The expiration of the Bush tax cuts and new Medicare taxes on investment income that were part of this year’s federal healthcare overhaul will push the top effective tax rate on dividends to 68 percent in 2011—highest among all industrialized nations, according to a new Tax Foundation report.
The study by Tax Foundation Senior Fellow Robert Carroll concluded the double tax on corporate profits—first under the corporate income tax and again under the individual income tax as dividends or capital gains—discourages productive capital formation, ultimately reducing wages and living standards for U.S. citizens.
“The U.S. integrated dividend tax rate of 68 percent is substantially higher than in other nations,” Carroll said. “The average rate among OECD member nations is about 44 percent, and the average among the larger G-7 economies is about 47 percent. The higher dividend rate is in addition to the high U.S. corporate tax rate of 39.1 percent, second only to Japan among industrialized countries.”
Layers of Tax
Corporate profits first are taxed at the individual company level and are subject to an average combined federal and state corporate tax rate of 39.1 percent. For income distributed as a dividend, the second layer of tax is then paid by individual shareholders, which before the enactment of health care reform legislation had a top rate of 17.3 percent.
With the expiration of the 2003 Bush tax cut at the end of 2010, the federal dividend tax rate will rise from 15 percent to 39.6 percent. There will also be a new Medicare tax of 3.8 percent on investment income. The integrated effective dividend tax rate will rise dramatically to 68 percent as a result.
The end of the 2003 tax cut will also raise the capital gains tax rate from 15 percent to 20 percent. Higher tax rates on dividends and capital gains will increase the overall effective marginal tax rate on investment for the entire economy from 17.3 percent to 19.1 percent. That’s about a 10 percent rise.
No Regard to Income
Even if the higher dividend tax rate is limited to families earning more than $250,000 per year, as President Obama has proposed, all households that hold dividend-paying stocks, regardless of their income, would be affected.
“The combination of the high dividend tax rate and high corporate tax rate raise serious concerns over the competitiveness of the United States as a place to locate investment,” Carroll said. “By injecting tax considerations into investment decisions, the double tax reduces the productive capacity of the U.S. economy and serves, ultimately, to reduce the living standards of U.S. citizens.”
Natasha Altamirano ([email protected]) is manager of media relations at the Tax Foundation.
Tax Foundation Special Report, No. 181, “The Economic Effects of the Lower Tax Rate on Dividends”: http://www.budgetandtax-news.org/article/27891.