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New Study findings about Higher Capital Gains & Dividend Tax Rates

New Study Indicates Higher Capital Gains & Dividend Tax Rates Would Spur Market Selloff and Job Loss

A recent study from the American Consumer Institute analyzed the potential impact of higher taxes on capital gains and dividend tax rates.

Key Findings:

  • The increase in tax rates will affect market capitalization
  • Share price declines will impact investors in tax-deferred accounts
  • Reduced capitalization will lead to fewer jobs in the economy

Read the full report here: http://www.theamericanconsumer.org

New study findings about dividends.

New ASI Study by Ernst & Young illustrates how U.S. investment tax rates lag behind international competitors and how further tax increases could harm the economy.

Companies need capital and certainty to survive, prosper and grow. They are making decisions today that impact business operations - such as hiring, research and development, and expansion - for years to come. Higher capital gains and dividend tax increases would reduce the incentive for new investors to purchase stock, drying up a vital source of permanent capital for companies looking to grow in a challenging economy.

Higher capital gains and dividend tax rates hamper U.S. competitiveness.

U.S. will lose its competitive edge by raising taxes on capital gains.

A report by Ernst & Young LLP, commissioned by the American Council for Capital Formation, compares individual long-term capital gains taxes among 25 major economies of the world as well as major trading partners of the U.S. The U.S. capital gains tax rate compares unfavorably with that of many other major economies. More than half of the countries surveyed have individual capital gains tax rates lower than that of the U.S.

According to the Organization for Economic Cooperation and Development (OECD),the U.S. currently has the highest corporate tax rate of any industrialized nation. Lowering that rate to 30.5 percent would only lower our country’s ranking to the fifth highest corporate tax rate in the world. The average highest tax rate among the OECD nations has fallen to around 45 percent.

The recent Bowles-Simpson report concluded that corporate income tax, “hurts America's ability to compete. On the one hand, statutory rates in the U.S. are significantly higher than the average for industrialized countries (even as revenue collection is low), and our method of taxing foreign source income is outside the norm... The current system puts U.S. corporations at a competitive disadvantage against their foreign competitors.”

Double taxation discourages dividend payments.

Corporate profits are taxed twice – first at the corporate level, and later at the individual level when companies pay their shareholders dividends. This double taxation will be exacerbated if: (1) the dividend tax rate increases; and (2) the tax rates for dividends and capital gains are “decoupled.”

A sharp rise in the dividend tax rate would provide a disincentive for corporations to pay dividends to their shareholders because they would be tax advantaged to retain their earnings instead. Most economists, tax experts and market observers agree that corporate decisions of this regard should be based solely on nontax considerations.

As the administration and Members of Congress explore ways to simplify the corporate tax code, they should seek to remedy the double taxation of corporate profits.

Higher dividend tax rates incentivizes debt financing.

Higher dividend tax rates can reduce the perceived value of a company’s stock and reduce the incentive for new investors to become shareholders. Because corporate interest expenses are tax deductible, but dividend payments are not, increasing taxes on dividends will encourage more corporations to favor debt financing over equity financing.

A recent Bloomberg Government report looked at studies conducted in 1992 by the Treasury Department, looking specifically at the effects of a dividend exclusion provision, whereby individuals would exclude dividends from their taxable income, eliminating the double taxation of dividends. Bloomberg contends in their analysis that the exclusion of dividends, “may help to encourage companies to increase dividends, giving them more financing, and reduce borrowing, which reduces their debt financing.”

Additionally, Bloomberg notes that, “If the tax on dividends is reduced, companies that already pay high dividends per share…may see an increase in investment in their shares without having to change their current dividend payout structure.”

Tax increases on dividends disproportionately affect seniors.

Senior citizens and those nearing retirement age represent a substantial portion of investors who own dividend-paying stocks and would be disproportionately affected by an increase. A January 2010 study done by Ernst & Young found that 27.1 million tax returns had dividends qualifying for the dividend tax rate reduction in 2007 (the latest year for which complete IRS data are available), reporting a total of $155.9 billion in qualified dividends. Of these tax returns, 61 percent were from taxpayers age 50 and older and 30 percent were from taxpayers age 65 and older.

It is clear that older taxpayers earn the lion's share of dividend and capital gains income and that allowing these tax rates to rise would disproportionately hurt older Americans.

Taxing investments undermines economic recovery.

Analysis by The Heritage Foundation indicates that higher tax rates on these forms of income would do serious economic harm:

  • Higher tax rates would lead to 413,000 fewer jobs in 2018.
  • Economic output as measured by gross domestic product (GDP) after inflation would fall by $50 billion in 2012 from the levels that the economy would attain without this policy change.
  • These economic effects would be vividly evident in take-home pay. Personal income after taxes would decline by $133 billion after inflation in 2012 when compared, again, to levels that would likely prevail without tax rates going back up.

While it is currently popular to target high-income individuals for higher taxation, it is economic folly to target investment income. Raising the tax burden on investment income further damages the economy and ultimately affects all members of society. Policymakers have long known that taxing something discourages it. Taxing investment income would therefore reduce investment in the economy, which is dangerous during a period of recovery.

The economy benefits from lower capital gains tax rates.

A Small Business & Entrepreneurship Council analysis finds that over the past century, there have been five instances of substantive cuts in the capital gains tax. In each case, the economy benefited. In contrast, there have been two instances where an increase in the capital gains tax clearly had a negative impact on the economy:

  • The capital gains tax rate steadily rose from 25 percent to 49.1 percent over the period from 1968 to 1976, and over that time average annual real economic growth underperformed the post-World War II average (3.0 percent vs. 3.5 percent).
  • With the capital gains tax hike in 1987 came slower economic growth. From 1987 to 1996, real annual GDP growth again under-performed – averaging only 2.9 percent compared to the post-World War II average of 3.5 percent.

Higher taxes on capital reduces wages across the board.

A report from the Institute for Research on the Economics of Taxation finds that the particular tax increases that the Congress might adopt would damage the economy and reduce the tax base. In fact, they are likely to result in lower federal revenues, and larger budget deficits. Higher tax rates on capital income would discourage investment and result in a smaller capital stock than would exist if the rate remained at 15 percent.

Higher taxes on investment will impact the middle class.

The level of taxes on dividends has an inverse relationship to the number of companies that pay a dividend. So if the tax rate on dividends increases—even if it’s only for high earners – less dividend money will be paid out, hurting investors at all income levels.

A CATO Institute study examined this relationship in the first year following the 2003 dividend tax cut. Annual dividends paid by S&P 500 companies rose from $146 billion to $172 billion. In addition, twenty-two companies that did not previously pay dividends initiated regular dividends. And equity values rose more than $2 trillion after the tax cut.

We could expect the opposite to happen if Congress moves to raise the dividend tax rate, as dramatic tax increases will discourage companies from paying dividends.

Dividends serve an important corporate governance function.

Policymakers interested in improving corporate governance should be encouraging businesses to pay dividends. Dividend payments force companies to have cash from real (not paper) profits in order to pay dividends to shareholders. Dividend payments are the ultimate form of accounting transparency. A low dividend tax rate lowers the effective tax rate on corporate earnings. This low rate can influence managerial behavioral and delivers a number of economic benefits:

  • Better corporate governance and more efficient resource use—Low dividend tax rates make paying dividends a more attractive proposition for companies than retaining earnings; this promotes a more efficient allocation of capital and give shareholders, rather than executives, a greater degree of control over how a company's resources are used.
  • Higher stock prices and healthier balance sheets—Low dividend tax rates make investing in equity more attractive to investors, helping stock prices and making it easier for companies to finance new investment by issuing new shares of stock rather than by issuing debt. This means less debt financing and healthier corporate balance sheets, reducing the risk of bankruptcy during hard economic times.