise taxes for millions of Americans—at every income level and age. What is less known is that seniors, many of whom depend on investment income to fund their retirement, will be hurt the most.
If Congress fails to act, tax rates for investment income will soar beginning Jan. 1, 2013. The top tax rate on capital gains will jump to 23.8% from 15% and the top rate on dividends will nearly triple to 43.4% from 15%. The House of Representatives is considering legislation to extend the current 15% tax rate on investment income for one year. But the Senate plan, scheduled for a vote this Wednesday, would raise the top tax rate on capital gains and dividend income to 23.8% for individuals making more than $200,000 per year and joint filers earning more than $250,000.
Now is not the time to raise tax rates on investment income—even if limited to upper-income taxpayers. Raising taxes on dividends and capital gains will have a devastating, domino-like effect that would hurt the economic security of millions of Americans at every income level.
Given the low rates on interest-bearing investments such as certificates of deposit, many older investors have turned to dividend-paying stocks to supplement their income. And for good reason. Total dividend distributions jumped to about $680 billion in 2011 from $340 billion in 2008, according to a recent study by J.P. Morgan. Another big jump is expected in 2012.
Higher tax rates will encourage upper-income investors to shift to other investments—here and abroad—with lower tax penalties. This could put pressure on dividend-paying companies to reduce the size of their quarterly dividend checks and to find alternative ways to return value to investors.
If this happens, all taxpayers who receive dividend income, but especially seniors, would be hit. For those living on fixed incomes and counting on dividends to help pay their bills, smaller dividend checks could be devastating.
As wealthy investors begin selling their dividend-paying stocks to lower their taxes, the value of those stocks will likely fall. This will be another hit for seniors and the majority of other investors holding dividend-paying stocks directly or indirectly through retirement plans or other mutual funds.
When Congress set the top tax rate on dividend income at 15% in 2003, it established a link between the top dividend rate and the top tax rate paid on long-term capital gains. Parity between dividend and capital gains tax rates is a critical issue—we cannot have our tax code picking winners and losers. Individual investment decisions should be driven by the markets and the performance of the companies themselves.
Discouraging investment in dividend-paying companies also will hurt vital sectors of the economy—including manufacturing, utilities and telecommunications firms—that are critical to economic growth and job creation. Reducing the capital these sectors can raise in equity markets will force them to increase their debt financing. This, in turn, will lead to an even riskier economy with overleveraged companies.
It is important to remember that if a company decides to pay dividends, the earnings already are taxed twice—first at the corporate level when the company pays taxes on its earnings (at a federal statutory rate of up to 35%), then later at the individual level when shareholders receive the dividends.
According to a study prepared this year by Ernst & Young for the Alliance for Savings and Investment, the top U.S. integrated dividend tax rate is currently 50.8% (when both corporate and individual taxes are factored in). If the current rates expire, this rate will rise to 68.6%—the highest level among developed nations.
Congress and the administration have stated their intent to address comprehensive tax reform in the near future—a necessary and overdue undertaking. America has the highest corporate income tax rate in the industrialized world, a dubious distinction that places a further drag on our ability to compete internationally. While elected officials determine the process and the particulars of reform, they cannot dangle taxpayers, investors and businesses over a precipice of uncertainty with respect to investment tax rates.
With the economy still struggling, now is not the time to reduce dividend income through higher taxes. Our grass-roots advocacy campaign, Defend My Dividend (www.DefendMyDividend.org), has a simple message for Congress: Keep tax rates on dividend income low and in line with the tax rates on capital gains. It’s good for American businesses, good for the economy, and good for all investors—especially seniors.