Companies Rushing to Pay Dividends Before Expected Tax Hikes

Published December 4, 2012

Uberbillionaire Warren Buffett recently declared tax rates don’t matter to investors, but the actions of publicly owned companies and investors as the nation nears the “fiscal cliff” say otherwise.

Numerous companies have announced special dividends ahead of the end of the year, when tax rate cuts that were approved during the George W. Bush administration will end unless Congress and President Obama agree to extend them. New taxes tied to the ObamaCare health care law also will go into effect.

On November 28, for instance, Costco announced it would declare a special dividend that will deliver $3 billion to shareholders. The money will be taxed at the 2012 rate of 15 percent instead of the 43.4 percent rate (39.6 percent because it would be taxed as regular income, plus a 3.8 percent ObamaCare surcharge) that could hit top earners at the beginning of 2013.

The Wall Street Journal recently reported 173 large publicly traded companies had announced special dividends, up from 72 in the same period a year ago, and noted a Bloomberg analysis that showed 59 companies on the Russell 3000 Index had declared one-time payouts from September to mid-November, four times the number during that period last year.

“It’s certainly not surprising. What companies are doing is very wise. They’re saying, ‘You’re our shareholders, we had an intention of paying a dividend, so why not pay it now to make it worth more to you?'” said Robert Genetski, an economist, author, financial consultant and operator of the Web site.

In a November 28 column, Chicago Tribune business reporter Gail MarksJarvis also noted individual investors are taking action: “Nervous investors fear that all three [utilities, real estate investment trusts, and master limited partnerships] could face higher taxes next year, and some have been selling high-yielding investments rather than wait for them to decline in value amid tax concerns later.”

‘Destructive of Growth’

Genetski said businesses and investors are signaling “the ball has started to roll. I mean everyone is figuring out ways to avoid as much of the tax hike as possible. That’s what’s so damaging about this. The methods that are used to do this are destructive of economic growth. People don’t go to work to pay taxes, and they work hard to avoid taxes.”

In a November 25 column for The New York Times, Buffett called for a minimum tax of 30 percent on taxable income between $1 million and $10 million, and 35 percent on amounts above that.

“Between 1951 and 1954, when the capital gains rate was 25 percent and marginal rates on dividends reached 91 percent in extreme cases, I sold securities and did pretty well,” Buffett wrote. “In the years from 1956 to 1969, the top marginal rate fell modestly, but was still a lofty 70 percent — and the tax rate on capital gains inched up to 27.5 percent. I was managing funds for investors then. Never did anyone mention taxes as a reason to forgo an investment opportunity that I offered.”

But Genetski pointed out virtually no one paid those tax rates. Personal exemptions adjusted for inflation were higher, there were more allowable deductions and exemptions, and there were easy ways to reduce taxable wages, such as taking company stock and cashing out with a capital gains tax rate in the range of 25 percent.

‘Unknown Magnitude’

“If the tax hikes [that could occur if the government goes over the fiscal cliff] hit, I believe it’s going to have a negative effect on the economy,” he said. “The first place we will see it is in financial markets. In terms of how much impact on the economy, it all depends on how large the tax hikes happen to be. My guess is, along with a lot of people, we will see some hikes. But what’s unknown is the magnitude of the hikes they’ll finally approve.”

Larry Kaufmann, an economic consultant and senior adviser at Pacific Economics Group, likewise is not surprised at a surge in special dividends.

“This is exactly how corporations looking out for their shareholders should act,” he said.

“As of right now, I expect the U.S. to go over the fiscal cliff and let all the Bush tax cuts expire,” he said, and added, “The impact of tax increases and the increased regulatory burden from Obamacare will be disastrous.

“I fully expect another recession [in 2013], with both residential demand and especially capital investment by business plunging,” Kaufmann said. “I wouldn’t be surprised if 2013 makes people long for the good old days of 2008-2009, especially if the euro and the European Commission melt down and there is a new Mideast war — both of which I think are more than 50 percent probable.

“Sorry to be so pessimistic, but we’re living through some ugly times,” Kaufmann said.

Ross Kaminsky, a self-employed trader and investor who blogs at the Web site and writes for The American Spectator magazine, said, “Since we have a president who made clear, in a 2008 debate with Hillary Clinton, that he would raise capital gains tax rates ‘for purposes of fairness’ even if it did not bring in any additional revenue to the government, it is no surprise that we are on the path that we’re on. This is a president who said on [November 29] that he would not agree to a ‘fiscal cliff’ deal which did not include raising tax rates, not just raising tax revenue, from upper-income Americans.

‘Better Get Cash Out the Door’

“So what is a company to do in this environment where the only thing that appears certain is that all tax rates are going up: income taxes, capital gains taxes, and dividend taxes, with the latter potentially ready to triple for some? If you have any cash, you’d better get it out the door as soon as possible.”

He said stock buybacks take too long, “So a large special dividend and/or moving dividends forward from the first quarter of 2013 into the fourth quarter of 2012 makes good sense from a cash-flow perspective.”

Kaminsky said it’s “a near certainty that Republicans simply do not have the political leverage to keep all of the current tax rates in place or even close to their current rates.

“The problem is that if paying dividends were the best thing that a company could do with its cash, that would have been the plan independent of tax policy. Most companies would rather pay a modest dividend and put the rest of the money to work in order to grow the company, expand geographically, buy better technology, hire more employees, or add product lines or inventory. The drastic increases in tax rates for investment income, in which category I include both capital gains and dividends, is forcing companies to make decisions which are not the decisions management would have been expected to make if tax rates were not changing dramatically.”

He said someone who owns Costco stock, for example, may feel happy for a day or two after receiving a big check, but most investors forget that a stock price is immediately adjusted downward by the per-share amount of the dividend. And they should be “deeply concerned” that the federal government is forcing the company they have invested in to make decisions that slow the company’s growth.

‘Returning Cash Instead of Growing’

“Particularly in the context of a massively competitive global economy, this is terrible news for investors in multinational companies that are being put, by our government, into a position of having to return cash to shareholders instead of battling for customers, or growing organically or through acquisition,” Kaminsky said.

In the short term, he said, this will have little economic impact, but over the long run the value of many American companies will be lower than they otherwise would be — not just for the obvious reason that higher capital gains and dividend taxes lower stock values, “but more importantly because government is forcing companies into sub-optimal strategies for corporate growth. It’s also worth noting that company growth tends to be a compounding phenomenon over time. So hurting growth now will likely have long-lasting impacts even if Republicans are eventually able to overturn the tax policies of class-warrior Democrats led by Barack Obama.”